The US dollar is edging higher against most of the major currencies in a session devoid of much news. The Canadian dollar and the Japanese yen are the exceptions. The euro is the weakest of the majors; off about 0.3% near $1.0650. After a strong advance yesterday, sterling just missed recording an outside up day and is consolidating yesterday's gains in a narrow range.
European politics is widely cited as an important driver. The most obvious metric is the premium being paid over Germany. Yet the premiums narrowed a little yesterday and are narrowing a little today. Moreover, on the one hand, some observers argue investors are not taking the political risk seriously enough, and on the other hand, other accounts emphasize how much the spreads have widened already. How can the Stiglitz scenario be discounted? He suggests the monetary union could blow up this year.
The US 10-year yield is holding below the 2.40% that was breached yesterday. Recall the yield peaked the day after the December 14 FOMC decision to hike rates near 2.64%. It fell to 2.30% on January 17 and recovered over the next week to 2.54%. It has been drifting lower. The March 10-year note futures peaked on January 17 at 125-13. Yesterday, it reached 125-10. The 125-16 area is the 38.2% retracement of the sell-off since the US election. The BOJ targets the 10-year yield and has had to become more active in defending it as rising global rates exert some upward pressure on Japanese rates.
Although the dollar-yen rate is sensitive to US rates and the differential with Japan, the greenback has been resilient in the face of the latest decline in the Treasury yield. The dollar remains within the roughly JPY111.65-JPY112.80 range established on Monday. Still, until the dollar resurfaces above JPY112.80, the technical tone is vulnerable.
The correlation between the dollar-yen rate and the TOPIX (percent change, 60-day rolling) is about 0.37, which is the highest since last September. The correlation between dollar-yen and the S&P 500 has slipped to 0.18. It was above 0.5 for most of the first nine months of 2016.
Perhaps it is the lack of other substantive news, but many are talking about the decline in China's reserves below $3 trillion. But there is little here besides the obvious. First, for all practical purposes reserves at $2.9982 is the same thing as $3 trillion. Second, there is nothing critical about $3 trillion. Moreover, we suspect Chinese officials do not simply look at the value of the reserves in dollar terms, but also in SDRs. Third, yes, China is still experiencing capital outflows. However, China is not likely to respond by having a dramatic change to its managed float, as some have suggested. Instead, China is more likely to use formal and informal controls to limit the capital outflows. Fourth, the yuan appreciated by 0.9% last month and is up nearly 0.2% this month. The stabilization of the currency and the premium of the offshore yuan (CNH) over the onshore yuan (CNY) may suggest that there may be less speculative flows and perhaps more business flows, such as paying back some previously borrowed dollar, tourism (related to the Lunar New Year) and direct investment.
With today's slippage, the euro has retraced 38.2% of the rally from the year's low near $1.0340 at the start of the year. A convincing break of this area (~$1.0645) requires a push below the end of January low near $1.0620 to see a test on $1.0585, the 50% retracement objective and previous congestion area. A move above $1.0665 may help steady the single currency.
Sterling has been confined to about a half a cent range at the upper end of yesterday's range. The strong momentum eased in the US afternoon. A break of the $1.2430- $1.2440 area would suggest that yesterday was a bit a head fake. Rather than a running start at the old highs and perhaps $1.28, it could be a bull trap.
The Aussie is holding below $0.7700 but found a good bid ahead of $0.7600. A move above $0.7640-50 would spur another run at $0.7700, which proved a real nemesis last year. The US dollar dipped below CAD1.30 briefly last week, and with the help, softer oil prices (and the API estimate of a large build of US oil inventories) helped the US dollar recover to CAD1.3200 yesterday. It is consolidating yesterday's gains today. Support is seen in the CAD1.3130-CAD1.3140 area.