Santa Rally Underpins Dollar

For many investors, today marks the end of the year, but it is ending on a favorable note. The combination of the FOMC meeting and the SNB adoption of negative interest rates underscored the dollar and equity bullish divergence theme.

It struck us that too many people were doing all kinds of mental and verbal gymnastics to account for what was a technical move. The correction, which came after a strong six-week trend move, lasted a week, December 9-16. The S&P 500 and the Dow Jones Stoxx 600 have both recouped around 70% of that downdraft.

The euro peaked near $1.2570 on December 16 and has not been able to resurface above $1.2300 for nearly 24-hours. With the SNB's move, effective the same day the ECB's meeting, January 22, is no coincidence. Just as the market is feeling more confident in a rate hike by the Fed near mid-2015, it is feeling more confident of a broader asset plan from the ECB. The euro is holding a little above the low set on December 8 just below $1.2250. In the thinning holiday markets, moves may be exaggerated, but now it seems asymmetrically so to the downside.

The dollar peaked against the yen on December 8 near JPY121.85. The violent correction ended in front of JPY115.50, a key technical retracement level of the dollar's advance from both October 15 and October 31. The JPY119.50 high the dollar has recorded today corresponds to a 61.8% retracement of the dollar's decline over the past week. A move above there would suggest a return to the highs and beyond.

Ironically, today’s dollar gains against the yen come as BOJ Governor Kuroda seemed to express concern about the pace of the recent moves. It was practically a forgone conclusion that the BOJ would not alter policy or break new ground at its last meeting of the year. The Nikkei gapped higher yesterday and today. It closed on its highs and appears poised to test the high from December 8 a little above 18000.

Sterling is uninspired. It is caught between the strength of the dollar and the weakness of the euro (and Swiss franc). Since mid-November sterling has been confined to a $1.56-$1.58 trading range. There have been a handful of violations of the two-cent range, but it has largely held. The euro has been in a wider range. Since September it has been peaking in the GBP0.8000-50 area and bottoming in the GBP0.7800 area. The divergence between the UK and euro area will become more pronounced. However, political uncertainty, especially with the Scottish Nationals indicating they are willing to cut a deal with Labour, may detract from sterling’s advantage. Meanwhile, the FTSE has recouped 61.8% of its week-long decline.

Incorporating the latest census data to measuring economic activity, China revised up the size of its economy at the end of last year. The 3.4% increase is CNY58.8 trillion. This is about $300. To put that into perspective, consider it roughly the size of the Singapore’s GDP. This is the first step of the process. The next step is to adopt the international standards regarding methodology, which China has signaled it will early next year. This will likely boost estimates of the size of China’s economy another 3-5%. One consequence of such revisions is that it makes comparisons to GDP, such as debt/GDP or current account surplus/GDP marginally smaller. We suspect there is little policy implications in the changed optics.

On the other hand, the PBOC has taken steps to ease the liquidity squeeze in the interbank market. It has injected an unspecified amount of liquidity through the Pledged Supplementary Lending facility and it has fully rolled over the MLF funds (CNY 500 bln three month loans) that were maturing. The flurry of year-end IPOs in China has begun, and between yesterday and December 25, there are an estimated dozen IPOs that are tying up over CNY3 trillion (~$480 bln). Getting past the IPOs, with no repos expiring next week, many expect the liquidity squeeze to ease. The 7-day repo rate, which is a useful metric of interbank liquidity, soared 154 bp today (213 bp on the week) to almost 6.0%. The PBOC has been preferring to keep it below 4%.

The Shanghai Composite rose 1.7%, led by telecoms and utilities. This is a new four-year high. Since the PBOC surprised investors by cutting the benchmark rate on November 21, the Shanghai Composite has rallied almost 25%. Its correction lasted two day (December 8-9) and has been covering since.

Canada reports CPI and retail sales today. The consensus expects a 0.2% decline in headline inflation and a 0.1% rise in the core rate. The central bank expects price pressures to ease. The surprise may be in retail sales. The headline is expected to be 0.3% lower after a 0.8% rise in October. There is scope for an upside surprise. Excluding autos, retail sales are expected to rise slightly after a flat reading previously.

The divergence theme weighs on the Canadian dollar, which continues to be treated like as petrol currency. The US dollar has found good support this week near CAD1.1560. The commodity intensive Toronto Stock Composite has rallying strongly in recent day, but has generally under-performed. The highs for the year were recorded in early September.