Dollar Mixed, Markets Calm Ahead of FOMC Decision

  • UK Parliament rejected most of the proposed Brexit amendments yesterday
  • Markets seem to be counting on a delay to Article 50 but we think the odds of a no-deal Brexit have risen
  • The FOMC decision is due this afternoon
  • The US Treasury makes its quarterly refunding announcement
  • US-China trade talks begin today in Washington
  • Japan reported firm December retail sales; Australia reported Q4 CPI
  • Turkey central bank released its quarterly inflation report; Mexico Q4 GDP is expected to grow 2.0% y/y; Chile central bank is expected to hike rates 25 bp to 3.0%

The dollar is mixed against the majors ahead of the FOMC decision.  Aussie and Loonie are outperforming, while Swissie and Stockie are underperforming.  EM currencies are also mixed.  TRY and THB are outperforming, while MXN and IDR are underperforming.  MSCI Asia Pacific was up 0.1%, with the Nikkei falling 0.5%.  MSCI EM is up 0.2% so far today, with the Shanghai Composite falling 0.7%.  Euro Stoxx 600 is up 0.2% near midday, while US equity futures are pointing to a higher open.  10-year UST yields are up 1 bp at 2.72% ahead of the quarterly refunding announcement.  Commodity prices are mostly higher, with Brent oil up 0.8%, copper up 0.5%, and gold up 0.1%.

UK Parliament rejected most of the proposed Brexit amendments yesterday.  These included Corbyn’s amendment to keep the UK in a customs union with the EU, Grieve’s amendment to give Parliament control of Brexit, Cooper’s amendment to debate a bill to extend Article 50, and Reeve’s amendment to extend Article 50 if no deal is reached by February 26.

The only ones that passed were Spelman’s amendment to avoid a no-deal Brexit and Brady’s amendment to ditch the Irish backstop.  Most commentators are calling it a victory for May.  Yet the victory may ring hollow given the EU’s refusal to reopen talks on the Irish backstop.  EU President Tusk stressed this again after the UK Parliamentary vote ended last night.

Markets seem to be counting on a delay to Article 50 but we think the odds of a no-deal Brexit have risen.  Indeed, the two amendments are at odds with each other.  If the EU stands firm on the Irish backstop, UK parliament is unlikely to pass the deal and we would most likely get a no-deal Brexit come March 29.  We see no reason to be bullish sterling now.

Sterling softened up in the wake of the votes but has stabilized today.  The $1.32 area seems to be a near-term top absent any further positive Brexit developments.  Indeed, we thought too much good news had been priced in and so a corrective move back to the $1.2830 area (50% of the January 3-25 rally) seems likely.  The 200-day moving average near $1.3050 will provide some near-term support.

The FOMC decision is due this afternoon.  It is about as much of non-event that one can get.  Indeed, no one is expecting a hike in Q1, with WIRP showing odds of 1% for a hike this week and 4% for a hike March 20.  However, markets will be focused on any reference to the Fed’s balance sheet policy.  WSJ reported Friday that some Fed officials are considering an earlier than expected end of its balance sheet runoff.

For the first time ever, there will now be a press conference after every FOMC meeting and that’s good thing.  We expect Powell to again counsel “patience” and “flexibility.”  Because of the FOMC media embargo, there won’t be any Fed speakers until Kaplan gets the ball rolling Friday.

The US Treasury makes its quarterly refunding announcement this morning.  With the budget deficit expected to continue expanding, the market will have to absorb more and more supply.  Back in October, Treasury announced debt sales of $83 bln vs. $78 bln in July.  We expect another increase this time, which would be the fifth straight quarter of increased auction sizes.

During the North American session, we will get some minor data.  The US reports weekly mortgage applications, ADP employment (+181k expected), and December pending home sales (0.5% m/m expected).  The Q4 GDP report scheduled for today has been delayed due to the shutdown.

US-China trade talks begin today in Washington.  Vice Premier Liu heads up the Chinese delegation, while the US team includes USTR Lighthizer and Treasury Secretary Mnuchin.  President Trump will reportedly make an appearance.  Talks are scheduled to run until Thursday, but we note that the last round of talks in Beijing were extended a day due to what was characterized as solid progress.  The March 2 deadline when US tariffs kick in again is looming, but we do not expect a breakthrough this week.

Eurozone Q4 GDP data will trickle out this week.  France reported earlier today, with growth slowing as expected to 0.9% y/y from 1.4% in Q3.  This will be followed by Spain (2.3% y/y) and Italy (0.3% y/y expected) Thursday.  Later Thursday, eurozone will release its reading and growth is expected to slow to 1.2% y/y from 1.6% in Q3.  It’s clear that the Q3 slowdown was not temporary and it has intensified in Q4 and now Q1.

Germany reports preliminary January CPI later today, which will be followed by the eurozone reading Friday.  Inflation is expected to ease a tick to 1.6% y/y.  German state data was delayed until February 21 due to a base year change.  Eurozone headline inflation is expected to ease to 1.4% y/y from 1.6% in December.

Considering the deteriorating outlook, markets were disappointed that the ECB and Draghi were not as dovish as hoped this month.  Rather, the ECB has put off any policy changes until the March 7 meeting, when new staff forecasts could give the ECB cover to tilt more dovish.  Market is becoming increasingly skeptical of the ECB’s ability to lift rates this year.

Yet the euro has been able to gain a toehold above the $1.14 area this week.  It feels heavy, however, and we need to see a break above the $1.1465 to signal that the uptrend is intact.  That would set up a test of the January 1 high near $1.1570, which also coincides with the 200-day moving average.

Japan reported firm December retail sales.  Sales rose 0.9% m/m vs. 0.4% expected.  Japan data has been coming in softer than expected in Q1, and so the retail sales data is unlikely to have any impact on policy.  The BOJ has signaled that stimulus will remain in place until at least FY2021.  USD/JPY remains rangebound and very much dependent on global drivers rather than domestic ones.

Australia reported Q4 CPI.  Headline inflation was higher than expected at 1.8% y/y but still slowed from 1.9% in Q3, while trimmed mean was steady at 1.8% y/y, as expected.  Still, we see no policy implications from the data as the RBA is likely to keep rates steady into 2020.  AUD saw a bounce today but is still having trouble breaking above .7200.

Turkey central bank released its quarterly inflation report.  Inflation forecasts were tweaked down slightly, but Governor Cetinkaya said a “convincing” drop in inflation is needed before taking any action on rates.  This suggests no cut at the March 6 policy meeting.  Markets see a risk that the bank starts an easing cycle prematurely, which would not be taken well.

Mexico Q4 GDP is expected to grow 2.0% y/y vs. 2.5% in Q3.  The economy remains sluggish, but Banco de Mexico cannot cut rates while the peso remains vulnerable and inflation remains above target at 4.8% y/y.  Next policy meeting is February 7, no change is expected then.

Chile central bank is expected to hike rates 25 bp to 3.0%.  CPI rose 2.6% y/y in December, which is in the bottom half of the 2-4% target range.  It just started the tightening cycle in October and markets see one hike every quarter this year.  We think this is too aggressive a pace.  Chile reports December IP Thursday, which is expected to rise 1.0% y/y vs. 0.4% in November.