Dollar: Softer, Consolidating Recent Gains

The US dollar is sporting a slightly softer profile, but the price action is really more of a consolidation than a trend reversal. The euro has gained nearly 0.5% today but remains well off last Friday's high of about $1.1375.

The euro's gains late yesterday and earlier today were partly fueled by signs that the Swiss National Bank had intervened. We had previously suggested that the price action appeared to be consistent with intervention after the cap was removed. Many were skeptical, thinking the removal of the cap was an indication that 1) the SNB was under pressure, not to expand its balance sheet further and 2) was stepping away from the market.

Yesterday's weekly report showed that sight deposits rose 8% in the week ending January 23. This is the largest rise in sight deposits since July 2013. This was followed up by comments by the SNB's Danthine, who reinforces this interpretation, arguing that current franc levels are unjustified and that the SNB was still prepared to intervene. As we do not think the SNB's worldview has changed, we suspect that what is ultimately involved here is a change in tactics. The cap offered a Maignot Line of sorts. It committed the SNB to obvious intervention. The new tactics inject more ambiguity and intervention discretion.

That said, the euro-franc cross remain volatile. It initially extended yesterday's gains to the post-cap high near CHF1.0385 only to be sold back off below CHF1.01 in mid-morning European activity. As the euro came off against the franc, it also surrendered some of its gains against the dollar.

Greece bonds and stocks are lower. Market participants remain divided. Some remain concerned that the demands that Syriza has for its official creditors are too much. Any concessions, they worry, will be similarly demanded by others. There are still those who think that Syriza is "blackmailing" the creditors with the threat of default. On the other hand, we continue to expect hard negotiations and officials have until the end of February to reach an agreement. At the end of February, the two-month extension ends. We expect compromises to be struck. It could include a smaller target for the primary budget surplus. It could include some reduction in the debt servicing costs.

The major economic data of the day was the UK's Q4 GDP report. The 0.5% quarter-over-quarter expansion was slightly below market expectations (0.6%) and Q3's 0.7% pace. The year-over-year rate slowed to a still respectable 2.7% from 3.0% in Q3. A detailed breakdown is not available with the first estimate. However, the modest slowing of the UK economy is not surprising. It has been unfolding since the middle of last year.Sterling slipped roughly half a cent on the news, after initially extending toward $1.5120.

The December 2015 short-sterling futures contract that retreated yesterday following the weekend bearish comments by Carney and Forbes slipped further today to test the 20-day average near an implied yield of 75 bp. The implied rate has not closed above its 20-day average in since early December 2014.

Given the Greek election, the beginning of the Italian presidential selection process at the end of the week, investors are sensitive to broader political developments. The UK election is roughly 100 days away. The latest Sky poll shows Labour winning 286 seats to the Tories 265. This would leave Labour 40 seats shy of a majority. In the UK, when a party fails to achieve a majority, it is often called a hung parliament. In other countries, it is simply called a coalition government.

The ECB provided 38.6 bln euros in funding at its main repo operation (MRO) today. It is the most since last May. The driver here appears to be the expiry of the remaining LTRO funds. There is roughly 40 bln euros outstanding. Today's demand appears to have been bolstered by the replacement of this with MRO funds. It is not unexpected or very surprising. Since it is replacing one source of funding with another, the impact on the overall liquidity is unlikely to be significant.

The PBOC also provided extra liquidity to its banking system. It provided CNY 60 bln via 7- and 28-day repos. The main aim seems to be avoiding a liquidity crunch around the New Year. Given that the yuan nearly moved the entire 2% allowed vs. the fix yesterday, there is some predictable talk that the band maybe widened. We suspect such a move is not imminent.

Meanwhile, the ruble has pared some of its losses scored in the wake of the new sanction threat and Russia's loss of investment grade status by S&P. It is the first rating agency to do so. This may not impact many institutional investors. Although split ratings are awkward, many mandates require two ratings of three or four agencies to take away the investment grade rating before it is truly considered lost.

There has been a sharp reversal of fortunes. There had appeared to be some softening of Europe's commitment to sanctions on Russia. However, the Ukrainian government went on a powerful offensive in east Ukraine. Some suspect influence by some foreign governments, encouraging Ukraine. This was a trap for the rebels and Russia, who were forced to escalate or lose negotiating ability, let alone strategic territory. Now the idea of modifying the sanctions appears off the table again. The conventional view was that Russia would use its foothold in east Ukraine to destabilize the entire country. Instead, it looks like Ukraine with some allies is using east Ukraine to keep Russia isolated.

The US reports December durable goods orders. This will be the last piece of data for economists fine tuning Q4 GDP estimates ahead of the report at the end of the week. The Bloomberg consensus calls for a 3.0% annualized pace. The FOMC begins its two-day meeting today. Little change in the statement is expected when it is released tomorrow.

The Reserve Bank of New Zealand meets tomorrow. It is expected to signal that its mini-tightening cycle has ended. A more neutral stance is anticipated. Tomorrow Australia reports Q4 CPI. An expected softening of price pressure will likely fan expectations that the RBA could cut rates as early as next month. Both currencies are little changed today.