Dollar Firms, While Equities Search for Stability

The swings in the equity markets are subsiding, bond yields are firm and
the US dollar is extending its recovery. 
   Although US
equities closed lower, the MSCI Asia Pacific Index snapped a four-day drop by posting
a 0.25% gain.  However, the MSCI Emerging Markets Index is off nearly as
much, though the range was modest.  European markets are also lower, and
the range for the Dow Jones Stoxx 600 is the smallest in more than a
week.  

There have been several developments in addition to the price action to
note. 
  First, China reported a January trade surplus that was
less than half the forecast size.  The $20.34 bln surplus contrasts with
expectations for a little changed reported from the December $54.7 bln. 
Exports were up 11.1%, which marked a small acceleration.  That was not
issue.  Imports surged 36.9%.  They were up 4.5% year-over-year in
December, and while acceleration was expected, nothing on this magnitude was
anticipated.  

The data is likely distorted by the impact of the Lunar New Year, which
was earlier in 2017.
  But the optics work in the China’s favor which
is facing increased trade tensions with the US.  By China’s calculations,
its trade surplus with the US narrowed to $22 bln.  Exports rose 12.5,
while imports from the US rose 26.5%.    

Separately, a Reuters reported that there may be a loosening up of the
controls of outbound capital flows (QDLP), and the yuan, which has been
strengthening steadily since mid-December snapped back today.  

The US dollar rose 0.75% against the yuan, its biggest move since the 2015
devaluation.  The greenback returned to levels seen at the end of last
month (~CNY6.3250).  

Second, the Reserve Bank of New Zealand provided a dovish hold for
investors, and the New Zealand dollar fell to the its lowest level since
January 10 (~$0.7175).
  The central bank pushed out further when its
expects to reach its inflation target (now late 2020, a two-year delay) and
shaved its GDP forecast.  This signals that policy may be on hold longer
than the market previously expected. The strength of the New Zealand dollar
(~5% on a trade-weighted basis in the past 2.5 months) was unexpected, but the
central bank continues to expect it to weaken. 

Third, the focus now is on the BOE meeting and quarterly inflation report
where forecasts are updated.   
There is little doubt that the
policy is on hold.  The question is how many MPC members disagree. 
The consensus expects no dissents, but a single dissent would not be too much
of a miss.  Two dissents and the market may take more seriously a hike in
May (now about 48% chance).  The BOE forecasts had assumed that about 62
bp of tightening would be delivered over the next three years. 

It may be interesting to compare the BOE’s forecasts with the new EC
forecasts. 
The EC forecasts were updated earlier this week. 
They show the US economy expanding 1.8% last year and 1.4% this year before
slowing to 1.1% in 2019.  Next year’s forecast is particularly
pessimistic.  Governor Carney argued before Parliament that prior to the
referendum, the BOE warned that Brexit would send sterling lower, inflation
higher, and would be a negative shock for the economy.  And indeed, this
has come to pass.  The BOE forecasting period covers much of the post-March
2019 period, and yet so little is known.  This alone dictates
caution.  

Fourth, after the BOE meeting and press conference, attention will shift
back to the United States.  
The performance of the US equity
market is important.  It is presently little changed.  The key is not
so much direction as volatility.  Some work suggests volatility is
auto-correlated, meaning that one volatile day is often followed by another
volatile session.   The surge is gradually subsiding.  Although
there appears to be no impact on monetary policy or broader economic trends,
many are debating if this marks a new regime for investors.   

The other key issue in the US today is the pending government shutdown
starting tomorrow unless action is taken. 
As we noted yesterday, the
Senate has a two-year plan that would boost defense and non-defense spending by
around $300 bln (including disaster relief) over the next two years.  The
Senate will likely formally approve the plan early today and then the drama
shifts to the House of Representatives.  A conservative group (Freedom
Caucus) is balking at the increase in domestic spending, and a Democrat group
wants a promise for an open debate on immigration, which is what was made in
the Senate.    

Before the House votes, the US will be auctioning 30-year bonds to round
out the quarterly refunding. 
  The soft 10-year auction yesterday
weighed on yields and may have encouraged the afternoon pullback in
equities.  

With today’s losses, the euro has given back half of its gains from the
year’s low (January 9 ~$1.1915). 
A move below $1.2225 would target
$1.2150-$1.2160 next.   Note that there is a 574 mln euro option
struck at $1.2265 that expires today.  There are 1 bln euros struck at
$1.22 that expires tomorrow.  The intraday technical readings suggest
consolidation is likely in North American today.

The greenback is firmer against the yen, but has only marginally extended
yesterday highs
.  The market seems tentative.  A move above
JPY110 would be promising, but last week’s high near JPY110.50 seems
distant.  There are two option strikes to note that expire today: 
JPY109.40 ($415 mln) and JPY110 ($475 mln).  

Sterling has formed a shelf with its lows over the past two sessions and
today in the $1.3835-$1.3850 area. 
Initial resistance is seen in
the $1.3820-$1.3840 area.  A move above $1.40 would improve the technical
tone and create space for another cent advance in the coming days.  

The dollar-bloc currencies are extending their recent losses, and
important technical levels have been approached.
  The Australian
dollar, which had been probing $0.8100 at the end of last month is now testing
$0.7800.  The $0.7820 area housed the 50% retracement of the rally from
early December.  The 61.8% objective is near $0.7745.   The US dollar
has made new highs against the Canadian dollar for the year, retracing 50% of
the losses since mid-December, but the CAD1.2600-CAD1.2625 may prove sticky
today.  

Disclaimer

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