European Interest Rate and Oil Price Adjustment Continue Ahead of US/Canada Jobs Report

Overview: Better earnings from Amazon, Pinterest, and Snap lifted US tech after th dramatic loss on Wall Street yesterday.  Most Asia Pacific bourses rose, led by the 3.75% rally as Hong Kong re-opened.  India and New Zealand were exceptions and slipped lower.  Real estate and industrials are dragging the Stoxx 600 in Europe lower (~-0.75%). This is sufficient to offset the week’s earlier gains and threatens to extend the losing streak for a fifth consecutive week.  US futures are firm.  The adjustment in rates continues.  Japan’s 10-year is approaching the upper end of the range permitted under yield-curve control (0.25%). The fx sensitive two-year German yield is up for the ninth consecutive session, during which time it has risen by more than 35 bp.  The US premium is narrowing for the sixth session, and it is more than 30 bp tighter.  The swaps market is pricing in about 10 bp of tightening by the ECB around mid-year.  The US 10-year year is hovering around 1.82%., a four-basis point increase on the week.  The dollar is mostly firmer, paring this week’s losses.  The dollar-bloc and Swiss franc are under-performers today.  The euro extended yesterday’s gains but is holding below last month’s high near $1.1485. The South Korean won, and Russian rouble lead the emerging market complex higher.  The rouble has appreciated 2.5% this week, leaving it off about 1.6% for the year.  The JP Morgan Emerging Market Currency Index is little changed.  It is up about 1% this week before local Latam currency markets open.  It would be the fourth weekly gain in the past five.  A winter storm around Texas spurs fears of a disruption to the US energy market and helping lift oil and gas prices. Beyond the weather, low inventories, and limited capacity to boost output are underpinning prices. A couple of large producers announced plans to boost shale production in the US.  March WTI is now above $91.50, as it rises for the seventh consecutive week.   Gold is firm and is making new highs for the week near $1815.   It is up about 1.2% for the week.  Copper has little changed on the day, and is up about 3.7% for the week, after falling 4.7% last week.  

Asia Pacific

The Reserve Bank of Australia’s monetary policy statement did not impress the market.  The RBA continues to imply that the rise in prices in temporary.  It sees core CPI poking above 3.0%, but then returning to 2.75% through mid-2024.  The wage price index is expected to rise 2.75% this year and 3% over 2023.  Governor Lowe said earlier this week that a rate hike this year is a “plausible scenario.”  The market thinks it is a certainty.  The swaps market has the first hike priced in around mid-year and about 120 bp of hikes over the next 12 months. 

South Korea’s January CPI rose 0.6%, a bit more than expected.  The year-over-year rate eased to 3.6% from 3.7%.  The median forecast (Bloomberg survey) expected a 3.4% rate.  The core rate rose to 3% from 2.7%, which was also a little higher than expected.  The central bank meets on February 24.  It hiked rates twice last year (August and November) and hiked again last month, lifting the seven-day repo rate to 1.25%.  While a hike is possible, March seems like a more likely timeframe. 

Before China’s mainland markets re-open, the Caixin non-manufacturing and composite PMI will be reported.  Weaker readings are expected.  Travel during the holiday appears to have not been particularly strong.  When the mainland markets closed last week, the dollar finished at almost CNH6.3680 against the offshore yuan.  It is currently changing hands around CNH6.3580.  The dollar settled last week around CNY6.3610 against the onshore yuan.  

Elevated yields and firmer stocks helped the dollar extended yesterday’s gains.  The greenback is straddling the JPY115 level and has hardly moved more than 15 ticks away in either direction.  Last week’s settlement was close to JPY115.25, and the dollar finished last year slightly above JPY115.00.  At the end of last week, we thought the Australian dollar looked best from a risk-reward point of view and did not expect the $0.7000 break to be sustained.  The Aussie rallied to almost $0.7170 yesterday but has stalled.  It is near $0.7100, where a A$750 mln option expires today.  A break of the $0.7090 area could see it set back toward $0.7045-$0.7065.   


The hawkishness of the Bank of England was not only in the 25 bp rate hike and the confirmation that that all maturing issues will no longer simply be recycled into now purchases.  This was already widely expectation and telegraphed.  However, that four of the nine members favor a 50 bp hike, something the BOE has done since getting its independence in 1998.  Governor Bailey cast the deciding vote.  Recall, that Mervyn King (BOE Governor 2003-2013) was out-voted twice during his tenure.  Bailey’s call for British workers to hold off demands for higher pay may be tone deaf.  Between higher energy bills and tax increases, real incomes are set to fall the most in a generation.  The Bank of England governor gets paid nearly GBP500k a year.  It does not put the Tories in a sympathetic light.  

Separately, tensions with the EU over the Northern Irish border ae likely to rise after the Northern Ireland’s agricultural minister ordered his staff to stop inspections, which would seem to violate the Brexit agreement.   Meanwhile, a new front was opened against UK Prime Minister Johnson.  His chief of policy resigned over what she said were “scurrilous” claims by the prime minister about Labour leader Starmer.  This was quickly followed by three other resignations (private secretary, chief of staff, and communications director). 

