Markets Catch Collective Breath

Overview: After last week's flurry of activity that saw the US dollar extend its recovery, it has begun off the new week largely consolidating in relatively narrow ranges. The Australian and New Zealand dollar's remains softer, and the Swiss franc is virtually flat, but the other G10 currencies, led by sterling are posting small gains. A break-through on the Northern Ireland protocol, which has been rumored for a more than a week may be announced shortly. The news stream is light and conducive to the consolidative tone, but the dollar's recovery does not seem complete. Despite weekend protests against AMLO's downsizing of the electoral watchdog and rising tensions with the US over its steel exports, the Mexican peso is the strongest of the emerging market currencies, outside of the Russian rouble and is near the five-year highs set last week. 

Asia Pacific equities were mostly lower after the pre-weekend losses in North America and Europe. Europe's Stoxx 600 has recouped its decline from the end of last week, and US index futures are trading with a firmer bias. Benchmark 10-year yields are firmer, mostly 1-3 bp higher in the US (near 4.84%) and Europe. UK Gilts are an exception and are five basis points higher near 3.65%. Gold is flat near $1811. It is off about 3% over the past two weeks. April WTI is also flat near $76.30. It has fallen by around 4.5% over the past couple of weeks. News of the US 200% tariff on Russian aluminum (and derivatives) seem to be having little immediate impact.

Asia Pacific

The BOJ caps the 10-year on-the-run bond at 0.50%. The generic yield has not settled below there since February 9. The presumed near governor of the Bank of Japan, Ueda spoke for the second day before the Diet. He did not add much to what he said last week. He is prepared to adjust monetary policy when inflation is sustainably above 2%. Yet, Ueda agrees that despite the headline being more than twice as high, it is not sustainable as it reflect cost-push inflation and not strong demand. Moreover, he expects inflation to begin falling. Tokyo's January CPI at the end of the week will be the first test of this hypothesis, which we share. It is a very good indicator the national figures. We identified three forces that should begin easing Japanese price pressures:  government subsidies, falling energy prices, and the appreciation of the yen on a trade-weighted basis. 

During the 2008-2010 Global Financial Crisis, a common meme was to draw comparisons between the US/Europe and Japan. While Japan had already been there in terms of expanding the central bank's balance sheet as the zero-bound of interest rates were approached. It was not, though, the first country to adopt a negative policy rate. That dubious honor goes to Denmark in 2012. A op-ed in the Financial Times, citing bank research, suggests it is now China who is turning Japanese.  Of course, the collapse of Japan's property bubble more than three decades ago still seems to be the go-to comparison. Japan and China (along with several countries in East Asia) shared a common development model, which in political economy is known as export oriented. Import substitution, the other major model was favored after WWII, but the experience of several Latam countries that were arguably large enough to try it, further encouraged East Asian model of export-driven industrialization. The scale that China must operate on given its size is overwhelming. And it would be regardless of its political structure. One key difference is what comes next. Japan has a lost decade. China most likely will not. The IMF projects Chinese will expand by 5.2%, which is also the median forecast of economists in Bloomberg's survey. We suspect that if they are wrong, it is on the low side. Coming from the annual National People's Congress (starting March 5) new economic targets will announced.

The dollar is consolidating the pre-weekend gain that carried it to about JPY136.50 and is in a little more than half of a yen range above JPY136.00. The JPY136.65 area corresponds to the (38.2%) retracement of the dollar's decline since the multiyear high set in late October near JPY152.00 and the 200-day moving average is near JPY137.15. A break of JPY136.00 could see a pullback toward JPY135.35-50. That said, we like it higher and suggest potential toward JPY140.00. The Australian dollar is seeing last week's 2.2% drop extended. It had begun last week testing the $0.6900-20 area and today slipped slightly below $0.6700. The low for the year set on January 3 a little above $0.6685. The lower Bollinger Band is around $0.6705. The selling pressure does not appear exhausted, and the $0.6720-40 area may now cap upticks. The dollar is snapping a four-day advance against the Chinese yuan, and it is only the second decline since February 9. The pullback is only after the greenback poked above CNY6.9730, a two-month high. The PBOC set the dollar's reference rate at CNY6.9572, well above the pre-weekend fix of CNY6.8942. This reflects the dollar's rally after the mainland's regular session ended on Friday. The fix was tight to market expectations (CNY6.9570). The yuan has fallen by about 2.9% here in 2023, which is a middling performance in Asia and among emerging market currencies.

