A Bit of a Pre-Weekend Reprieve in Europe, but Return of China on Monday is Worrisome

After another difficult Asian session that saw the Nikkei fell 4.8% (12.3% on the week), the capital markets against have stabilized in Europe.  Equity markets are mostly higher, with the Dow Jones Stoxx 600 up nearly 2% led by energy and financials.   

Oil prices are up a bit more than $1 a barrel though it still leaves Brent off almost $3 on the week and WTI off $3.6.  This follows yesterday's close, which was the lowest since 2003.  Talk that the drop in price is increasing pressure on producers.  Moody's warned that the drop the fall in prices is jeopardizing the Russian budget, and Venezuela is facing challenges to service its external debt, forcing continued liquidation of its gold. 

With the stabilization of equity market and oil, the flight into core bonds has slowed, and yields are mostly a couple of basis points higher though gilts are under-performing.  Italian and Spanish yields are a few basis point lower.  Portugal remains under pressure.  The benchmark yield is up five basis points to bring this week's increase to 75 bp.  The Eurogroup issued a statement yesterday indicating that additional measures will be implemented to reduce the deficit and that the proposed steps will be reviewed in the Spring,   

The eurozone expanded by 0.3% in Q4 15, as expected for a 1.5% year-over-year pace.  If anything, this is on the high side of estimates of trend growth.  Breakdowns are not available with the first release, but it does appear that growth was driven primarily domestically rather than exports. However, Q4 ended on a soft note as evidenced by the 1.0% fall in December's industrial output.  While this is well below the 0.3% consensus, weak national reports, including Germany, France, and Italy, suggest the surprise was not as great as it may appear.

The euro peaked yesterday near $1.1375 and is nearly a cent lower, which still leaves it up on the week by a 1.25 cents.  A break of $1.12 is needed to begin carving out a top.    The dollar is flattish against the yen near JPY112.60.  A move above JPY113.00 is needed to suggest something more than simply bouncing along the trough.  Despite the dramatic intraday move yesterday, few think the BOJ actually intervened.  Talk that the MOF's Asakawa met with Prime Minister Abe continues to keep many participants, and the media focused on intervention.     

However, we continue to believe that despite the dramatic moves in the yen, the bar to intervention is high.   Except for the coordinated assistance after the Japanese earthquake/tsunami, there has not been a unilateral intervention for several years.  

We think that the first line of defense, besides “we are watching” type of comments will be the G20 meeting later this month.  The G20 (and G7) position seems clear.  Markets should determine foreign exchange prices, and excess volatility is to be avoided.  A reiteration, perhaps strongly stated,  is the most than can be expected.    There does not seem to be the basis of coordinated intervention. 

Chinese markets have been closed all week.  They re-open on Monday.  Over the weekend, it may report new yuan loans and aggregate financing.  These are expected to show an increase in overall financing, but with limited contribution from the shadow banking.  China may also report January trade figures.  While exports and imports may still be falling in dollar terms, they are expected to have risen in yuan terms. 

 Perhaps more important than the economic data is how the markets perform.  Given the dollar’s broad performance and the stronger offshore yuan ($1 = CNH6.5672 last week and is now ~CNH6.5285), the onshore yuan may strengthen.  The equity market is vulnerable in light of the global sell-off over the past week.    The anxiety about the re-opening of Chinese markets may keep participants cautious about taking on new risk ahead of the weekend. 

The US calendar features January retail sales.  The headline will be weighed down by falling prices, but the key measure that excludes auto, gasoline and build materials is expected to have risen by 0.3% after a decline of the same magnitude in December.  A firm reading may help ease concern about the wealth effect stemming from the sell-off in equities.  

Separately, the University of Michigan’s preliminary sentiment report may also attract more attention than usual.  Here too the market turmoil is not expected to have weighed on confidence.  The Bloomberg survey shows a consensus expected 92.3 from 92.0 in January.  This would match the three-month average and compares to a 90.8 six-month average.  Given the decline in market-based measures of inflation expectations, the survey results may also draw attention.  The final January reading shows the one-year expectation at 2.5% and the 5-10 year at 2.7%.  

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