Foreign Exchange traders were not impressed by the robust US CPI and Retail Sales prints and continued to flood into the top 2018 consensus trades.The Euro had an astonishing day closing above 1.2200 level as Euro bulls have not satisfied their appetite nor did they apparently own enough EUR in the size they want. But the fact the dollar barely blinked at the core CPI beat emphasises the lack of conviction in the US dollar early in 2018. The week will probably get off to a slow start with Martin Luther King Day celebrations in the US. However, the US calendar is light this week, and the dollar could continue to falter in the absence of any tier one data catalysts to halt the trend.
Hopes for an immigration deal in the USA were dealt a blow as in typical partisan fashion; lawmakers continued to exchange brickbats derailing any hope for a settlement and raising the possibility of a government shutdown. An agreement on this issues would have guaranteed stopgap funding and broader budget consensus Given the paper-thin margin of a majority the Republican holds in the Senate and the possibility the fiscal hawks will vote no for a funding extension, its believed Democratic votes are needed.
The most prominent story’s on the markets remain higher Oil prices and rising US bond yields. And by extension, the far-reaching implication of higher energy prices lifting inflation expectations which are providing the most meaningful signal for higher US Bond Yields.
Oil Markets
Oil prices remained firm despite US Rig count rising by ten last week, according to Baker Hughes. So far the rise has done little to dent bullish sentiment despite growing signs oil prices are topping out. However, with oil executives basking in the afterglow of OPEC production cuts and recent supply disruptions, the big question emerges: will shale producers get back into the swing of things in a more substantial way?
The real wildcard in the deck, however, is the possibility of significant supply disruptions from the fragile five OPEC countries which could add another $5 -$ 10 per barrel from the geopolitical risk premium alone. Iran presents a considerable tail risk as a mix of populist, political and terrorism-related disturbances could lead to higher instability knocking out oil production and precipitating a massive oil supply shock.
US Bond Markets
The US Bond yields move higher with two-year Treasuries hurdling above the significant 2 percent levels as Friday’s CPI data cemented the odds of a March rate hike. Two-year US Treasury yields are the markets most robust gauge of Federal Reserve expectations. With higher oil prices and a stronger inflationary signal generated from CPI, traders are now moving towards the Feds three rate hike dots for 2018. But the data did little to influence the pace of Fed normalisation beyond 2018 or alter the long-term ” terminal rate. “
Ten year Treasuries closed the week at 2.55 % up .37% In addition to higher inflation signals, supply concerns are weighing on sentiment as the prospect of the Feds scaling back on their massive Bond buying orgy comes to the fore. The latest move by the BoJ to scale back the pace of QE has sent jitters through Global Bond markets, but dealers are waiting for some possible policy confirmation in today’s Sakura report.
Gold Markets
Gold was initially dragged lower by a robust US CPI print and stronger than expected Retail Sales data, triggering intraday stops. However, the yellow metal rebounded quickly when USD dollar demand failed to materialise and then Gold roared higher in the NY afternoon session when EUR/USD demand accelerated driving the DXY below the critical 91 level suggesting the USD downtrend is resuming.
While the weaker USD remained Golds primary driver, investors are keeping an eye on the simmering geopolitical hot spot in the Middle East. A war of words escalated when Iran promised to retaliate after US President Donald Trump’s decision to target the head of its judiciary with sanctions, but Tehran fell short of saying what type of action they may take. Iran remains among the most poignant of geopolitical risks this year following President Trump’s decision not to ratify Iran’s compliance on the nuclear deal. Gold investors are likely under-positioned for a significant escalation which could lead to considerable price increase.
Equity Markets
There is a broader gap forming between investor expectations and market reality which is starting to wave multiple yellow cautionary flags. Higher interest rates and geopolitical uncertainty have to enter the picture at some point. But Investors continue basking in the afterglow of US Tax Reform assuming there will be no end to this unstoppable run which is now feeding off US domestic economic strength and a stronger global growth narrative. As we enter earnings season, the fear of missing out mindset takes hold, but if the markets remain at this pace, we could breach my 2018 year-end Global stock market forecast before the end of February which will for once leave me honestly lost for words.
The strong performance in Friday’s US stock market session is pointing to a healthy start to the week for Asian equity markets.