Europe

Part of the narrative that helped feed the euro's recovery, especially its latter phase, from the multi-year low in late September (~$0.9535) to the early February high (~$1.1035) was reduced left-hand tail risk (dramatic negative outcome). The relatively warm winter, conservation, lower energy prices eased fears. Now as the market is pricing the outlook for Fed policy, the economic outlook in Europe is less certain. Initially, Q4 22 German GDP was expected to be flat. It came in at -0.2%. At the end of last week, it was revised to -0.4%. Consumption and capital spending were weaker than projected. Although the flash February composite PMI jumped back above the 50 boom/bust level for the first time since last June, and the confidence measures have been tracking improvement, the economy may still be contracting. The median forecast in Bloomberg's survey projects a 0.4% contraction this quarter. The German 2-year yield rose nearly 12 bp before the weekend and after GDP report and is up a few more basis points today. The yield has risen by 50 bp in its three-week advance.

The data highlight of the week is the preliminary February CPI. Given the base effect, the 0.5% monthly rise will allow the year-over-year headline rate to ease to 8.2% from 8.6%. Recall in February 2022, the eurozone's CPI rose by 0.9%. More significantly, in March 2022 consumer prices surged by 2.4%. As this drops out of the 12-month comparison, the headline rate will fall sharply. The more pressing problem comes from the core rate, which reached a new cyclical high in January of 5.3%. The median projection in Bloomberg' survey is for it to be unchanged in February.

Eurozone money supply growth last month was weaker than expected (3.5% vs. 3.9% median forecast in Bloomberg's survey and 4.1% in December) and business confidence reports were softer than expected. However, the euro is stabilizing in a narrow range after making a marginal new low closer to $1.0530. It has approached $1.0570. Resistance may extend to $1.0580. There are options for around 1.65 bln euros that expire today at $1.05. There is another set of options (~1.3 bln euros) that expire there tomorrow. A break-through on the Northern Ireland protocol may be announced shortly but the prospects do not appear to be lending sterling much support. It is holding below $1.20 after taking out the pre-weekend low by a few hundredths of a cent as it frayed the 200-day moving average (slightly below $1.1930). The intrasession momentum indicators are over-extended, warning of the follow-through buying in North America may be limited.

America

The strength of personal consumption last month (1.8% in nominal terms and 1.1% in real terms) coupled with firmer than expected deflators strengthen the conviction of the direction the market was already moving. The two-year note yield jumped almost 12 bp to rise above 4.80%, for the first time since 2007. The swaps market pushed a little closer to a 5.50% terminal Fed funds rate. Good economic news is still seen as negative for the equity market and the major US indices fell by at least one percent ahead of the weekend. The 2-10-year inversion is testing the area (a couple basis points around -85 bp) that held in early December and earlier this month, which is the most in more than 40 years. On the other hand, of note is Fed Chair Powell's preferred measure the three-month bill yield compared with its 18-month forward rate. It is about 21 bp inverted but is has climbed steadily as the economic data strengthened. It has been around -100 bp before the January employment report.

We expect the next batch of high-frequency data to provide evidence for our hypothesis that the market is getting carried away by the recent reports. The next batch of data begins today with the January durable goods orders. Due to the volatility of commercial aircraft orders, the headline rate is seen falling by 4% after a 5.6% rise at the end of last year. However, excluding aircraft and military, capital goods orders are expected to have fallen for the third consecutive month and the fourth time in the past five months. Although auto sales likely slowed and the ISM services, which provided a 1-2 punch with the jobs report on February 3, the market may need to see the next employment report (March 10) to take the January-fluke hypothesis more seriously.

Canada reports Q4 current account figures. A deficit in line with the Q3 shortfall of C$11 bln is expected. It would translate into about an CAD18 bln deficit for the year. It recorded a nearly C$20 bln merchandise trade surplus. It will feed into the Q4 GDP estimate due tomorrow. Still, the Canadian dollar may see marginal impact from the report. It is consolidating last week's losses that saw the greenback climb to CAD1.3665. It had begun the week near CAD1.3440. Mexico reports its January trade balance. Last year, Mexico recorded a trade deficit of about $26.5 bln. It has run a small deficit in 2019 and large surplus in 2020. The deficit returned in 2021. Recall that January 2022, Mexico posted a record deficit of nearly $6.3 bln. Note that Mexico's steel exports to the US have become a potential flashpoint, and there were large demonstrations over the weekend against the dilution of the electoral watchdog. The dollar's surge saw it test MXN18.50 at the end of last week. It has come back offered and is probing the MXN18.35 area. The greenback appeared to carve out a little shelf near MXN18.30-MXN18.33 last week. Stops below there still seem vulnerable. 

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