She Can’t Accept No

Overview: The UK Prime Minister has two weeks to strike a new deal with the
EC over the Irish backstop or return to Parliament in mid-February to consider
alternatives, six weeks before
Brexit.  Sterling has recovered about half of yesterday’s drop.  The
Australian dollar jump back to $0.7200 was aided by the nearly 10% jump in iron
ore price after Vale announced a sharp reduction in output.  The Mexican
peso is the weakest of emerging market currencies after Fitch cut Pemex’s
credit rating two notches to BBB- and
maintained a negative outlook.  Equities are narrowly mixed. 
Although Chinese and Japanese stocks fell, most of the other regional markets
rose.  The Dow Jones Stoxx 600 in Europe is eking out a small gain through
the morning, led by consumer discretionary and materials sector.  Bond
markets are also mixed.  Italian bonds may be building a concession ahead
of today’s supply.   The ADP private sector jobs estimate, the FOMC
meeting, and Mexico’s Q4 GDP are the highlights from the North America
Australia reported slightly
softer Q4 CPI of 1.8%, down from 1.9% in Q3.  It rose 0.5% on the
quarter.  Evidence softer inflation reading will not sway the investors or
policymakers is evident by the more than three basis point increase in Australia’s
two-year yield.  The more important news for investors was the
9.5% rise in iron ore prices to 15-month highs, as Vale announced that
decommissioning of trailing dams will cut its output by 40 mln tons.
Australia’s equities rose 0.2%, but the material sector was up over 2%. 
Japan reported retail sales
rose 0.9% in December, which was more than twice the gain expected after a 1.1%
decline in November (initially 1.0% decline).  The year-over-year rate
ticked down to 1.3% from 1.4%.  Economists expected a 1.0%
pace.  While stronger retail sales are
helpful, the economic rebound from the contraction in Q3 still seems
 Tomorrow Japan is expected to report a 0.5% decline
in December industrial output.  It follows a 1.0% slide in November after
October’s 2.4% surge as the reconstruction from the natural disasters
At least 20 Chinese companies
warned of weaker earnings today, blaming the economic slowdown and accounting
changes.  Nevertheless, Bloomberg data suggests foreign investors may
have bought a record amount of Chinese shares this month through the Shanghai
and Shenzhen connect facility.
  It appears foreign investors bought
CNY52 bln (~$7.8 bln) of A-shares.  
The Chinese yuan rose about
0.25% against the US dollar.  The greenback was sold for the sixth
consecutive session and has not fallen below the 200-day moving average
(~CNY6.7250) for the first time since last June.
  Officials had seemed
to imply they did not want it to go
beyond CNY6.70, but the market seems intent on testing officials.  The
trade talks get underway today and tomorrow in Washington.  The most that
can be reasonably expected is for both
sides to accept that progress is being made
and that there is time for another round of talks before the early March
deadline.  Next week’s Lunar New Year holiday is draining liquidity, and this is evident in the money market (and
forwards in Hong Kong).  The Australian dollar is testing the
$0.7200 area.  The high for the month was
set near $0.7235.  We are more inclined to sell into these gains
than look for an upside break.
  The dollar is in less than a quarter
yen range against the Japanese currency. There is a nearly $400 mln
option at JPY109.30 that expires today. 
 There are much larger
options struck at JPY110 that expire tomorrow and Friday ($1.3 bln and $1.8 bln
When everything was said and
done, the UK House of Commons authorized the Prime Minister to seek
alternatives to the current backstop provisions in the Withdrawal
Agreement.  The EC and several countries individually, and notably Ireland
has summarily rejected this.  If a customs border cannot be
between the Republic of Ireland and Northern Ireland, nor a border between
Northern Ireland and the rest of Britain there is one obvious solution: 
Remain in the same customs union. 
Parliament rejected this course
yesterday.  Sterling’s six-week rally reflects perceptions of diminished
downside risks, but the House of Commons vote that rejected a no-deal exit barely scraped by (318-310), and it is not binding (like the referendum
itself?).  Positive action still must be taken to avoid a hard
Brexit.  May was given a
two-week mandate.
