Dollar Downside Correction Continues Without A Ruble Reprieve

The US dollar's recent losses against the euro and yen have been extended. Oil prices continue to swoon, and the price of Brent oil has fallen below $60, while WTI approached $54.

While most emerging market currencies are higher today, a notable exception is the Russian ruble. Very early Tuesday in Moscow, the central bank hiked the key interest rate to 17% from 10.5%. This follows about five days after the central bank hiked by 100 bp.

The continued drop in oil prices did Russia no favors, but Russia's own experience in the late-90s, would have warned that its move was fraught with risk in any event. In 1998, Russian interest rates were near 150%, and this did not stop the ruble from falling. The interest rate is annualized, but the ruble's average net change over the past 12 sessions is a little more than 5% daily. The actual volatility over the past month is 57.2%.

Many fear that capital controls may be the next step for Russia. Although many investment managers reduced exposure to Russia as of the end of September, Russia's total external foreign debt stood near $680 bln. Despite Putin's talk about wanting to seek alternatives to the dollar, and his willingness to accept yuan for its oil sold to China, around two-thirds of its hard currency debt is thought to be denominated in US dollars. The price of insurance via a five-year credit default swap is now near 580 bp, more than double the price as of the end of October. It is the highest since 2009.

The 2% decline in the Nikkei kept the dollar under pressure against the yen. Last week's low near JPY117.45 was taken out, and the JPY117 retracement target has likewise given way. The low thus far has been near JPY116.25. The next key retracement target is near JPY115.50. This level corresponds with a 38.2% retracement of the move that began on Oct 15 and a 50% retracement of the move since the BOJ expanded its asset purchases on October 31.

HSBC's flash manufacturing PMI for China fell to 49.5 from 50.0. This is a slightly larger decline than the market expected and follows on the heels of last week's disappointing data. This did not deter the resumption of the rally in Chinese shares. The Shanghai Composite was up 2.3%, led by a 5% rise in the financial. The market closed on its highs.

Two other developments in China are noteworthy. First China reported foreign direct investors rose 22.2% year-over year in November. During the first eleven months of the year, direct investment flows into China are about $106 bln. The combination of the large current account surplus and the direct investment inflows (basic balance) are the reason why some economists argue the yuan should be appreciating.

Second, although we look for some additional monetary accommodation from the PBOC, we see new initiatives on the fiscal front. Chinese officials have approved a CNY192 bln (~$31 bln) construction/infrastructure project. It involved new roads in three provinces and CNY80 bln for a third airport near Beijing.

The eurozone flash PMI was better than expected and this, coupled with the better German ZEW survey, helped lift the euro through the $1.2500, which had capped it until now. This corresponds with 38.2% retracement from the October 15 high near $1.2900. Above there, the next target is $1.2565. The flash manufacturing PMI rose to 50.8 from 50.1, and the service reading rose to 51.9 from 51.3. Both were better than expected. The manufacturing was lifted by Germany, which saw its service measure slow further (51.4 from 52.1). Both of France's measures improved but remained below 50.

The ZEW survey showed a marked improvement in German investor confidence. The assessment of the current situation improved to 10 from 3.3, which was twice the improvement expected. The expectations component jumped to 34.9 from 11.5. It is the highest since April.

For its part, the UK reported lower than expected inflation. The November CPI slipped by 0.3% for a year-over-year pace of 1%. The core rate also ticked down to 1.2% year-over-year from 1.5%. As for producer prices, the input prices accelerated to the downside, falling 8.8% year-over-year, which was not quite as much as the market expected (-9.2%). The output side was considerably firmer than expected. This combination speaks to corporate margins.

The North American session features US November housing starts and permits data. The housing market has disappointed this year. The Fed starts its two day FOMC meeting amid volatile markets and the continued drop in oil prices. The key focus is how the FOMC modifies its forward guidance now that the asset purchase program is over.