G-10
The Euro
Remarkable best describes Friday’s Euro rally which looks poised to make further gains after signalling a bullish outside week. While it’s conceivable Euro will trade 1.30+ this year, but interim targets towards 1.24-1.25 near-term look like a logical take profit zone and probably the next congestion point. In the meantime, the hawkish ECB minutes and diminishing political risk should continue to drive sentiment. Politics will remain a key driver of opinion with both CDU and SPD converging to a Grand Coalition. But of interest this week will be ECB speakers Weidmann and Coeure whose comments will be carefully watched after the release of the hawkish ECB minutes. Not a great time to be short Euro.
The Japanese Yen
Today’s Yen focus is on the Sakura report with the market keying on Kuroda’s opening speech. At the October meeting, he was happy with the level of monetary accommodation.But if he mentions any adverse implications from the current pace of QE, especially towards the banking sector, the likelihood of a policy shift will escalate dramatically and send USD/JPY towards 110. But certainly, if last weeks not so stealthy taper was a trial balloon, the stronger Yen response, could lessen the chance for further QE policy shifts
The Canadian Dollar
NAFTA headlines will continue to be tricky to trade.But look for the Bank of Canada to provide the most precise signal for continuous direction. However, with a substantial build-up on long CAD positions risk skews to the downside especially if the rate hike theme turned one and done for 2018. Or the whole position blows out if no rate hike is offered up. Poloz has tossed a few curveball in the past, and implications around NAFTA could give cause for pause.
Gold and energy sectors look solid which provides a decent footing for commodity-related currencies. The weaker US dollar trend seems to be re-emerging which should play favourably into the stronger Australian Dollar narrative despite Chinese steel prices falling and by default weighing on Iron Ore prices on Friday
The Australian employment data comes into focus Thursday, but given the volatility in this series it generates poor trading signals and has minimal impact on RBA policy.
Perhaps more significant is the China Data Dump also due out Thursday where market watchers will be intently monitoring for any economic slowdown on the back of Pboc tighter monetary policy amidst significant Mainland administrators financial reforms. GDP is expected to come in around 6.7 % while industrial production is expected to hit 6.1 %. There is a real possibility the regulatory facelift could weigh on all indicators, but we would need to see GDP drop below 6.6 % and or Retail Sales to fall below 10% to raise any significant consternation. While an upside surprise will likely produce a significant lift in commodity prices and support the Aussie dollar along with the regional currency basket
The Chinese Yuan
The Yuan surged on the back of broader USD weakness and is poised to make further gains this week. The DXY falling below 91 suggests a deeper USD sell-off is on the cards, but traders will key on Monday Fix which usually provides the best gauge for Pboc policy as well as dictating broader regional sentiment. While there was a lot of focus on the suspension of the Counter-Cyclical mechanism, active traders in the RMB space were more baffled by the Yaun sell-off than anything else as the policy shift implies neither a ” line in the sand” nor does it represent a weaker RMB policy. The argument for the stronger Yuan remains solid as regulators do not want currency weakness to divert attention from economic growth, investment inflow and regulatory reform.
Over the weekend China has reportedly tightened rules on property loans made by non -bank firms, signalling further evidence that regulators are determined to rein in the runaway shadow banking sector.
Asia FX
The markets recovered soundly from the midweek equity wobble after China’s SAFE denied the US bond market rumours. Also and as expected the market has shown little respect or regulators jawboning the Won which ultimately proved ineffective and did little else than provide the market better levels to buy KRW. So much for the apparent so-called line in the sand as traders cut through the psychological 1060 level like a hot knife through butter. Despite the BoK to steady policy rates, capital inflow remains significant as the robust US economic data and the stronger global growth narrative have major exporting nations riding the wave of positive risk sentiment.
The Stars continue to align for the Ringgit with higher oil prices, a weaker USD trend emerging, US equities surging, stable domestic economic landscape and a BNM rate hike in the offing.But from a technical perspective, the breach of the critical 3.98 barriers brings the 3.95 level well within reach short-term. However, given that the market has been milking the same signals for the past three months, the real question is where the next major catalyst will emerge?Malaysia will be the clear winner from Belt & Road Initiative (BRI)as China will continue to export excess capacity through Foreign direct investment while expanding construction contracts to improve critical forks in BRI transport networks.This resulting domestic economic growth from BRI will add significant points to the recent MYR outperformance.