Dollar Slide but Resilience Demonstrated while Yuan Squeezed Higher

There are two main developments. 

First, the high degree of uncertainty expressed in the FOMC minutes and
the repeated references to the strong dollar spurred a wave of dollar selling.

The dollar retreated in Asia, but European participants saw the pullback as a
new buying opportunity. 

Second, Chinese officials have continued to squeeze liquidity in the
offshore yuan market (CNH), and some reports suggest that state-owned enterprises were encouraged to sell
foreign exchange holdings.
In addition to more formal and informal capital
controls, Chinese officials triggered a short squeeze that has been painful
enough to likely deter aggressive sales in the
. In these two days, as the overnight deposit rate for yuan in
Hong Kong rose to 80% and the three-month
deposit rate jumped 100 bp, the CNH has rallied nearly 1.9% and on the onshore
yuan (CNY) has gained 1.1%. 

Longer-term outlooks will not change due to the short squeeze.  
More powerful fundamental drivers include the broader trajectory of the dollar
and interest rate differentialsStill, capital controls and the willingness of
officials to facilitate such a powerful squeeze demonstrates their resolve and
ability to manage the challenges. 

Separately, there was more confirmation of the stabilization of the
Chinese economy.
  The Caixin services PMI rose to 53.4 from 53.  This combined with the improvement reported
earlier in the manufacturing PMI, the composite rose to 53.5 (from 52.9), which
is a new record for the two-year-old time

The key takeaway from the FOMC minutes is that there is much uncertainty
surrounding the size, timing, and
composition of the new administration’s fiscal efforts.
This told investors that officials are not
particularly confident in their forecasts and projections, which Yellen had
admitted at the post-FOMC press conference that the steeper rate path reflected
very modest adjustments to a few changed forecasts among the

The US 10-year yields that reached almost 2.52% on Tuesday (2.57% on
December 28) fell to 2.43% yesterday and follow through buying pushed the yield
briefly below 2.40% for the first time in nearly a month.
two-year yield approached 1.295 last week and fell to 1.19% at the end of last
week.  It has held that level today.   

The rally in the US bond market carried over into Asia, but Europe is
Peripheral yields are 2-3 bp higher while core yields are little changed.  UK Gilts are
underperforming after a strong service PMI.  It rose to 56.2 from
55.2.  Many economists had expected a decline.  With the three PMI
readings in tow, the composite rose to 56.7, the highest level since
mid-2015.  The average in Q4 16 was 55.6 compared with 51.6 in Q3 and 52.5
in Q2.  

We also note that the German construction PMI reached a nine-month high
in December, while the eurozone retail
PMI bounced to 50.4 from 48.6.
  The eurozone
growth appears to be broadly stable, and prices are firming.  Even the
core rate ticked up to 0.9%, while most economists had expected it to remain at
0.8%.   Many expect price pressures to remain low in Europe due to
the still large output gaps.  A caution, however, comes from what appears
to be a loosening link between factor usage, such as near full employment (in
Germany, UK, Japan, and the US) and yet lower inflation than expected.

Today’s data highlight from the US will be the ADP private sector employment
  The Bloomberg median is for 175k after 216k in
November.  It will overshadow the weekly jobless claims, especially with
the monthly jobs report tomorrow.  Markit and ISM report December
non-manufacturing PMIs.  There may be some headline risk, but the focus is
on the labor market.  The employment sub-index will likely draw the

The euro reached $1.0575 in Asia, 2.3 cents above Tuesday’s low. 
However, the upticks were sold into, and the euro was pushed back to $1.05.  The key issue for participants
today is whether the dollar’s downside correction is over.  The lack of full participation and tomorrow’s US jobs
report are also factors.  On balance, we suspect the euro will find better
support in the $1.0450-$1.0470 area.  

The yen is the strongest of the majors, but it too has seen its earlier
gains pared considerably.
  The dollar peaked on Tuesday near
JPY118.60.  In Asia, it traded briefly through JPY115.60, the lowest since
the Fed’s rate decision in the middle of last month.  However, the
dollar’s resilience is again evident.  Europe took the dollar back toward
JPY116.70.  The JPY117.00-JPY117.50 may be difficult to

Sterling, which had bottomed near $1.22 on Tuesday reached through
$1.2360 today, from where it was sold down to $1.2270 before finding buyers in
The intraday technicals warn
that the low may not be in place today.  

The Australian dollar has unwound its gains that had carried it to
  Support is seen in
near $0.7270 and then $0.7240.  The US dollar fell to CAD1.3255 bounced
back to CAD1.3310.  Gains above CAD1.3350 are needed to lift the


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