China was a Currency Manipulator for a Few Months

Overview:  The leaked US decision to lift the currency manipulator designation on China was the latest fodder fueling the new record highs in the S&P 500. The risk-taking appetite helped extend the rally in the MSCI Asia Pacific Index for the fourth consecutive session. Europe's Dow Jones Stoxx 600 is little changed and trying to snap a two-day decline. US shares appear directionless in the European morning. Benchmark yields are slightly softer in Europe and US Treasuries, with yesterday's rise lifted Asia Pacific yields today. Supply concerns appeared to have been a facto, raising EU yields, including the 10-year German Bund to eight-month highs (~-15bp). Meanwhile, UK rate adjustment continues, and the two-year yield is off around 20 bp in the past four sessions. The US dollar is firmer against most of the major and emerging market currencies today, but ranges are small, and the activity is subdued. The JP Morgan Emerging Market Currency Index is threatening to extend its decline for the fourth session. March WTI is hovering around unchanged levels as it straddles the $58 a barrel level. Gold continues to trade heavily though found some support near $1536, having peaked during the heightened US-Iran confrontation to about $1611.  

Asia Pacific

The markets hardly reacted when the US cited China as a currency manipulator five months ago. Word leaked out before the release of the Treasury report, which was due last October but was delayed ostensibly pending the US-China talks. Reports that it would not be cited as such in the Treasury's next report is supposed to be a significant event. It is not. Some observers link the yuan's strength, and it is at its highest level since last August to a quid pro quo. China manipulates strengthens its currency, and the US lifts the designation. It assumes Chinese officials gave the label any significance when the IMF itself refuted such claims. By citing a 1988 law instead of the congressional update of 2015, US Trump Administration effectively debased the threat and removed the stigma. Ultimately, it was seen as a political rather than an economic judgment. China, successfully snapped the near-magical significance investors and observers had given the CNY7.0 level. 

Another explanation of the yuan's strength draws from the same drivers that have lifted emerging market currencies broadly. Events have turned in investor favor (China-US trade, UK election, USMCA, contained US-Iran confrontation), and East Asia, outside of Japan, looks to be recovering. This was evident in the recent PMI readings, Samsung's forward guidance, and more constructive semiconductor industry news. The dollar peaked on September 3 against the Chinese yuan. Since then, it has strengthened by about 4.3%. At that same time, the South Korean won has appreciated by around 5.15% and the Taiwanese dollar by about 5.05%. The conventional view (that we argued against) was that the yuan's depreciation meant to offset the US tariffs. Now, the risk is that the currency strength begins offsetting the easing of monetary policy. Is it too cynical to suggest that the yuan records a high around the signing of the trade agreement? 

China reported a recovery in both imports and exports in December. The trade surplus widened to $46.8 bln from $37.2 bln in November.  Despite the trade tensions with the US and the resulting decline in exports to the US, China's overall trade surplus increased last year.  The average monthly balance was about $35.1 bln compared with $29.2 bln in 2018. In December, exports rose by 7.6%, the fastest in nine months, while imports surged 16.3%, the most since October 2018.  

The US dollar has poked through JPY110 for the first time since last May. It seems to reflect two considerations. First, the downturn in the Japanese economy appears more severe than previously anticipated, with Q4 19 GDP seen contracting by more than 3% now. Second, and arguably more important, is the risk-on mood that has seen equities rally and global yields firm. There is a $360 mln option at JPY109.75 that expires today and a $1.3 bln at JPY110 on January 16. The next chart points are seen in the JPY110.50-JPY110.70 area. The Australian dollar is consolidating and is about a 20-tick range centered around $0.6900. There is a large (A$1.4 bln) option at $0.6905 that expires today and a smaller one (~A$555 mln) at $0.6930 that will also be cut. The Chinese yuan edged higher for the fourth consecutive session. The dollar is trading below CNY6.89.

