Greenback Extends Recovery

Overview: The honeymoon for risk assets that began the year ended with a bang at the end of last week with the monster US jobs report and the rebound in the service ISM. Disappointing news from several large US tech companies provided extra encouragement. The yen's weakness helped Japanese stocks today, but the other larger bourses in the Asia Pacific area were sold, with losses in Hong Kong, the CSI 300, South Korea, and Taiwan off more than 1%. Europe's Stoxx 600 also is down more than 1% today, which if sustained would be the second largest drop this year. US futures are also sharply lower. The bond sell-off seen before the weekend is also continuing. The US 10-year yield is up eight basis points to trade above 3.60%. European yields are mostly 8-12 bp higher and the peripheral premium is widening over the core. UK Gilts have been hit the hardest, and the 10-year yield is up almost 15 bp to near 3.20%.

The dollar is broadly higher as what we suspect is an overdue correction is unfolding, aided by a reassessment following the data at the end of last week. The Japanese yen is the heaviest as the market's respond to the possible (if not likely) successor to BOJ Governor Kuroda. The Swiss franc is off the least and is nearly flat on the day. The challenge is that the greenback's gains have stretched the intraday momentum indicators and the US economic calendar is light today. While our targets for the dollar's correction have not been met, Tuesday is often a countertrend day and nimbleness may be rewarded.

Asia Pacific

News that BOJ Deputy Governor Amamiya has been approached to replace Governor Kuroda sent the yen sharply lower in early Asian activity. Of the leading candidate, Amamiya was seen as the one to most signal continuity. Of course, the key will be the trajectory of the economy and inflation. Later, other reports indicated that no formal decision has been made, but the yen's weakness persisted. The swaps market has a positive overnight rate (now -0.10%) starting next month almost 0.07% by the end of H1 23. This seems too aggressive, and especially if Amamiya gets the nod, which seems likely. Even before this development, we saw potential to JPY135, the dollar's high since the December surprise.

China's balloon in US airspace captured the imaginations of many and gave more proof of the fragility of the relationship. With Beijing seemingly softening its "wolf diplomacy" tactics, it is unclear what it sought to gain from such a clumsy, blatant move. The US Pentagon acknowledged that 1) this is not the first time a Chinese balloon has entered US airspace and 2) that there is not much in the way of additional intelligence that the balloon would have acquired that Chinese satellites have not already picked up. Apparently, there were three such incidents during Trump's presidency. The Washington Post quoted national security and aerospace experts opining that the shape (round rather than cigar-shaped) shares characteristics with high-altitude balloons that would be used for meteorological data-gathering rather than long-distance travel. According to reports, the US has known about the Chinese balloon since January 28. Given that it is not the first time such an event has taken place, posed no military or physical threat, and was of limited intelligence value, the US response seemed to reflect domestic political calculations. There were several media references to the possible juxtaposition of Secretary of State Blinken's planned trip to Beijing and pictures of the balloon in US airspace. Poor optics. China and the US spy on each other. The bug in Merkel's cell phone several years ago, ostensibly planted by Americans, underscore that even friends and allies spy on each other. Blinken's trip was postponed, not canceled. The initial signals were that retaliatory action was not planned, but pressure is reportedly building for possibly, new controls on technology exports to China.

The dollar gapped higher against the yen in reaction to the reports about BOJ Governor Kuroda's replacement. The gap is unfilled (~JPY131.20-JPY131.50) and is apparency on the weekly bar charts gives it extra significance. Rising US rates also helps underpin the dollar. We suspect there is potential toward JPY135 in the coming week or so. The Australian dollar extended its pullback that began last Thursday when it reversed from almost $0.7160. It fell to almost $0.6885 today. Our initial target is the $0.6850 area. The intraday momentum indicators are stretched. Resistance is seen around $0.6950, which held on a bounce in the local session. The Chinese yuan has been surprisingly resilient today. The dollar initially edged up from the CNY6.8025 opening but subsequently returned to almost CNY6.7700. The greenback now is around the middle of the day's range (~CNY6.7850). The PBOC set the dollar's reference rate at CNY6.7737 compared with the median forecast in the Bloomberg survey for CNY6.7808. It is among the biggest gaps this year.

