Euro Pokes Above $1.09. Will it be Sustained?

Overview: The Lunar New Year holiday has shut many centers in Asia until the middle of the week, though China's mainland is on holiday all week. The signaling of a downshift in the pace of Fed tightening by some notable hawks helped lift risk appetites ahead of the weekend and saw the S&P 500 snap a four-day decline. Ahead of the weekend the NASDAQ posted its single biggest advance since last November. The downtrend line drawn of January 2022 highs in the S&P 500 is found near 4010 today. US equity futures are little changed. Europe's Stoxx 600 is posting a small gain. Benchmark 10-year yields are trading with a firmer bias and are up mostly 2-3 bp.

In contrast to the signals of a quarter-point hike next week by the Fed, the ECB has pre-committed to 50 bp and the hawks are pressing for another 50 bp in March. Earlier this month, some reports seemed to suggest a case was building for a 25 bp move in March. The divergence helped lift the euro above $1.09 today for the first time since last April, but it is struggling to maintain the momentum in the European morning. The economic calendar in North America is light today and the quiet period ahead of next week's FOMC meeting means no Fed officials will speak on the record.

Asia Pacific

The Bank of Japan offered commercial banks JPY1 trillion (~$7.7 bln) five-year loans at 0.145%, a few basis points lower than the five-year JGB yields interest rate to buy government bonds. It is the longest-term so far and was over-subscribed by a little more than three-time. It is a collateralized loan, and the facility has been around for over a decade, though the outstanding amount was around JPY466 bln at the end of last year. Last week, the BOJ increased the flexibility of this facility and Governor Kuroda indicated that it could consider a making such loans at a negative rate, if needed. Separately, note that non-commercials (speculators) in the futures market continue to reduce the net short yen position. It has been halved from around 46.9k contracts at the end of last year to about as of January 17. That is the smallest since February 2021. Each contract is for JPY12.5 mln (~$97k)   

Separately, it is not clear what to make of the news that the government representatives attending the BOJ meeting in December, when it surprised everyone by expanding the band of the 10-year JGB and increasing it bond purchases, asked for a short recess. The recess lasted slightly more than a half-an-hour toward the end of meeting. Government representatives at BOJ meetings is not uncommon and their presence did not change the outcome.  Nor was the recess unprecedented, according to reports.

The dollar is trading inside the pre-week range against the Japanese yen (~JPY128.35-JPY130.30) in quiet turnover. The 20-day moving average is near JPY131 today, and the dollar has not closed above it since early November. Last week's low was around JPY127.25, its lowest level since last May. The Australian dollar's pre-weekend advance has been extended and it is trying to establish a foothold above $0.7000, which has so far eluded it despite intraday penetration last week. It reached almost $0.7065 last Wednesday before reversing lower and settling around $0.6935. The stretched intraday momentum indicators caution against chasing it today. China's mainland markets are closed all week and the dollar has drifted lower against the offshore yuan, but it remains within the pre-weekend range. The greenback settled against the onshore yuan near CNY6.7845 before the holiday.

Europe

There are three developments to note over the weekend. First, Germany and France seemed to agree on the need for a European response to the roughly $500 bln tax and subsidies the US has approved for EV, batteries, and semiconductors.  This, coupled with EC President von der Leyen's endorsement of a "Green Deal Industrial Plan" sets the stage for next month's summit. However, the tension within Europe is between large countries with fiscal space and others that are smaller and limited space to spend. The risk is fragmentation of the internal market, and this speaks to the need for an EU-level program, which could include a new funding by the European Investment Bank. State aid rules also may be adjusted and allow for fast-tracking clean energy initiatives. To be sure, the spur to action is not just about countering the competitive challenge of the US. There is also the recognition of the challenge posed by China, with its heavy subsidies and restrictions to market access.

Secondly, while still stopping short of sending its Leopard tanks to Ukraine, Germany's foreign ministry indicated it would not block others, specifically Poland, from sending its Leopard tanks. Russia's military advances, coupled with international pressure for Germany to relent, seems to be softening its position. The German government does not yet appear to have made the position official and some reports suggest it is now in the economic ministry's hands. Reports also indicate that Poland has not yet formally made a request. Poland has indicated it was prepared to send its 14 Leopard tanks, in coalition with others, to Kyiv. Germany new defense minister Pistorius acknowledged for what apparently was the first time that Ukraine needs tanks to recapture territory taken by Russia. 

Third, in contrast to some signals from some Fed hawks, including Governor Waller, that a quarter-point move next week may be appropriate, ECB hawks are still pushing for a half-point move next week and in March. Both the Dutch and Finnish central bank presidents advocated the larger moves. The US premium over Germany for two-year borrowings is near the recent trough of 160 bp. It peaked last August a little shy of 280 bp. 

The euro poked above $1.0925 in holiday-thin Asian turnover, pulled back to around $1.0890 and tried again and made in early Europe but stalled in front of the earlier high. Some buying may have been related to the nearly 1 bln euro option that expires today at $1.0925. As we have noted, the $1.0940 area corresponds to the (61.8%) retracement of the euro's losses since the peak on January 6, 2021. There are options for 775 mln euros at $1.0950 that expire Thursday. It may require losses through $1.0860-80 to be of note. For its part, sterling drew slightly nearer $1.2450, and took out the mid-December high by a couple of hundredths of a cent in Asia but has been offered in the European morning. It has returned to session lows near $1.2370. The low at the end of last week was set near $1.2335, and a break, and especially a close below this could sour the technical tone.

America

Quietly, the average retail price of gasoline has been creeping higher. It bottomed as few days before Christmas near around $3.10 a gallon and is now poking about $3.40. Recall that it peaked near $5 a gallon last June. The pullback helped reduce headline inflation. Some refinery outages in New Jersey and the Gulf Coast contributed and the price of crude oil has also risen, ostensibly on anticipation of Chinese demand. February WTI bottomed near $70 in early December and settled last week at its highest close ($81.30) since mid-November. The continued rise in gasoline prices comes despite the build of 3.5 mln barrels reported last week (for the week ending January 13) twice what was expected. It follows a 4.1 mln-barrel increase the previous week. US crude inventories have surged by nearly 27.4 mln barrels in the first two weeks of the year. That is the biggest increase in a two-week period since late-Feb-early March 2021. US crude stocks are about 3% above the five-year average. 

The busy week begins off slowly today with the December leading economic indicators, which we noted have fallen every month through November last year but February. The highlight of the week may be the first estimate of Q4 GDP Thursday and the PCE deflator on Friday. The Bank of Canada meets Wednesday, and the swaps market is pricing in around an 80% chance of a quarter-point hike, which is seen at the last in the cycle. Reports that Brazil and Argentina will officially launch the preparatory work for a common currency has captured attention, but we are skeptical that it will be launched anytime soon.

The US dollar peaked against the Canadian dollar last Thursday near CAD1.3520 and settled last week by CAD1.3375. Follow-through selling has taken to almost CAD1.3340 today. The month's low was closer to CAD1.3320. A break of that area could retarget the low from the middle of last November around CAD1.3225. Intraday momentum indicators are stretched, and we envision a return to the CAD1.3380-CAD1.3400 area in the North American morning. The greenback spiked from MXN18.5665 to MXN19.11 last Wednesday-Thursday before pulling back ahead of the weekend. We do not see a macro development behind the sharp price action and suspect it had more to do with market positioning. The carry remains attractive, and despite some measures by AMLO, Mexico still looks relatively stable compared to several other countries in the region. It is also protected by the USMCA under the US green subsidies. The next downside corrective target is near MXN18.7750.

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