New Year, Same Old Drivers

  • The new US Congress was sworn in over the weekend; Georgia elections odds have improved for the Democrats based on early voting, absentee ballots, and polls, but flipping two seats would still be a surprise
  • Eurozone final manufacturing PMI was softer; Turkey reported higher than expected December CPI; Israel is expected to keep rates steady at 0.10%. 
  • Japan’s final manufacturing PMI edged higher; reports suggest Prime Minister Suga is mulling a state of emergency for Tokyo and the surrounding areas; Singapore reported solid advance Q4 GDP; Caixin reported softer December China manufacturing PMI; commodities are starting the year on a very positive note, turbocharged by a weaker dollar and the reflation trade

A new year but similar concerns on the virus front. The race between the vaccine logistics and new strains continues as the virus outlook worsens. Several countries have stepped up their containment measures including the UK (closing schools), Thailand (restrictions on businesses and gatherings) Germany (considering longer restrictions), and Japan (considering new state of emergency). That said, markets are starting the year off on a risk on note, with global equity markets and commodity prices moving higher still.

Our weak dollar call remains intact as we move into 2021.   DXY has broken lower to trade at its lowest level since April 2018 near 89.423. This sets up a test of the February 2018 low near 88.25.  With Brexit finally out of the way, sterling is making new highs near $1.3705 and should eventually test the April 2018 high near $1.4375.  Likewise, the euro is testing its recent high near $1.2310 and should eventually test the February 2018 high near $1.2555.  The yen has made a clean break below 103 and is on track to test the March low near 101.20.  What happens to the greenback after these key targets are hit will largely depend on how well the US controls the virus in 2021 as well as the outlook for further fiscal stimulus.

 

AMERICAS

The new US Congress was sworn in over the weekend. Nancy Pelosi was re-elected Speaker of the House but presides over a narrow 222-211 Democratic majority. This is the smallest majority for either party in 20 years. Of note, there was no challenger from her own party. While Congress has a lot of work to do, it is really in limbo until the final makeup of the Senate has been determined after the two runoff elections in Georgia tomorrow. Indeed, after the presidential certification this Wednesday, the Senate won’t convene again until after January 20, when Biden is sworn in as President.

There, the elections odds have improved for the Democrats based on early voting, absentee ballots, and polls, but flipping two seats would still be a surprise. Polls have been scarce, but the recent averages show both Democratic candidates ahead by some 2 percentage points for both races, well withing the margins of error. Furthermore, these polls probably don’t fully account for the impact of Trump’s recent combative rhetoric about the elections. In other words, it’s pretty much a coin toss that Democrats must win both times. There is a lot at stake for markets since this possible outcome is arguably not priced in. The additional fiscal boost that could result would come at a time when markets are keenly focused on rising inflation expectations.

This is a key data week for the US but it starts off slowly. Today, only November construction spending (1.0% m/m expected) and final Markit December manufacturing PMI (56.3 expected) will be reported. Then, tings pick up rather quickly with December ISM manufacturing and auto sales tomorrow and ADP private sector jobs Wednesday. Of course, the highlight is jobs data Friday, where consensus sees only 50k jobs added. Evans, Bostic, and Mester speak today.

 

EUROPE/MIDDLE EAST/AFRICA

Eurozone final manufacturing PMI was softer. The headline manufacturing PMI fell to 55.2 from 55.5 preliminary. The drop was due mainly to Germany, whose reading fell to 58.3 from 58.6 preliminary. France was steady at 51.1 while both Spain and France improved from November to 51.0 and 52.8, respectively. Elsewhere, UK final manufacturing rose a couple of ticks to 57.5. Eurozone final services and composite PMI readings will be reported Wednesday, which have greater potential for weakness due to the renewed lockdowns.

Turkey reported higher than expected December CPI.  Headline inflation rose to 14.60% y/y vs. 14.20% expected and 4.03% in November.  It is the highest since August 2019 and moves further above  the 3-7% target range.  To make matters worse, PPI inflation accelerated to 25.15% y/y from 23.11% in November, suggesting higher CPI is in the pipeline. The bank just delivered a larger than expected 200 bp hike to 17.0%.  Next policy meeting is January 21.  If the bank wants to make a very strong statement of its commitment to orthodox policy, another hike then would do the trick.

Bank of Israel is expected to keep rates steady at 0.10%.  For now, we see steady rates along with continued intervention to prevent excessive  shekel strength.  At the last policy meeting November 30, the bank left rates steady whilst noting that “The positive results in coronavirus vaccine tests are increasing optimism regarding the rapid return of the economy to a path of growth in the coming year.”  This suggests no rush for further easing measures.  The bank is also likely waiting to see how the March 23 election plays out.  Ongoing political instability has prevented passage of budgets for both 2020 2021, which means fiscal stimulus has been limited.

 

ASIA

Japan’s final manufacturing PMI edged higher. It was revised higher to 50.0 from the 49.7 preliminary reading and is the highest since April 2019. Final services and composite PMI readings will be reported Wednesday. Yet it’s way too early to get excited about the recovery, especially as the virus numbers continue to rise in Japan.

Reports suggest Prime Minister Suga is mulling a state of emergency for Tokyo and the surrounding areas due to record high virus numbers. While he gave no further details, local media reported that it could begin as early as this week and last for a month. With the economic outlook so uncertain, we cannot rule out further fiscal stimulus this year. That said, the Bank of Japan is likely to remain on hold for now. Next policy meeting is January 21 and no change is expected then.

Singapore reported advance Q4 GDP.  Growth came in at 2.1% q/q vs. 1.3% expected and a revised 9.5% (was 9.2%) in Q3.  For the year, GDP contracted -5.8% vs. +0.7% in 2019. The economy continues to recover along with much of the region, but there are clearly risks of slowing momentum.  If the economy continues to slow, the MAS may ease policy by adjusting its S$NEER trading band at the next policy meeting in April.

Caixin reported softer December China manufacturing PMI.  It fell to 53.0 vs. 54.7 expected and 54.9 in November and is the lowest since September.  Caixin services and composite PMI readings will be reported Wednesday, with services is expected to rise a couple of ticks to 58.0.  For now, the mainland economy continues to recover and this is helping many of the regional exporters recover as well.  Yet there are signs that the economy is losing momentum and so the PBOC is nowhere close to removing its accommodative stance.

 

COMMODITIES AND ALTERNATIVE ASSETS

Commodities are starting the year on a very positive note, turbocharged by a weaker dollar and the reflation trade. Agricultural prices in particular are rising, due also to weather conditions and hog feed demand from China. Meanwhile, gold broke back above the $1,900 level and silver is back to levels not seen since September. Energy markets are benefiting from a mixed outlook presented by OPEC+ ahead of their monthly meeting today on output restraints. Separately, Bitcoin rose to nearly $35,000 yesterday before crashing back below $30,000 in the early London session. To state the obvious, any asset that can lose nearly 20% of its value in a day makes it less than ideal to serve as a safe haven or reserve currency.