Short Summary on US Thanksgiving

While US markets were closed for the celebration of Thanksgiving, the underlying trends remained intact.  Here is a summary of several developments.

The euro edged to a new low, a little below $1.0520 before stabilizing between $1.0540-$1.0580 in the European afternoon.  The low is a new 20-month low. The long awaited test on parity is approached, but to reiterate our longstanding call, we expect the euro to retest the lows from 2000 (~$0.8250) before the bear market is over.  Shorter-term initial resistance is seen at $1.06, and a move above there targets the $1.0650-$1.0660 caps from earlier this week.   

The euro has fallen about 4.5% since the US election.   The economic data has mostly been better than expected, and investors have little doubt about a rate hike next month.  However, the power of the move is due to the fact that it is not simply the US side of the equation that is moving.  

The ECB is widely expected to extend its asset purchases in a couple of weeks and modify its self-imposed rules to address the shortage of some securities.  Many have come around to our view that one of the most politically practical steps would be for the ECB to modify the interest rate floor for securities that presently stands at the minus 40 bp deposit rate.  The modification could come from applying this rule at the portfolio level rather than the individual security level.  This would, for example, allow the ECB to buy more German two-year notes, which had fallen to new record lows earlier this week.  Over the past week, the German two-year yield has fallen by 10 bp, while the US two-year yield has risen seven bp.  

Reports on Wednesday suggested that the ECB and the Bundesbank are considering modifications in their securities lending programs to help ease pressure in the repo market.  When the ECB buys bonds, it not only denies investors of securities to purchase, but it also creates a shortage of collateral.  The ECB and Bundesbank has a securities lending program, but some of the conditions make it too onerous and rigid (Bundesbank program, for example, makes some of the securities it buys available, but only in exchange for other German debt and a week at a time.   The rules could be modified.  To the extent that it eases a source of scarcity, it points to higher rates, which is how investors interpreted the news.  However, in the larger picture, most of the time there are more important drivers for European interest rates than technical factors in the repo market.  

The US dollar extended its gains against the Japanese yen.  It rose to JPY113.50, a new eight-month high.  It was trading near JPY105 the day before the US election.  The sharp rise in US interest rates, in absolute terms and relative to Japan unleashed the explosive force.  At JPY113, the dollar retraced 61.8% of this year's decline from a JPY121.70 high in January.  The next targets are in the JPY115.00-JPY115.60 area.   Japanese stocks continued their advancing stream, with the Topix having risen for 10 consecutive sessions.  

Sterling edged higher against the dollar, but it remains largely sidelined.  A $1.23-$1.25 range has dominated activity this month.  Hammond's Autumn Statement showed that the UK government is counting on what it previously called "overburdened" monetary policy to continue to do whatever heavy lifting the UK economy needs.  Next year's growth forecast was slashed to 1.4% from Osborne's March estimate of 2.2% (on ideas the UK would remain part of the EU).  Growth is expected to improve to 1.7% in 2018, though down from 2.1% previously.  The slower growth translates into more debt, for which there will be more Gilt issuance than some had projected.  

The rise in the dollar and US interest rates have severely weighed on emerging market assets. It boosts the cost of debt servicing as local rates rise, and lifts the cost of external debt refinancing. Many observers who conceived the of a world economy driven by a currency war are increasingly flummoxed by the resistance of emerging market countries to further currency devaluations. 

The Turkish lira has been one of the hardest hit currencies since the US. election (-8.4%).  The central bank surprised the market on Thursday with an unexpected 50 bp hike in the repo rate to 8.0%.  The overnight lending rate was lifted 25 bp.  The dollar made new highs against the lira following the hike.  The Indian rupee and Vietnam dong fell to record lows, while the Philippine peso was sold to new eight-year lows.  The worst performing currency since the election of Trump has been the Mexican peso.  It has depreciating by over 11%.  It slipped on Thursday, for the third consecutive session of losses. 

The MSCI Emerging Market equity index slipped 0.4% on Thursday.  It remains stuck near four-month lows.  While emerging markets remain on out favor, the industrial metals remain hot.  Copper rose more than two percent to extend its rally for the fourth session.  It is at highs not seen in more than a year.  Zinc and lead also advanced.   The CRB index looks bullish.   Brent was flat near the best levels of the month ahead of next week's OPEC and non-OPEC meeting.  News developments include indications from Iraq that it may consider a cut in output, which may have been offset by concerns that Russia may agree to a freeze (at elevated levels ) rather than a cut.  

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