Europe

What the Bloomberg headline called a "slide" in OPEC's output last month turned out to be an estimated 60k barrels a day or 1/5 of 1%. The imprecision of such estimates suggests for all practical purposes, output was flat last month. A small decline in Saudi and Libyan output appears to have been offset by a small increase elsewhere. To the chagrin of the US, OPEC+ announced a two million barrel-a-day cut in production. Its assessment seems to be more accurate than the US as oil prices have drifted lower. Russian oil exports appear to be more resilient than Washington anticipated/hoped. The EU 's ban on refined oil products from Russia is beginning, and with the G7 are capping prices for third parties. A combination of rising US inventories and, maybe, a little dimming of the optimism about China has seen oil prices fall over the past couple of weeks. While India, Turkey, and China appear to have largely replaced Europe as buyers of Russian oil, the US is also concerned that China is buying Iranian oil too. Estimates suggest Iranian output has been increasing and, in December, was at its highest level in four years, over 2.6 mln barrels a day. Still, Russia is being squeezed fiscally. Before the weekend, it announced it would sell RUB160.2 bln over the next month (February 7-March 6), which is about $2 bln. It could very well continue at this pace for months as it fills the fiscal hole. A question that arises is, given the freezing of the central bank's reserves in euros and dollars, what will Russia sell. Here, China is a likely candidate. Russia is believed to have held around CNY310 bln (~$46 bln) at the end of last year. Russia's holdings accounted for about 15% of the IMF (COFER) estimate of yuan reserves (the most recent data is from Q3 22). Separately, India, reportedly is buying Russian oil through Dubai agents and paying in UAE dirhams.

France's Finance Minister Le Maire and German Economic Minister Habeck will be in Washington tomorrow, meeting with senior officials, including Yellen (Treasury), Raimonde (Commerce), and Tai (Trade). The issue is the economic nationalism that discriminates against Europe because there is no free-trade agreement. The Biden administration seems to have offered a small olive branch:  tax credits may also be available for commercial vehicles, which might be an opportunity for European producers. Also, Yellen has suggested a trade deal on critical minerals and metals might be possible. However, Senator Manchin has unequivocally indicated such dilution runs against the intent of the Senate. Meanwhile, the EU heads of state will be meeting at the end of the week to discuss its formal response. In the ever-present tension between addressing problems at the "federal" and national levels, the latter seems to be pulling ahead. One risk is that this leads to greater divergence,  

Corrective pressures on the euro have offset the stronger than expected increase in December German factory orders (3.2% vs. expectations for a 2.0% gain, and a trimming of the November fall to 4.4% from -5.3%). The euro barely traded above $1.08 today (the high was about $1.0805) and selling pressure was strongest in the European morning, where the low session low has been recorded (~$1.0760). We have suggested potential into the $1.0700-50 range ahead of next week's US CPI. With today's downside extension, the euro has retraced nearly half of its gains since the January 6 low near $1.0485 and the intraday momentum indicator is oversold. Sterling's losses have also been extended. It peaked last week at $1.2400 and approached $1.2025 in the European morning. We see the risk back to the January low near $1.1850. It has been capped about $1.2070 today. It has not traded below $1.20 since January 6, and we note that the 200-day moving average is slightly above $1.1950 now.

America

It seems clear that the 517k increase in January nonfarm payrolls is an exaggeration. It overstates the case, but at the same time, the labor market continues to be resilient. Weekly initial jobless claims have been below 200k for three weeks running. The jump in the average work week (34.7 hours) was also impressive after the recent softness. At the same time, the growth in average hourly earnings slowed. Moreover, the service ISM, for which the market gives greater credence than the service PMI, jumped to 55.2 from 49.2. And even better, new orders surged to 60.4 from 45.2. As a result, economists are likely to revise higher their forecasts for Q1 23 GDP. The Atlanta Fed's GDPNow will be updated tomorrow from 0.7% (February 1 estimate). 

It is a busy week for the Fed. No fewer than officials speak. That includes Chair Powell's Q&A at midday tomorrow at the Economic Club in Washington. Here is what the Fed funds futures strip is implying post FOMC, post-jobs, post-ISM services:  First, the terminal rate is seen a little above 5% rather than a little below it. Second, the market is more convinced a of a move in Q2. The yield March contract yields 35 bp less than the June contract. Third, the market still sees a rate cut in Q4. The implied yield of the December contract finished last week 27 bp below the September contract.

Canada's Ivey purchasing managers survey is unlikely to disrupt the corrective forces that are weighing on the Canadian dollar. The continued sell-off in US equities add to the weak backdrop. The greenback has approached CAD1.3450 after finishing last week a little below CAD1.3400. Last week's high was near CAD!.3470, and we have suggested a potential target near CAD1.3550. Here, too, the intraday momentum indicators are stretched, suggesting some caution may be in order for North American operators. The Mexican peso has also been caught up in the US dollar's correction. It made a new three-year low last Thursday near MXN18.50 and shot up to almost MXN19.00 before the weekend. It briefly poked above MXN19.09 today. We projected the correction could carry the greenback into the MXN19.30-MXN19.50 area.

 

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