Dollar is on the Defensive Despite Firmer Rates

The US dollar is softer against nearly all the major currencies. 
Participants appear to be growing increasingly
frustrated with emerging priorities of the new US Administration.  They
want to hear more details and discussion of the tax reform, deregulation, and
infrastructure plans.  However, the priority today is on authorizing the
construction of a wall between the US and Mexico and possible action on
immigration from “terror-prone”
countries, according to press reports.  

Sterling is the strongest of the major currencies.  Having
reached almost $1.26 today, it is at its best level since December 14, when the
Fed hiked rates for the second time in the cycle.  After an initial
wobble, sterling recovered smartly after
the Supreme Court’s decision yesterday requiring a both chambers to vote on a
bill to trigger Article 50.  The general sentiment appears to be that
while different amendments will be submitted, the small Tory majority may be sufficient to frustrate the most dramatic
proposals, such as having a second referendum on the entire deal.  

We anticipated that the court ruling would prove anti-climactic and that sterling was
for additional near-term gains.
  Yesterday’s knee-jerk
reaction saw sterling fall to test the trendline drawn off the early September
and December highs, and the neckline of a possible head and shoulder bottom
pattern (~$1.2425 and $1.2415 respectively) and recover to close on its
highs.  And today, follow through buying has lifted it further.  The
intraday technical readings are stretched
A support band between $1.2500 and $1.2550 may be sufficient to deter sharper

On the other hand, the Australian dollar is the weakest of the majors,
being the only one lower against the dollar.
  It is off about 0.6%
after a disappointing CPI report. To frame the issue, recall that the
Australian dollar fell in each of the last three months of 2016, and four of
the last five months.   However, this month has been a different
story.  It is the strongest of the majors, gaining around 5% coming into
today’s session.  

The Q4 CPI miss was not major, but it has spurred talk that the central
bank could cut rates again, with some thinking as early as next month.
Consumer prices in Q4 rose 0.5% instead of 0.7% as it did in Q3 and as the
median forecast in the Bloomberg survey had expected.  The year-over-year
pace was 1.5% up from 1.3%, but just off the 1.6% anticipated.  The
trimmed mean and weighted median were also 0.1% less than expected.  While
the RBA cannot be pleased with the sharpness of the Australian dollar’s
appreciation,  we have not convinced
the miss on Q4 CPI is sufficient to push the central bank into another rate

Despite firm US yields after yesterday’s seven basis point increase in
the US 10-year yield yesterday, and rising equities, the dollar is practically flat against the yen.
Japan reported a larger than expected December trade surplus (~JPY641.4 bln,
more than twice the Bloomberg median).  The December trade balance is
nearly always better than November’s but what stands out is that jump in
exports.  The 5.4% rise year-over-year is nearly five times larger than expected
and snaps a 14-month contraction.  Of note, exports to the US rose 1.3%
from a year ago, while exports to the EU were off 4%.  The big story is
the 12.5% jump in exports to China, its largest trading partner.  On a value basis, exports of auto parts and electrical
circuits each rose 38%.   

The contraction of imports continued.  The 2.6% decline
year-over-year was larger than expected, though it is the smallest contraction
since first going negative at the start of 2015.  The combination of
stronger exports and weaker imports allowed Japan to report is fourth
consecutive trade surplus.  It may spur economists to revise up Q4 GDP
forecasts, and turn more optimistic on Q1 17.  Both the Topix and Nikkei
rose for the first time this week. The 1.0% and 1.4% respective gains were the
best since January 4 the first trading session of the year for Japan. 

The Japanese equity gains were part of the regional rally after the US
S&P 500 rose to new record highs yesterday.
  The MSCI Asia Pacific
Index rose nearly 0.5% to record its highest close since late September.  Led by financials and
industrials, European shares are rallying as well.  The 1% gain of the Dow
Jones Stoxx 600, if maintained would be the largest since the day before the
Fed hiked last month.  The gap higher today suggests the nearly monthly
long correction after a 5.7% rise in December.  

The German IFO disappointed, but the market reaction was minimal. 
Essentially the assessment of the current situation improved slightly, but the
expectations components softened.  This combination weighed on the
business climate measure (109.8 vs. 111.0), which is still at elevated levels.

While we continue to think that the euro’s upside correction may be in
its final stages, it does look poised to push higher first. 
A retest
of yesterday’s high near $1.0775 seems likely.  The next technical
objectives are in the $1.0820-$1.0850 area.  Support is seen near $1.07.  

The US and Canada’s economic calendars are light, offering a little distraction from political events. 
Although it may not be a market-mover, global investors will be watching for
the Italian court ruling on Italy’s political reform (lower chamber only), and
are sensitive to the implications for the
timing of the election.  The 5-Star Movement is running neck-to-neck with
the PD, even though problems in the local government in Rome, which it leads,
raise questions of whether it has succeeded becoming a governing power rather
than simply an opposition force.  


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