Equity markets were fragile after last week's rout, while bond markets extended the recovery. The dollar was mostly firmer to start the new week. Japan, China, and Taiwan saw equities advance, but not enough to offset weakness elsewhere, and the MSCI Asia Pacific Index was off around 0.75%. It fell by 1.7% last week. Europe's Stoxx 600 fell the first three weeks of the year and was off another 2.1% today. US futures surrendered their early gains.
Bonds were bid. The US 10-year that had toyed with 1.90% three days ago, was approaching 1.70%. European benchmark yields were 2-4 bp lower and the periphery was outperforming the core. China's 10-year benchmark yield was around 2.77% at the end of last year and was by 2.67% today. It looked to be on its way toward 2.50%.
Meanwhile, the dollar was mostly firmer. The yen and Swiss franc appeared the most resilient. The Australian dollar and Scansis were leading the declining currencies. Among emerging market, the Turkish lira, Philippine peso, and Chinese yuan were firm, but most others were lower, led by the Russian ruble. It fell by around 5% over the past four weeks and down another .75% today. The JP Morgan Emerging Market Currency Index, which had risen for the past three weeks was off for the second consecutive session.
Turning to the commodity complex, gold was firm, though holding below last week's high just shy of $1848. March WTI was steady, slightly heavier, slipping below $85, after falling for the last two sessions. US natgas prices were around 2.7% lower after falling 6.2% last week. European gas prices surged almost 12%% higher, recouping last week's 4.9% loss in full. Iron ore prices were snapping a four-day, nearly 11% advance. Copper was around 1.8% softer, cutting last week's gains by more than half.
Asia Pacific
Japan's flash PMI disappointed, but the new quasi-emergency measures in the face of a surge in the virus was the main culprit. The manufacturing PMI remained firm, rising to 54.6 from 54.3, but the services collapsed to 46.6 from 52.1. This dragged the composite back below the 50 boom/bust level to 48.8 from52.5.
Separately, at least five prefectures felt the impact of the 6.6 earthquake in the southern islands. Lastly, after a 90-minute call before the weekend, US/Japanese officials sought a "quick resolution" to the steel and aluminum tariffs imposed on national security grounds by the US in 2018.
Australia's preliminary PMI also disappointed. The manufacturing PMI eased to 55.3 from 57.7, but here too the virus sapped the service sector. Its PMI slumped to 45.0 from 55.1. The composite was at 45.3, down from 54.9. Australia reports Q4 CPI tomorrow. The year-over-year pace is expected to tick up to 3.2% from 3.0%, while the trimmed and weighted mean prices were forecast (Bloomberg survey) to 2.3% from 2.1%.
The US dollar was testing this month's low against the Japanese yen near JPY113.50. A break would initially target the JPY113.00 area, but the risk may extend to JPY112.50. On the upside, the greenback met resistance ahead of JPY114.00, where, just below a $460 mln option expires today.
The Australian dollar was extending its losses today. It peaked last Thursday near $0.7275 and was pushing at $0.7150 in the European morning, which was around the halfway mark of the rally from the Dec. 3 low a little below $0.7000. The $0.7115 area corresponded to the next retracement objective (61.8%). Note that a A$410 mln option expires tomorrow at $0.7100.
The dollar gapped lower against the Chinese yuan and proceeded to drop to almost CNY6.3240, its weakest level since April 2018. The greenback has fallen in 10 of the past 12 sessions. The yuan was also higher against its trade-weighted basket (CFETS) and appeared to be at its highest level since August 2015. The record trade surplus and portfolio capital inflows were offsetting the policy divergence. The PBOC set the dollar's reference rate at CNY6.3411, slightly stronger than the market (Bloomberg survey) for CNY6.3407.
Europe
Germany's preliminary PMI surprised to the upside. The manufacturing PMI rose to 60.5 from 57.4, well above expectations, which had anticipated a decline. The service sector rebounded to 52.2 from 48.7. The composite moved back above the 50 boom/bust level for the first time in three months (54.3).
France, on the other hand, disappointed. The manufacturing PMI did not decline as much as expected (now 55.5 from 55.6), but the service PMI fell more (53.1 from 57.0). This dragged the composite to 52.7 from 55.8 (Bloomberg median forecast was 54.7).
The aggregate readings were mixed. The manufacturing PMI rose to 59.0 from 58.0, better than expected. The services PMI fell to 51.2 from 53.1 (expected 52.0) and the composite fell to 52.4 from 53.3. This was the fifth decline in the aggregate composite in the past six months. It peaked last July at 60.2. The virus seemed to be the key and appeared to be disrupting Q1 economic activity. Geopolitics, European politics, and elevated energy prices were doing no favors.
