Important Developments, Little Price Action

There have been several developments, but the global capital markets are mostly quiet. The US dollar is little changed against most of the majors (sterling is the exception), though the dollar-bloc is firm. Equity markets are somewhat firmer, but not more than one would expect given yesterday's rally in the US (with the S&P 500 putting together its best 4-day rally in more than a year).

The big event today is the BOE's Quarterly Inflation Report and the updated economic assessment and forward guidance. We noted yesterday that the implied yield of the March 2015 short-sterling had fallen by about 30 bp since Jan 23 as the market priced in Carney's push back against early tightening expectations. While Carney continues to argue against the need for an early rate hike, the BOE boosted this year's growth forecast to 3.4% from 2.8% (Nov) and lifted its 2015 forecast to 2.7% from 2.3%.

Carney indicated that the new forward guidance would look at a broader range of economic indicators, without being exceptionally specific. And although Carney's economic comments were sobering (recovery neither balanced nor sustainable), the market has responded with skepticism. The March 2015 short sterling futures contract is lower, implying higher yields, the yield curve has steepened and sterling has rallied. Sterling advanced a little more than a cent to $1.6550. A sustained break of the $1.6500 area will encourage a test on the multi-year high set on January 24 near $1.6670. The euro is not match for sterling and after yesterday's reversal, the euro has lost another 0.5% today. A sustained break of the GBP0.8260 area will re-target the GBP0.8170 area seen in late January.

Core bonds are little changed, while bonds in the European periphery are firm. Indeed that is news in itself. Given the doubts raised of the legal status of the ECB's Outright Market Transaction (OMT) scheme and heighten concern that the Italian government may be on the verge of collapse, it is notable that Italy's asset markets are showing little concern. Italy sold one-year bills today at a record low interest rate of 0.676%.

Italian Prime Minister Letta was to announce a new coalition pact yesterday, but PD head Renzi withheld support, setting off a flurry of meetings. Renzi and Letta are meeting later today. Previously the center-left PD was to hold a conference next week to discuss its strategy and relationship with the Letta coalition government. The meeting was moved up to tomorrow, but evens may be spinning even faster. While Renzi has often indicated he wants the Letta government to pass electoral reforms, though has been impatient. Without electoral reform, there is no point in calling a new election. Therefore, Renzi and Letta cannot reach an agreement, President Napolitano would likely offer Renzi the opportunity to see if he could command a majority in both chambers. The point is that the markets are taking this on with little fanfare.

Japan reported a dismal December machinery orders data, a proxy for capital investment. The market had expected a decline after the 9.3% increase in November. However, the 15.7% drop was nearly four times larger than the Blooomberg consensus forecast. It warns of downside risks to next week's preliminary estimate of Q4 GDP (consensus was 0.7% quarter-over-quarter). Following last week's news that base wages had fallen for the nineteenth consecutive month, the weak report today highlights a important risk to Abenomics: Business are not cooperating.

China reported news that seemed, well, over the top. Influenced in part by the PMI data, the market expected a near flat export report in January. Instead exporters reportedly jumped 10.6% after a 4.3% pace in December. Imports were expected to have slowed to 4.0% from 8.3%, but reportedly rose 10%, with record crude oil , iron ore and copper purchases. This produced a trade surplus of $31.9 bln. The market had expected a $23.5 bln surplus. Given the issues surrounding falsifying trade reports to conceal capital flows and potential distortions caused by the Lunar New Year, many observers greeted the news with a jaundiced eye of skepticism and cynicism.

Still, the news seemed to encourage the recovery in Asian equities and so-called commodity related currencies. It may have helped the Australian dollar, for example, shrug off the erosion in consumer confidence ahead of tomorrow's employment data. The Aussie is trading at its best level since January 14. Nearby resistance is seen just below $0.9100.

The market did not seem to know what to do with Norway's news that its economy unexpectedly shrank by 0.2% in Q4. The knee-jerk reaction to sell off the krona was quickly reversed as participants realized that, more importantly, the mainland economy expanded by 0.6%. The consensus expected 0.4% growth. The relative strength of the consumer, coupled with the recent higher than expected CPI will ease concern at the central bank and the risk is that the market, which had been leaning to a rate cut, will be forced to reconsider. This could help pressure the euro toward support near NOK8.30 initially. A break of that area would signal a great correction to the Nokkie's 2013 trend lower.