Dollar Heavy into ECB

The US dollar is trading lower against all the major currencies as the
corrective forces continue to hold sway.
  The euro rose to nearly
four-week highs in the European morning, briefly pushing through $1.08. With
today’s gains, the euro has recouped
38.2% of the losses since the US election.  Although we have suggested potential in this correction toward $1.0850,
the next important retracement objective is a little above $1.09.  

The euro’s recovery ahead of the ECB meeting, however, seems to leave it
vulnerable to a buy the rumor, sell the fact type of activity.
Perhaps the
rumor is that Draghi has no important surprises to unveil.  Nearly everyone is looking for an extension of the
asset purchases, some operational adjustment to allow it to reduce the risks of
scarcity, and some measures to make it securities lending program more
user-friendly.   Also fitting in a pullback in the euro could be the
first increase in the US premium over Germany on two-year money for the first
time in five sessions today.  Initial support for the euro may be pegged in the $1.0740-$1.0760 area, with a
break sending the single currency back toward $1.07.  

There are three other developments
that are on the radar screen of international investors today.
Japan revised Q3 GDP unexpectedly lower to 0.3% rather than 0.5%, which reduces
the annualized rate to 1.3% from 2.2%.  Business spending and inventories
drove the revisions, while the upticks in consumption were insufficient to do more than blunt some of the impacts.  The GDP deflator was revised to
0.2% from minus 0.1%, leaving Japan as one of the few
countries still experiencing deflation.   

At the same time, Japan adopted the best practices in terms of GDP calculation (which other
countries such as the US and many European countries have already done)

Among other things, it means that research and development expenditures are counted as capital formation rather than an
intermediate input.  This means that
at the end of last year, the Japanese economy was about 6.5% larger (JPY532.2
trillion instead of JPY500.6 trillion). The dollar held above its week’s low
against the yen  (~JPY112.90).  A move now back above
JPY113.60-JPY113.80 would likely help stabilize the dollar’s tone. 

Second, China reported its November trade figures.  The surplus
was smaller than expected at $44.6 bln (compared with $49.06 bln in
October).  Both exports and imports rose.  Exports rose for the first
time in seven months on a year-over-year basis, even if just barely (0.1% in
dollar terms).  Imports rose 6.7%, the most in two years. Imports of
copper, iron ore and coal rose.  The
impact on either the dollar-bloc currencies, like the Australian dollar or
metal producers like the South African rand, has been muted.  

Since the end of July 2015, the
yuan has fallen 9.7% against the US dollar.
  This may help Chinese exports, especially as China continues to
evolve away from simple assembly work and toward more value added. 
However, as many other countries have found the linkage between currency
valuation and exports is far from simple or straightforward.  There is little substitute for stronger

Third, Italy’s political situation is far from clear.  A new
government will be formed, and it still
looks possible that Renzi, the head of the largest party, is a likely
candidate.  The state of the election law is problematic.  The
Constitutional Court will not review the electoral reforms for the lower
chamber until January 24.  There is no electoral law for the upper
house.  And there is no returning to the previous law, which was ruled

Many are still talking about the referendum results as being
anti-establishment and seem to think the Five Star Movement will be swept into
power and call for an immediate referendum on EMU membership. 
aside the fact that polls consistently show that the vast majority of Italians
want to the euro instead of a new lira; the
Constitutional Court has ruled out referendums on international treaties.

Late yesterday, Moody’s cut the outlook on
Italy’s credit rating to negative from stable. 
It is the Baa2 credit,
according to Moody’s, which is two notches into investment grade.  S&P
has it lower at BBB- and Fitch has it a
step higher at BBB+.  A one step cut by Moody’s would have little

DBRS is the one to watch.  It gives Italy an A rating.  It
is under review, which after postponing for the referendum, will make a
decision by early February.  It previously was most concerned about growth but recognizes the recent developments are credit negative. 
The DBRS rating is important because the most optimistic rating agency is the
one the ECB pays the most attention to in setting the haircut on collateral.  If DBRS cuts Italy’s rating, the
haircut will be larger.

The Financial Times lead story is that Italy has requested more time for
Monte Paschi to complete its capital raising exercise, arguing that the
referendum complicated matters.
  Meanwhile,  Italian banks shares
are gaining for the third session.  It is up nearly 2% after yesterday’s
almost 4.5% advance and Tuesday’s nearly 9% charge.  Italy’s 10-year
sovereign bond is underperforming with a six
bp rise in yields.  However, on
two-year money, Italy is outperforming the core and other periphery countries

The US reports weekly initial
jobless claims and Canada reports housing starts, permits, house prices and
capacity utilization rates.
  These are not market moving reported, and the focus will be on the


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