The ECB’s initial statement offered little news, but there were hawkish indications.  It has to do with the assessment of inflation and the absence of the commitment not to raise rates this year.  President Lagarde acknowledged that inflation was more elevated and for longer than anticipated.  While she attributed the elevation partly to the energy shock but recognized that the risks were tilted higher.  In March, the ECB staff will provide updated forecasts and there will be a more intense discussion about inflation.  Itis likely to see inflation above the 2% target.  

The sequence that the ECB laid out in December is still operational. The Pandemic Emergency Purchase Program will end in March and the pace of the pre-Covid Asset Purchase Program would double to 40 bln euro for the next six months.  Some “sources” were quoted on the newswires suggest that APP could end in Q3, while the plan outlined previously would have it fall back to 20 bln a month. The swaps market shows a 10 bp hike is discounted for around mid-year, which seems like a stretch.  Next month’s ECB meeting will see new staff forecasts (inflation higher) and new guidance on bond purchases.  

Although the German economy contracted in Q4 21, it appears to have finished the quarter on a firm not and it is carrying over into this year.  That was reflected in the manufacturing and service PMI.  That was echoed in the construction PMI reported today at 54.4, the fifth monthly increase and above the 50 boom/bust level for the first times since February 2020.  December factory orders jumped 2.8% (after a revised 3.6% increase in November from 3.7% initially).  This may spill over into next week’s industrial production report.  

The re-pricing of the outlook for ECB policy and European rates has been critical for the euro’s nearly 3% surge this week, which if sustained would be the largest weekly advance since March 2020.   The adjustment in rates began before the ECB’s meeting, and Lagarde pushed on an open door.  We anticipated a new low in the euro and thought last week’s move to almost $1.1120 was a down payment toward our $1.10 objective.  However, the subsequent price action may point to last week’s low being significant.  On the upside, the $1.1485-$1.1500 offers the nearby cap, but if the more significant hurdle may be closer to $1.16.  Sterling’s upward momentum stalled near $1.3630 yesterday.  It is trading inside yesterday’s (~$1.3540-$1.3630) range.  Recall, sterling settled near $1.3590 at the end of last week. It is up about 1.2% this week, which if sustained would be among the largest since late 2020.  Provided the $1.3540 area holds, we anticipate another run at the highs.  


Nearly everything is point to a weak US jobs report.  The Census Bureau’s Household Pulse Survey found that more than 14 mln Americans did not work for some part of the December 29 to January 10 period because either they had Covid, or were caring for someone with it, or taking care of a child who did not go to school or daycare. Weekly initial jobs claims spiked in the week that the establishment survey was conducted.  Employment metrics of the PMI and ISM surveys softened.  ADP shocked with a 301k estimated loss of private sector jobs last month.  Of course, it is Covid-related.  Roughly half the jobs lost, according to ADP were in the leisure and hospitality industry.  Another 20% were accounted for by the trade, transportation, and utility sectors.  Taken together with education and health services these areas account for about three-quarters of the job loss.  

More broadly, the US economy appears to slow to crawl at the start of 2022.  Fed Chair Powell acknowledged the sharp slowdown in the press conference after last month’s FOMC meeting.  As of February 1, the Atlanta Fed’s GDP tracker sees 0.1% growth here in Q1. The January composite PMI was not quite a weak as the flash estimate had it (50.8) but at 51.1, it marks the single biggest decline since April 2020.  It is the lowest reading since July 2020. While the magnitude of the decline is striking, the fact of the matter is that is has been trending lower since peaking last May.  Indeed, the only month it has not fallen since then is October 2021.  One of our key thematic points is that monetary and fiscal policy are being tightened as the US economy slows.  The doubling of the price of oil over the past year is a potent headwind that preceded that past three recessions.  The maturation of the inventory cycle reduces a tailwind.  The market expects policy makers to look through any downside surprise, and there will be another employment report before the FOMC meets in mid-March.  The market is pricing in about a 1-in-5 chance of a 50 bp move, even though no Fed official has endorsed this course even the noted hawk Bullard.  

A poor Canadian employment report should also be expected.  However, Canada’s labor market has healed more than the US.  Canada lost 1.95 mln full-time positions as the pandemic struck.  It has subsequently grown 2.19 mln full-time jobs.  Also, consider that participation rate is at 65.3% compared with the pre-pandemic rate 65.5%. Bank of Canada Governor Macklem confirmed that the labor market has healed.  The swaps market has 160 bp in seven meetings. Macklem suggested that the balance sheet could begin unwinding as rates rise.  The implication is for Q2 move.  

The US dollar has forged a shelf in the CAD1.2650-CAD1.2660 area in recent days.  The top side has been capped around CAD1.2720.  The intraday momentum studies suggest a new high is possible but may not prove sustainable.  The greenback has also been finding bids against the Mexican peso around MXN20.50. Here too, while the US dollar may move higher initially in the North American session, we are more inclined to fade it and look for a tested to the MXN20.55 area.  The central bank meets next week (after the January CPI figures).  Many are looking for a 50 bp hike (like in December) even though the economy contracted n Q4 for the second consecutive quarter.  Meanwhile, the government is floating the idea of another infrastructure initiative. 


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