The UK flash PMI disappointed as well. The manufacturing PMI eased to 56.9 from 57.9 and mixed the median forecast (Bloomberg survey) of 57.6. The services PMI slipped to 53.3 from 53.6. Optimistic economists had forecast a small rise. The composite ticked to 53.4 from 53.6, defying expectations for a small gain. It was the third consecutive decline in the composite PMI and the sixth in the past eight months, since peaking last May at 62.2. Meanwhile, the market was swirling with talk about other miscues by the Johnson government as Gray's report of her internal investigation is awaited.
Italy began choosing a new president today. There was one ballot a day to be cast by 630 members of parliament, 321 senators, and 58 regional representatives. In the first three rounds a 2/3 majority would be needed for victory. Starting with the fourth round, only a simple majority would be needed.
Berlusconi pulled out over the weekend. The risk was that if Draghi became the next president, efforts to name a new prime minister could falter, and thereby force snap elections. Traditionally, Italy has been viewed as a weak president model, but the president does have authority to name a prime minister (which was how Draghi got the job), force parliament to reconsider legislation and could name 1/3 of the Constitutional Court.
European politics was a key focus in the first part of this year. We have talked about UK and Italian developments. Portugal goes to the polls in a few days, and the French presidential election in April was already moving on radar screens as the latest polls showed Macron's support was fading, falling to 37% (from 41%) in December, and a 60% disapproval rating.
The euro was going no place quickly. For the fourth consecutive session it was blocked by offers in the $1.1360-$1.1370 area. It found bids near $1.1300 in the second half of last week. An option for almost 1.1 bln euros at $1.13 expires tomorrow. We saw the technical factors favoring a downside break and initial potential toward $1.1255.
Technically, sterling looked particularly vulnerable at the end of last week and follow-through selling today saw it approach $1.35. It peaked on Jan. 13 near $1.3750. The $1.3460 area was the next target. It was the (50%) retracement objective of the rally that began on Dec. 20 from about $1.3175. Also, note that the five-day moving average was poised to cross below the 20-day average for the first time in a little over a month.
America
With sharp losses in the stock market, talk about the "Fed's put" was rekindled. Indeed, the Fed funds futures had last week begun pricing in risk of a fifth hike this year, and about a 1-in-3 chance of a 50 bp move in March. The drop in equities has stalled the market's aggressiveness. But also note what could be a self-correcting mechanism too.
A sharp decline in equities saw private sector demand for US notes and bonds, and spurred talk of business downturn. We have argued that between the anticipated rate hikes, balance sheet reductions, fiscal tightening, and the more than doubling of the price of oil were powerful headwinds on the economy, the cumulative effect of which may not be fully appreciated. Note that a third of the S&P 500 by market cap report earnings this week.
Moreover, the tightening would be taking place as the US economy loses forward momentum. The US sees the flash PMI today. It was expected to have softened. The composite PMI has fallen in six of the past seven months since peaking last May at 68.7. The median forecast in Bloomberg's survey looked for it to fall below 57.0. The FOMC meeting at mid-week is the highlight, but the first look at Q4 GDP is the following day. Estimates have been shaved and the risk seemed to be on the downside of the median forecast (Bloomberg survey) of 5.3%.
The Bank of Canada also meets Wednesday. Economists in Bloomberg's survey saw standpat policy. The swaps market had almost a 73% chance of a hike discounted. Participants should be braced for increased volatility. We sided with the market and were inclined to see a hike.
They were not the only ones in the Americas that will likely hike this week. Chile is expected to hike 125 bp to bring the policy rate to 5.25%. It would be the first back-to-back hike since July-August, and would be the third move of 125 bp. Colombia was expected to raise its repo rate to 3.75% from 3.0%. It also hiked rates 50 bp in December after the first move in the cycle in October for 75 bp.
The US dollar bottomed last week near CAD1.2450 and bounced to almost CAD1.26 before the weekend. This was the previous neckline of a head and shoulders topping pattern we have monitored. We have been looking for a countertrend bounce and in Europe, it was testing CAD1.2615. Initial resistance was around CAD1.2630, a near-term retracement objective and the 20-day moving average. Above there, potential was to CAD1.2650-CAD1.2675.
The greenback carved a low near the Mexican peso's 200-day moving average last week (~MXN20.28) and traded up to MXN20.5665. It was knocking on this area today. A move above here could spur initial gains toward MXN20.65. The momentum indicators favored the US dollar.