Price Adjustments Abound

There is a sense that the global economy is entering a new phase, and the markets are adjusting.  Rates and energy are being re-priced, with knock-on effects on risk assets. Although European rates were already rising before the ECB meeting, the  refusal to rule out a hike this year pushed on the open door.  

The stronger than expected US January jobs data and a dramatic upward revision (709k) in the previous two months emboldened rate hikes expectations.  The market sees more than an almost 45% chance of a 50 bp hike in March and nearly 145 bp of tightening over the next 12 months. At the end of last year, about 85 bp of tightening was discounted.  

The European interest rate adjustment also has been significant.  Benchmark 10-year yields rose 19-45 bp last week alone (Germany was the lower end of the range and Italy the upper). Two-year yields jumped 11-41 bp (France was the lower end of the range and Italy the upper).  The swaps market has about 60 bp of hikes discounted by the ECB over the next year with a 10 bp move around mid-year. 

Weather and some geopolitical tensions may be contributing to the latest gains in oil, but the underlying issue is the relatively low inventories and limited capacity to expand output among most OPEC+ countries.  Although the oil producers have ostensibly boosted oil output by 400k barrels a day last month, this month, and plan another 400k barrels a day next month, the actual output is considerably less. Even Russian capacity appears nearly exhausted.  Investment has withered.  

With oil prices pushing above $90 a barrel, US shale production is about to ramp up.  Exxon has recently announced plans to boost output by 25% from the Permian Basin.  Chevron, with a considerably larger base will boost output by 10%.   It is not clear what price triggers the Saudi officials to reassert its role as the swing producer.  It may be around $100-$110 a barrel. 

Equities are making an adjustment too.  The S&P's impressive recovery off the January 25 low (~4222) ended with a gap lower opening on February 3. It stalled near the (61.85) retracement objective. That gap is found between 4543 and 4544.  The NASDAQ rally stalled near its (50%) retracement mark of this year's leg down, and it also gapped lower on February 3.  It entered the gap, but failed to close it. The gap is now found between roughly 14223 and 14264.   Europe's Stoxx 600 held the (61.8%) retracement target in the middle of last week and proceeded to drop more than 2.6% in the last two sessions.  

Let's look at how the dollar is faring.  

Dollar Index:  The Dollar Index had approached the 97.70 area in late January, the (61.8%) retracement objective of the down move since peaking near 103 when the pandemic first struck.  It stopped shy (~97.45) before being turned back.  The main culprit appears to be the shifting views on the ECB.  The Dollar Index had begun last week above its upper Bollinger Band.  The MACD and Slow Stochastic have turned down.  It is possible that the Dollar Index's rally, which began on January 6, 2020, put in a significant high, completed some kind of five-wave technical move.  Last month's low was near 94.65.  A convincing break of 94.40 would lend credence to the bearish outlook.  It could spur an initial move to around 93.50 which holds the 200-day moving average and is the halfway mark of the rally that began last year on January 6.  

Euro: According to Bloomberg, shortly before US employment report, the euro rose above last month's high by 1/100 of a cent to near $1.1485.  The unexpected strength of the report knocked the euro to a new session low, slightly above $1.1410.  It also stopped the deterioration of the US 2-year premium after a five-day 27 bp narrowing of the differential.  However, it needs to take out the $1.1485-$1.1500 area to denote anything important.  If the low at the end of January (~$1.1120) is significant, the euro may head toward initially, the (38.2%) retracement of the losses seen since last January 6 peak  (~$1.2350) found near $1.1600.  The momentum indicators have turned up.  Playing for the euro breakout failed twice in January.  A move below $1.1340 would suggest a third.  

Japanese Yen:  The dollar finished last week knocking on the downtrend line connecting the early and late January highs.  It starts the new week around JPY115.50.  A break targets the five-year high seen in early January around JPY116.35. Surging global rates pose a challenge for the BOJ which has capped the 10-year bond yield at 0.25%.  It does not want to tighten financial conditions as its inflation target remains elusive, while the economy may contract this quarter.  Correlations between the changes in the exchange rate and US yields and the S&P 500 have broken down over the past month.  However, the correlation with bonds is stronger and looks poised to increase.  A break of JPY114.75 would be disappointing.  