Europe

While the trade focus is on the US-China signing a Phase 1 deal tomorrow, this is mostly a formality. The next phase of the Trump Administration trying to rebalance US trade arguably begins in earnest today as EU's trade negotiator Hogan meets with Lighthizer today. US-EU relations will likely dominate the trade 2020 trade agenda. The US has several outstanding grievances, and some are political in nature. Given the modus operandi of the US government, the risk is of some escalation in pressure as the talks "progress."

Germany, Italy, and Ireland remain on the US currency watch, and Switzerland was re-added. There was an indication that Ireland may be dropped off the list on the next report, due out in April (though the one released yesterday was initially expected last October). Since Germany, Italy, and Ireland do not have independent currency policies, do not intervene in the foreign exchange market, it seems incongruous to put them on the watch list. And if they are on the watch list, shouldn't the other countries that share the euro be on the list too? Doesn't this also further undermine what used to appear as an effective threat?   

ECB President Lagarde is already showing a different communication style. She has formally requested that the impending strategic review of monetary policy is not discussed by members before her press conference on January 23. She also called for the two-day meeting to start a little earlier to allow for more discussion. The strategic review is the first since 2003.

The euro is in less than a fifth of a cent range below $1.1145. There are no fresh impulses. There is a 3 bln euro option at $1.11 and another at $1.1170 for 1.8 bln euros that expire today. If the range is going to be extended today, the intraday technicals seem to favor the upside, with the next chart resistance seen in the $1.1160-$1.1180 area. Sterling's downside momentum stalled near $1.2955, but it is yet to sustain any meaningful upticks. Today could be the ninth session in the past ten that sterling has fallen. The $1.30 area offers initial resistance, but a move above $1.3020-$1.3040 may be needed to signal anything of note.  

America

The US recorded a budget deficit of $356.6 bln in the first three months of FY20. The old-fashion reason was evident: expenditures (+6.7%) rose faster than revenues (+4.6%). Spending on Social Security, military, and Medicare, the three largest areas, totaled about $855 bln. Revenues grew from household and corporate tax payments, and income from tariffs rose nearly 20% to around $21 bln. Germany's challenge is just the opposite. It had a record budget surplus in 2019 (~13.5 bln euros). The larger than expected surplus was flattered by the low-interest rates. There seems to be an agreement to use the surplus, and the difference within the Grand Coalition is emerging sees the CDU favor corporate tax cuts while the SPD wants to invest in schools and climate change. 

The North American diary is light today. The highlight is the US December CPI. We cautioned about an inflation scare due to the base effect. In November and December 2018 and January 2019, US CPI was flat. These zero readings drop out and will most likely be replaced with positive readings. On top of that, higher energy prices will probably lift headline measures. Incidentally, EMU.had a similar experience. Headline CPI in December is expected to have increased by 0.3% after the same increase in November. This will lift the year-over-year rate to 2.4% from 2.1%. The core rate can rise by 0.2% and leave the year-over-year rate at 2.3%. The other point this illustrates is that headline CPI typically converges with the core rate, not the other way around. Separately, the Fed's Williams and George speak today. George was a hawk and opposed last year's rate cut. Williams, as the NY Fed President with a permanent vote on the FOMC, votes like a Governor. There is little doubt that the Fed is on hold for at least the near-term.   

The US dollar is at a three-day high against the Canadian dollar (~CAD1.3075) and is flirting with the 20-day moving average (~CAD1.3065), which it has not closed above in more than a month. There are two expiring options to note today. The first is for $590 mln at CAD1.3050, and the other is for $620 mln at CAD1.3075. A break above CAD1.3100 would lift the greenback's tone.  he US dollar's downside momentum that carried it from MXN19.60 in early December to MXN18.75 this week is fading.  he greenback is straddling the MXN18.80 area.  he high nominal yields attract carry-trades (like long pesos against the yen or Swiss franc) and give them staying power. Nearby resistance on a closing basis is seen near MXN18.90.  

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