A Bloody Friday

recycle trash and the environment, marc

  • The recovery of US shares and oil yesterday proved short-lived
  • The risk is that US economic data disappoints
  • Three Fed officials speak today: Dudley, Williams, and Kaplan
  • The Hong Kong dollar posted its biggest two-day decline since 1992
  • Russia reports November trade; the central bank gets more hawkish

Price action: The dollar is mixed against the majors even as risk appetite wanes. The yen and the euro are outperforming, while the dollar bloc and sterling is underperforming. The euro is trading just above $1.09, while sterling traded at a new cycle low near $1.4335. Dollar/yen is trading lower near 117.30. EM currencies are mostly weaker. IDR and the CEE currencies are outperforming while RUB, ZAR, MXN, and BRL are underperforming. Continued IDR resilience is noteworthy in light of the Bank Indonesia rate cut and terrorist attacks. MSCI Asia Pacific was down 0.6%, with the Nikkei falling 0.5%. MSCI EM is down 1.3%, with the Shanghai Composite down 3.6% and the Shenzen Composite down 3.4%. Euro Stoxx 600 is down 2% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is down 4 bp at 2.05%, while European bond markets are mostly firmer. Commodity prices are mostly lower, with oil down 4-5% to new cycle lows below $30. Copper is down over 1%.

The recovery of US shares and oil yesterday proved short-lived. Asian shares were dragged lower with the help of Chinese equities. The 3.5% fall in the Shanghai Composite today brings the year-to-date decline to a little more than 18%. Taiwan, which goes to the polls this weekend (with an opposition that has been critical of the government’s pro-China policy), is ahead, bucking the trend to post minor gains.

European shares are also moving lower, with the Dow Jones Stoxx 600 off more than 1.7% near midday in London. The energy sector is leading the way with losses more than 2% today. With US production still higher than anticipated, and Iranian oil to hit the market as early as next week, oil has been drilled back below $30, reflecting a nearly 3.5% decline on the day.

The US dollar itself is mixed. It stands at the fulcrum. The dollar-bloc currencies, sterling and the Scandies are lower while the euro, yen, and Swiss franc are firmer on the day. Of note, the Australian dollar is the weakest of the majors, off 1.5% to new multi-year lows. The Canadian dollar is off 1%, as the greenback pushes through the CAD1.45 level for the first time since 2003.   Sterling is also at new multi-year lows, slipping below $1.4335.

The euro had flirted with the lower end of its $1.08-1.10 trading range that has largely bounded activity since the ECB meeting in early December, and has recovered to the middle of the range. The gains in the euro when share prices suffer sharp losses seem to reflect the unwinding of the use of the euro as a funding currency and short euro hedges.

For the third consecutive session, the dollar encountered sellers near JPY118.30. The broad risk-off backdrop, with weakness in equities and the lower US yields, kept the greenback on the defensive. The selling pressure eased near JPY117.25. A break would signal a retest on the recent low near JPY116.70.

It is the one-year anniversary of the Swiss National Bank’s decision to lift the franc’s cap. The dollar is trading with a softer bias, but is above CHF1.0. The euro had been near CHF1.20 a year ago. It fell to nearly CHF0.85. The recovery high was seen last September near CHF1.1050. It is now near CHF1.0950.

Despite the dramatic market moves, there does not appear to be a fresh catalyst. Given the price action since the start of the year, what stand out are not so much today’s directional moves, but yesterday’s brief reprieve that appears to be a bit of a bull trap. Moreover, given the importance of developments in China and the oil market, it seems unreasonable to expect a recovery in North America today as there was yesterday.

Indeed, the risk is that US economic data disappoints. There are two real sector reports that are the most important, namely retail sales and industrial production. Headline retail sales will likely be weighed down by falling gasoline prices and small decline in auto sales on a sequential basis. In addition, the unseasonably warm weather in much of the country likely dampened the usual winter clothing purchases. The GDP component, which excludes autos, gasoline and building materials, likely did better, but there is downside risks to the consensus 0.3% forecast after a 0.6% rise in November.

Industrial production may also disappoint as the energy sector, and weaker utility demand take a toll. The consensus forecast a 0.2% decline in December output. Coming into December industrial production fell every month last year but July and August.

Manufacturing has held up a bit better. It is expected to be flat in December as it was in November. Manufacturing output fell in five of the first 11 months of 2015 and was unchanged in two months. The divergence between the industrial and service sectors persists.

The US also reports producer prices and the Empire State manufacturing survey. Although the latter is among the first reads for January, both reports will be overshadowed by the retail sales report.

Three Fed officials speak today: Dudley, Williams, and Kaplan. Dudley is the first among equals. His observation in late August that a rate hike was less compelling offered a good tell that the Fed was not going to raise rates in September. The reasons the Fed gave for not hiking in September are becoming more relevant again, even though last week the US reported the largest monthly rise in jobs for the entire year.

The markets are unsettled, to say the least, and US market-based measures of inflation expectations are falling. The 10-year breakeven (the difference between the conventional yield and the yield of an inflation-linked note) is more than 10 bp lower than it was at the September FOMC meeting. Growth in the US economy appears to be tracking something less than 1% at an annualized pace in Q4, according to the Atlanta Fed. The January FOMC meeting is not seen as live, but market participants cannot be confident of a March hike either.

The Hong Kong dollar posted its biggest two-day decline since 1992. Yet HKD still remains in the strong half of the 7.75-7.85 trading band and has not yet traded above the midpoint fix rate of 7.80. However, Financial Secretary Tsang admitted that it’s possible that HKD could move to the weak side of the band. Again, we do not think it is a speculative attack, as some in the press are suggesting. Please see our recent piece entitled “Some Thoughts on the HKD Peg.”

Russia reports November trade. Both exports and imports are seen contracting -30% y/y, but would lead the 12-month total surplus to fall to $150 bln. This would be the lowest since March 2011. Meanwhile, rate cuts are off the table with the ruble weakening so much. Indeed, First Deputy Governor Yudaeva said that she can’t “completely” rule out a rate hike now, as inflation risks have intensified. These are the first hawkish signals from the bank, which was in an easing cycle but has kept rates at 11% for three straight meetings. These latest comments suggest they will remain on hold for much longer, until pressure on the ruble eases. Lower oil is taking a toll, with USD/RUB trading at new cycle highs today. The all-time high near 80 is likely to be tested and breached in the coming weeks.

Brazil monthly GDP proxy was slightly better than expected in November, contracting “only” -6.1 y/y vs. a revised -6.3% (was -6.4%) in October. The economy will likely remain in recession this year. IPCA inflation rose less than expected in December, but still moved further above the target range. COPOM next meets January 20, and we think it will restart the tightening cycle with a 50 bp hike to 14.75%. Yet despite whatever COPOM does, BRL weakness is likely to continue.