Markets are Eerily Calm

Overview: There is an eerie calm over in the capital market through the European morning today despite some ostensibly worrisome developments.  While many, like ourselves, expect UK Prime Minister May to survive a vote of confidence, it hardly clarifies the outlook.  The US government shutdown continues unabated, except that some furloughed workers are being ordered back without pay, while the economic impact is seen increasing, taking a little more than 0.1% off GDP a week.   US Trade Representative Lighthizer saw little progress in recent talks with China, according to a Senator he spoke with, though was pleased with the soy purchases.  The US and Europe are staking out positions for their trade talks, and a fight over agriculture has already been signaled.  The dollar is little changed, mostly inside yesterday’s ranges.  Global equities are narrowly mixed.  Peripheral European benchmark 10-year yields are softer, led by Italy after a successful syndicated bond sale yesterday.  Core bond yields are slightly firmer.   

Asia Pacific

Chinese officials have been rolling out stimulative measures to arrest the economic slowdown, which seems partly a function of its own internal dynamics, but also a function of foreign demand.  Some of the reduction in foreign demand is tied to the trade tensions with the US and some likely reflect weaker growth abroad.  Today’s record injection (CNY560 bln) is a record open market operation but is not part of the stimulus effort but appears motivated by technical considerations, such as today’s tax date and preparations for the upcoming Lunar New Year holiday.  Pressures have been building over the past week as the seven-day repo rate has risen by nearly 45 bp over the past week.  

Mostly due to natural disasters, the Japanese economy contracted in Q3.  It bounced back strongly in October, but the global headwinds seem to have cramped the recovery in November.  Earlier today, Japan reported core machinery orders were flat in November.  Economists had expected a small increase after a dramatic 7.6% rise in October.  The preliminary estimate for the overall machine tool orders for December had been reported previously to have fallen 18.3% year-over-year after a 17.0% fall in November.  The weak tertiary industry index slippage of 0.3% in November seems to reflect some payback after the 2.2% increase in October (initially 1.9%).    Japan will report December CPI before the weekend, and the effect of decline in oil prices will likely be seen.  The BOJ meets next week, and there is some speculation that it will shave its inflation forecasts due to the decline in oil (and rise in the yen?).  

The dollar remains in a JPY107.80-JPY109.00 trading range.  Toward the lower end of the range, there are around $1.8 bln in options struck between JPY107.80 and JPY108.20.  The Australian dollar is also moving sideways in a narrow range (~$0.7175-$0.7235).  The technical indicators appear to favor a downside break.  The New Zealand dollar is lower for the third session and is threatening to extend its range lower.  The dollar eased four of last week’s five sessions against the Chinese yuan, and after firming Monday, the dollar yesterday and today.   The dollar finished the local session below CNY6.76 for the first time since the middle of last July.  We expect officials to protest/resist a move below CNY6.70.  


At the end of last year, May survived a vote of confidence within the Tory Party. The MPs may be frustrated with her, but there was no acceptable alternative.  May is right:  the House of Commons rejected the Withdrawal Bill, but are still no closer to agreeing on an alternative.  That is what needs to be explored assuming she passes today’s confidence vote in Parliament.  She is expected to survive because most of those that rejected the bill yesterday, do not want to have an election, which would be the third one in four years.  May indicated that she would reach out to opposition parties to see what a majority wants.  There are several possibilities, including a second referendum, a Norway-style partnership, or a permanent customs union.    The EC has expressed its disappointment but has not offered new concessions.  It is possible that it will at some point, but the UK is still negotiating with itself.   If May does not survive the vote of confidence, sterling will likely sell-off.  If she survives,  a flurry of meetings over the next few days will see a new position emerge over the weekend and early next week.  We suspect the Brexit will be softer and take longer (beyond March 29) than anticipated.  

Separately, the drop in oil prices shaved UK headline inflation.CPIH eased to 2.0% from 2.2%, and CPI slipped to 2.1% from 2.3%.  However, the headline understates the decline, as core inflation edged higher to 1.9% from 1.8%.  Recall that last year, it peaked at 2.7% in January and trended lower after that posting the only increase in August before today’s report.  On the producer side, input prices were not as weak as expected while output prices were weaker.  This warns of possible pressure on the business margins.  

In his first speech of the year, ECB President Draghi offered a dour assessment to the EU Parliament.  He acknowledged that the slowdown may last longer than expected, though he still resisted the idea that the euro-area is headed for a contraction.  Draghi continues to pin his hopes on the strength of the labor market.  The ECB meets next week.  Draghi’s speech likely reveals the thrust of the content and tone of his remarks at the press conference.  Last year, the euro fell on nearly every ECB meeting day even as it prepared investors for the winding down and eventual conclusion of its bond-buying program. 

The euro is pinned about a third of a cent range near yesterday’s lows, straddling $1.14 area.  That is the middle of the $1.13-$1.15 trading range, which was briefly violated last week.  The euro peaked at $1.1570, but the breakout proved unsustainable.  Initial resistance now may be seen in the $1.1430-55 area.  Sterling returned almost to the seven-week high set on Monday near $1.2930 in dramatic recovery following the vote from a low near $1.2670.  A loss of the confidence vote could send it back toward there, while the upside on a victory may be more muted.  

North America

The partial US government shutdown limits the economic data that can be reported.  That said, the highlight today is the Fed’s Beige Book in preparation for the FOMC meeting at the end of the month.  That meeting will be all about Powell’s press conference.  The statement will most likely confirm the verbal signal of patience, which means no hike in March, and that policy is not a preordained course.  That does not contradict the reduction of the balance sheet which continues uninterrupted because it is not now a tool of monetary policy.  

The longer the shutdown persists, and it is difficult to say that any progress has been made, according to reports, the more economic damage will be inflicted.  It has already likely cost 0. 5 percentage points off Q1 GDP at an annualized pace.  Although some banks have announced Q4 earnings, Alcoa kicks off the broader market reports today.  Earnings growth for the S&P 500, according to FactSet has fallen from 17% back in September to 11%.  

Canada reports December CPI figures ahead of the weekend.  A 0.4% decline on the month will keep the year-over-year pace at 1.7%, while the core measures are a little firmer.  The Canadian dollar is also inside yesterday’s range.  The US dollar’s sharp downside momentum seen since the start of the year, stalled last week a little below CAD1.32.  The high thus far this week is just shy of CAD1.33. We look for this area to be surmounted in the near-term to test the CAD1.3365, the initial corrective target.  


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