  Without changing the UK’s red lines, it seems
highly doubtful that the EC will change its red lines.  UK officials must recognize
this and appear to be playing for time.  Sterling was sold yesterday
when it seemed that the risk of a no deal exit had increased.  Ideas
that a delay in Brexit is all but inevitable may be helping sterling stabilize
France reported its Q4 GDP rose 0.3%, which is the same as in Q3
but better than expected.  Ironically,
exports seemed the key, and they contributed 0.2 percentage points to growth.  Household demand was weak.  Consumer
spending slumped 1.5% in the month of December,
and it was the third decline in four months.
Growth last year slowed to 1.5% from 2.3% in 2017.  Several countries, including
Germany, Italy, and Spain report Q4 GDP tomorrow, and the preliminary aggregate figure for EMU will also be reported. 
Political risks may be
rising in Italy. 
Prime Minister Conte warned the government
is “wobbling.”  League leader Salvini’s strong anti-immigration
stance is leaving him vulnerable to some legal challenges, according to the
local press.  Meanwhile, the League support is
seen near 32%, roughly double last year’s electoral performance.  Tensions between the unlikely coalition
partners have reportedly increased, and the ambitious Salvini may be tempted to push
for an election ahead of the May EU Parliament elections on ideas that he could
head a center-right government with Berlusconi’s Forza Italia and the Brothers
of Italy. 
The euro is confined to a
quarter of a cent below $1.1450.  The market appears to be waiting for the
FOMC to provide more incentives.  There are no expiring options to note
today, but tomorrow there are options struck at $1.1400-$1.1405 for 2.2 bln
euros.  We anticipate the North
American session to probe the upside today.
   Sterling recouped about half of yesterday’s
decline and appeared to have lost some
momentum in the European morning as it approached $1.3120.  The euro is consolidating yesterday’s gains against
sterling.  It reached GBP0.8755 yesterday and has eased back
to GBP0.8715 today.  Chart support is seen near GBP0.8700. 
There are three main events on
the US diary today:  the resumption of
trade talks, the ADP private sector jobs estimate and the FOMC meeting. 
The first day of trade talks should not generate many headlines. 
The ADP jobs estimate is expected
to fall from 271k to 181k,  largely matching
the decline expected to be reported by the national report at the end of the week.  There the consensus
is for payback after a 312k job increase in December.
There is no doubt the FOMC
is on hold through the first part of the year. 
While the market anticipates that the Fed is likely on hold all year, many economists still look for a hike
or two.   The FOMC statement should be succinct
While it maintains the roughly balanced risk outlook, the forward
guidance will likely be replaced with the emphasis on patience, flexibility
and data dependence.
   Although the impact of the balance sheet reduction
is controversial, we look for some rhetoric that will ease the anxiety in some
quarters.  Powell is likely to emphasize what the Fed has already indicated, that
the balance sheet will remain much larger than before the Great Financial
Crisis.  He is unlikely to announce a
target in time or size
.  Note that although the Fed says it can reduce the balance
sheet by $50 bln a month since last October, it is
letting only about $40 bln a month roll-off.
Mexico reports Q4 GDP today. 
It is expected to slow from 2.4% to 2.0%.  The downgrade
of Pemex has hit the peso.
  It warns
about the quality of it as a standalone credit and notes that it has under-invested in upstream businesses.  The company has a total negative equity
balance since 2009, and there have been
14 consecutive years of declining output. 
Pemex dollar bonds (due 2027) had the biggest sell-off yesterday in
three weeks. 

The US dollar is trapped in
a CAD1.3200-CAD1.3285 trading range.
tested the top side yesterday and is set to push to the downside.  The dollar rose to almost  MXN19.15 in Asia after dipping below MXN18.97
yesterday.  It has not closed above the
20-day moving average (~MXN19.1370) since December 5.
  Elsewhere, note that Chile is expected to
hike rates 25 bp tomorrow (to 3%) and the currency has gained for the past four
weeks, leaving the greenback at the lower end of its five-month trading


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