Dollar Firm as Risk-Off Impulses Ease

  • Risk-off impulses have eased but the situation remains fragile
  • US and Canada data schedule is heavy today
  • Eurozone preliminary December inflation accelerated to 1.3% y/y, as expected; After eight months of deadlock in Spain, it looks as if Pedro Sanchez will be able to form a government
  • Markit reported weak final December Japan services and composite PMI readings; AUD continues to underperform
  • Onshore CNY has appreciated 0.4% to its strongest level against USD since August; Philippines December CPI came in much higher than expected

The dollar is broadly firmer against the majors even as risk-off impulses ease.  Sterling and yen are outperforming, while the Antipodeans are underperforming.  EM currencies are mixed.  CNY and KRW are outperforming, while the CEE currencies are underperforming.  MSCI Asia Pacific was up 0.9% on the day, with the Nikkei rising 1.6%.  MSCI EM is up 0.4% so far today, with the Shanghai Composite rising 0.7%.  Euro Stoxx 600 is up 0.6% near midday, while US futures are pointing to a flat open.  10-year UST yields are down 1 bp at 1.80%, while the 3-month to 10-year spread is down 1 bp at +28 bp.  Commodity prices are mixed, with Brent oil down 0.7%, copper up 0.1%, and gold up 0.1%.

The risk-off impulses eased yesterday as the day wore on, and that process continues for the most part today.  Oil ended lower Monday after making a new higher above $70, and is down modestly today.  Likewise, UST yields have rebounded along with USD/JPY.  US equities managed to close positive and futures are pointing to a solid open.  Of note, gold has yet to unwind any of its recent gains and is up for the sixth straight day and 10 of the past 11.  The dollar is broadly firmer and we expect this to continue.

Yet the situation remains fragile.  The US has sent three ships and over 2,000 Marines to the Persian Gulf, which follows a deployment of 3,500 soldiers in the end of last week. The problem is the near-certain prospects of Iranian retaliation, which will continue to weigh on risk appetite.  Indeed, the US has warned ships of unspecified threats by Iran across all Middle Eastern waterways.  It’s also worth noting that Iran has threatened not only US interest, but also any that support the US.  Markets are likely to remain on edge, making any sustainable rally in risk assets very difficult.



The US has a busy data week, capped off with December jobs data Friday.  Ahead of that, November trade (-$43.7 bln expected), factory orders (-0.8% m/m expected), and December ISM non-manufacturing PMI (54.5 expected) will be reported today.  The US economy remains in good shape and there is no reason for the Fed to deviate from steady rates anytime soon.  There are no Fed speakers.

Canada has a busy data week.  Ahead of the December jobs report Friday, November trade (-CAD1.2 bln expected) and December Ivey PMI will be reported today.  Next Bank of Canada meeting is January 22 and rates are expected to remain steady at 1.75%.  However, odds of a cut increase as the year progresses and a 25 bp move is nearly priced in by year-end.  Higher oil prices have helped the Loonie, with USD/CAD trading at lows not seen since October 2018.  Charts point to a test of the October 2018 low near 1.2785.



Eurozone preliminary December inflation accelerated to 1.3% y/y, as expected.  This is the highest reading since April but remains well below the 2% target.  The acceleration in the headline rate was due largely to energy prices, as core inflation remained steady at 1.3% y/y.  Eurozone also reported November retail sales, which came in at a stronger than expected 1.0% m/m.  Perhaps this wasn’t that much of a surprise after yesterday’s very strong reading of 2.1% m/m from Germany.  Despite some improved data, the euro remains heavy, unable to sustain the recent move above $1.12.

After eight months of deadlock in Spain, it looks as if Pedro Sanchez will be able to win a parliamentary vote today and form a government. If he succeeds in getting far-left Podemos on board with his Socialist Party, he will win a narrow margin if the Catalan nationalist party abstains as it has agreed. This will be the first coalition government in over four decades and will likely be a fragile one. Investors seem to have mostly ignored this long period of political uncertainty, at least as seen by Spain’s spreads to German bunds. The 10-year spread, for example, has been trending around the 70 bp level for several months, around the same as Portugal’s.



Markit reported weak final December Japan services and composite PMI readings.  Yesterday, final manufacturing PMI fell to 48.4 from 48.8 flash.  Today, services fell to 49.4 from 50.6 flash, helping to drag the composite PMI down to 48.6 from 49.8 flash.  This is the low for the cycle as well as the third straight sub-50 reading.  The economy slowed sharply in Q4 due to a combination of the typhoon and consumption tax hike.  The supplementary budget is meant to address this slowdown, and so the Bank of Japan is sidelined for now.  Next policy meeting is January 21 and no change is expected then.  USD/JPY has recovered after a brief foray below 108.  While the pair is subject to period jolts due to spikes in risk-off sentiment, we think there is scope for a move back above 109.

AUD continues to underperform.  There was little fundamental news today, but the pall of the ongoing wildfires continues to hang over the nation.  Odds of an RBA cut February 4 have risen in recent weeks to 57% currently.  We will be sending out an in-depth look at Australia later today.  Aussie is on track to test the December 10 low near .6800, and a break below the .6860 level would set up a test of the November 29 low near .6755.

The onshore yuan has appreciated 0.4% to its strongest level since August against the dollar. Also of note, the pair is below its 200-day moving average for the first time since May even as local equity indices continue to trade higher. China’s assets are still being buoyed the (now near-certain) prospect of the Phase One trade deal signed in mid-January. On the data front, China’s FX reserve stockpile increased slightly to $3.11 trln.  This was likely due to valuation effects and as well as reduced capital outflows as the diplomatic situation stabilized.

Philippines December CPI came in much higher than expected.  Inflation was 2.5% y/y vs. 2.0% expected and 1.3% in November.  This is the highest since June and back within the 2-4% target range after spending four months below it.  Next central bank meeting is February 6.  It is in the middle of an easing cycle but if price pressures continue to pick up, further easing is likely to be pushed out until the March 19 meeting.  Officials are keeping an eye on oil, though Governor Diokno said prices would have to rise to and persist near $90 per barrel to impact the bank’s inflation forecasts.  He added that the bank would likely resume easing in Q1.