British Pound:  Sterling's five-day rallied halted ahead of the weekend amid the broad-based US dollar gains.  It had recovered from the previous week's low near $1.3360 to poke above $1.3600 an intrasession basis, which is the (61.8%) retracement target of the slide since mid-January's high (~$1.3750).  The Governor Bailey cast the deciding vote for a quarter-point instead of a half has boosted the perceive odds of a 50 bp move at the next meeting (March 17) to almost 50/50.  Sterling found support ahead of the weekend near $1.3500. A break of the $1.3460 area could spur a move to test the recent low.  In the bigger picture, sterling has been trading in a roughly $1.32-$1.38 trading range for the better part of the past five months.  It is around middle of that range.  

Canadian Dollar:  The US dollar was little changed against the Canadian dollar net-net last week.  As we anticipated the US dollar eased from the CAD1.28 area it had approached.  The pullback proved shallow.  The CAD1.2650 area held on an intraday basis, while the (38.2%) objective of the leg up from the January 19 low (~CAD1.2450) near CAD1.2650 was not violated on a settlement basis.  The divergence between employment reports (US much better than expected--a revisions--than Canada's) and helped lift the US dollar back to the CAD1.28 area. Penetration of this area could target the CAD1.2965, last's year's high set in December, and the CAD1.3025 area, the (38.2%) retracement of drop since the March 2020 high around CAD1.4670.  The market continues to discount 165 bp of tightening over the 12 months, which, in effect, is a little more than one more hike from the end of last year.

Australian Dollar:  The Australian dollar bounced last week from deeply oversold levels and after closing below key support at $0.7000 on a daily and weekly basis.  While we anticipated the recovery, we were disappointed that stalled near $0.7170.  It failed to close above the 20-day moving average.  The pre-weekend sell-off nearly met the (61.8%) retracement of the week's gains in one fell swoop (~$0.7045). The price action was clearly more impulsive on the way down and then up.  The MACD appears to be rolling over, while the Slow Stochastic is still climbing.  The $0.7000 area remains important from a technical perspective.  It is just above an air pocket that extends toward $0.6750-$0.6800.  

Mexican Peso: The greenback's five-day advance against the Mexican peso ended at the start of last week, but here too the correction proved shallow.  It pulled back from near MXN20.80 to around MXN20.50 where it carved a base for a few sessions.  It recovered to almost MXN20.79 ahead of the weekend before consolidating.  Initial support is seen around MXN20.65.  The week ahead is important for the peso.  On February 9, the January CPI will be reported and the following day, the central bank meets for the first time with the new governor.  Mexico's CPI is expected to have remained above 7% for the third consecutive month.  The median forecast (Bloomberg survey) looks for a 50 bp hike.  The economy contracted slightly Q3 21 and Q4 21.  The momentum indicators are giving conflicting signals.  On balance, provided the MXN20.50 support area holds, the dollar may be able to work its way higher.   The peso gained about 0.6% on the week, only bested in the region by the Brazilian real.  However, it snapped a five-day advance after the central bank delivered the expected 150 bp hike.  Initial resistance is seen in the BRL5.36 area that houses a retracement objective and the 200-day moving average.  The MACD is turning higher and the Slow Stochastic looks poised to turn in the days ahead.  

Chinese Yuan: The mainland markets re-open after the long holiday celebration.  The offshore yuan is virtually unchanged from when the mainland markets shut on January 28.  The US dollar weakened against all the major currencies last week, this may make it difficult to deter a stronger onshore yuan.  The dollar settled slightly above CNY6.3610 on January 28.  Some investors ae interested in the spread between US and Chinese bonds.  The Chinese rate premium is being compressed.  Another market segment is not interested in the yield spread, but the capital appreciation/preservation.  Over the past year, China's bonds have increased in price while all others have fallen.  

 

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