Investors Remain Uneasy even as Equities Stabilize

There is an unease that continues to hang over the market.  It
is as if a shoe fell last week, and most investors seem to be waiting for the
other shoe to drop.  It is hard to imagine the kind of body blow that the
equities took last week without some kind of follow through and knock-on

Moreover, the focus today on US CPI may prove for nought.  The
consensus view is that the rise in US average hourly earnings spurred inflation
fears, a sell-off in US Treasuries, triggering the slide in stocks. 
Journalists and investors have put much weight in today’s CPI report.  We
think it is too much, but will be looking at how the market responds to the
news as an important reflection of market psychology. 

Specifically, the 0.2% and 0.3% rise in the core and headline rates
respectively will be unable to prevent the year-over-year rates from slipping
lower, due to the larger rise in January 2017. 
We do look for US
inflation to edge higher this year, but see it as beginning later in Q1 and
running through early Q3.  

First, we note that the market appears to have nearly fully discounted
the likelihood of a rate hike next month, has priced in about a 60% chance of
follow-up hike in June.
  Second, as of Feb 6, speculators in the
futures market had a record short 10-year Treasury position.  The yield
has not been below 2.805 this week and put in the recent high on Monday near
2.89%.  The technical indicators favor consolidation or higher prices
(lower yields).  Third, the S&P 500 closed higher yesterday for the
third advancing session.  It finished yesterday a hair above the 38.2%
retracement of its swoon (~2662.65).  The 50% retracement is a little
below 2703.  

The MSCI Asia Pacific Index rose 0.3%, but it was dragged down by the
heaviness of Japanese stocks. 
The Topix fell 0.8% and is now at a
four-month low.  Excluding Japan, the MSCI Asia Pacific Index was up
0.9%.  We note that foreign interest has returned to South Korean
equities.  Foreign investors bought a modest $154 mln of Korean shares
today.  European markets are following the US and Asia higher.  The
Dow Jones Stoxx 600 is up about 0.7% in broad gains.  

The yen remains very much the main focus in the foreign exchange
The dollar fell 1.25% against the yen last week, while rising
against all the other major currencies.  It has fallen each day this week,
and earlier today fell to a low near JPY106.85, its lowest level since November
2016.  The recent yen moves appear to be led by Japanese-based
investors.  It could be increasing hedge ratios.  It could be
reducing new buying of foreign securities.  Some link recent yen strength
to efforts to curb retail leverage.  

Thus far the reaction from Japanese officials has been quite modest. 
It jives with our understanding that at least some officials can accept a rise
in the yen, provided it is gradual and part of a broader move in the foreign
exchange market.  The yen’s strength is not simply against the dollar. 
It is appreciating on a trade-weighted basis.  In fact, with today’s gains
(~0.7%), it has appreciated for the seventh consecutive session on a
trade-weighted basis.  Over this period, it has appreciated by more than
3%.  The pace and breadth of the yen’s appreciation would seem to
challenge Japanese official resolve.

However, given the attitude of the US Administration, Japanese officials
will tread carefully. 
The OECD, for example, considers the yen the
most undervalued currencies on a PPP-basis (~9.75% undervalued at
JPY107.50).  Also, Japan has a current account surplus of around 4% of GDP
last year, up from less than 1% in 2013-2014.  

Stops apparently were triggered on the break of JPY107.  Th
reactionary bounce that also began in Tokyo is running out of steam in the
European morning near JPY107.50.  If the JPY106.80 is taken out, the next
chart level is in the JPY106.40-JPY106.60 area, but many will set their sights
on JPY105.  

Separately, Japan’s first estimate of Q4 17 GDP was disappointing.  The economy appears to have nearly stagnated, with the quarter-over-quarter pace of 0.1% in real terms and it was flat in nominal terms.  The bright spot was consumption (0.5% after -0.6% in Q3), but business spending was weaker than expected (0.7% rather than 1.1%).  Public investment and residential investment fell, while trade was a net wash.  The GDP deflator, which some suggest may be a better measure of inflation than CPI was flat after a revised 0.2% gain in Q3 17. 

Investors have been unable to get excited about much else today. 
A slightly higher two-year inflation expectation in New Zealand has the local
dollar leading the majors; eclipsing the yen, with a 0.6% advance.  It is
the fourth consecutive advancing session.  The Swedish krona is
dramatically unchanged following the Riksbank meeting, that shifted the first
rate hike to H2 this year from mid-year, and tweaked lower its inflation

The euro initially extended its three-day advance into today’s session, and
poked briefly above $1.2390 to see its best level since last Wednesday, where
it met good offers, and returned to where NY left it yesterday (~$1.2350).
  Still support is seen near $1.2340, and if risk appetites
return following the US CPI, the euro can resurface above $1.2400.  That
said, there are more than 2 bln euros of options struck between $1.2340 and
$1.2350 and another 1.5 bln euros struck at $1.2400, all of which expire

The euro is straddling resistance near GBP0.8900. On an intra-day
basis, it reached nearly GBP0.8930, it is has struggled to close above it since
late last November.   Against the dollar, sterling is trading within
yesterday’s ranges, but is still within last Friday’s range


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