Quiet Into Month's End

A fragile calm hangs over the foreign exchange market. as the month winds down. There have been some sizable moves in the underlying asset markets, month-end portfolio and hedge adjustments seem modest. Over the course of the month, global equities have rallied. Of note, among the majors the weakness of the Swiss franc (vs euro) and the Japanese yen looks to have given their equity markets a boost, with the Swiss Market Index up 8.1% and the Nikkei up 7.1%. The FTSE's 6.8% gain puts it at a close second within the G7 and sterling was the weakest of the major currencies losing almost 2.7% against the dollar (Japanese yen fell 4.7%).

Benchmark 10-year bond yields generally rose this month. Two exceptions are rather surprising. First, the 10-year JGB yield fell almost 4 bp in January, despite the yen's depreciation (and anticipation for more). Second, 10-year Italian yields fell 16 bp this month, despite the looming national election and increased uncertainty especially in light of the fallout from the Monte dei Paschi losses.

The most important development in terms of interest rates has been the backing up of Euribor, reflecting a passive tightening of monetary conditions in the euro area, which began before, but is exacerbated by the early repayment of LTRO funds. Consider that last month the implied yield of the March Eurodollar futures contract was around 15 bp more than the implied yield of the March Euribor futures contract. Earlier this week, the implied US yield dipped below the European yield.

Most of the major and emerging market currencies are little changed against the dollar from yesterday's NY close. The New Zealand dollar is among the strongest among high income countries, following a RNBZ's relative hawkish statement following the much anticipated decision to keep rates on hold. In emerging markets, the South African rand is enjoy modest gains, with the dollar pushing back below ZAR9.0 in what seems to be largely driven by month end considerations.

The absence of significant price action, however, does not reflect the lack of economic news. In Japan, data suggests that the stage is being set for a recovery in Q1. Infrastructure spending is boosting construction and helping lift housing starts. Industrial production rose 2.5% in December and although it was below the 4.1% consensus gain, it was still the best in six months.

In Europe, Germany reported an unexpectedly strong employment report, with a 16k decline in the unemployment queues (compared with a 8k increase the consensus anticipated). And the November 3k increase was revised to show a 2k decline. Nevertheless, the improved labor picture did not carry over into domestic consumption. German retail sales collapsed by 1.7% in December. The Bloomberg consensus was for a 0.1% decline. Adding insult to injury, the 1.2% increase in November was cut in half in the revision.

France also reported disappointing domestic consumption, but not as poor as Germany. Household spending in France was unchanged. The market had expected a 0.2% gain, the same as in Nov. This means that for all of 2012, consumer spending fell 0.1% in France.

We note that despite rumors of SNB reserve diversification, the figures released today show little change in the allocation of SNB holdings. The euro's share increased by 1% to 49% and this seem to come at expense of the Japanese yen, whose share by 1% to 8%. All of the other allocations were unchanged and there was no sign that the SNB bought Norwegian krone, as market speculation suggested.

Lastly the fallout from the unexpected 0.1% decline in Q4 USD GDP has been minimal. It is widely recognized as a a bit of a fluke that is unlikely to be repeated due to the large draw down in the preliminary estimate of inventories and the sharp drop in defense spending. The real problem is not Q4 GDP, but the impact of the end of the payroll tax holiday that will hit consumption in Q1 and the coming sequester that may weigh on Q2 GDP. The FOMC statement was broadly neutral though talk of an early exit from QE3+ is premature.