Week Winding Down on Firm Note, but Wild Ride may Not Be Over

Overview:  The biggest reversal in the S&P 500 since 2010, allowing it to string the biggest two-day rally in three years helped lift Asian and European shares today.  All the Asia-Pacific equity markets advanced today but Japan, where the strength of the yen saw the Nikkei and Topix buck the move.  European equities.  The 1.4% rally in the Dow Jones Stoxx 600 near midday in Europe retraces 2/3 of this holiday-shortened week’s decline.  Benchmark 10-year bond yields are little changed.  The rally in US shares late yesterday was not enough to lift the 10-year yield back above 2.80%, and Australia, New Zealand, and Japanese yields eased.  The 10-year JGB yield slipped into negative territory for the first time since September 2017.  European yields are mostly a little firmer, with Italian and UK bonds yields dipping a slightly.  The dollar is lower against most major and emerging market currencies.  The dollar-bloc currencies and sterling are consolidating, while the euro, Scandis, and yen are extending yesterday’s gains.  Oil prices are firmer, recouping half-to-two-thirds of yesterday’s drop.  US shares are trading higher, and the S&P 500 is up almost 0.5%.  


Japan reported a slew of economic data.  Most of it was soft, but after contracting in Q3, the world’s third-largest economy likely expanded in here in Q4.  Industrial output fell 1.1% in November, but after the 2.9% gain in October, economists had forecast a sharper decline.  The unemployment rate unexpectedly ticked up to 2.5% from 2.4%, though the jobs-to-applicants ratio also rose (1.63 from 1.62).  The most disappointing news came from retail sales, which fell 1.0% after a 1.3% (initially 1.2%) rise in October.  However, economists had expected retail sales to have held up better and expected only a 0.4% decline.  The MOF’s weekly portfolio report featured heavy foreign selling of Japanese bonds last week.  The JPY2.2 trillion sold liquidates about 2/3 of what was bought in the previous two weeks and are the most since the end of September.   It is not unusual for there to be large swings around the fiscal and calendar turns.  

South Korea also reported a drop in November industrial output.  The 1.7% drop (Bloomberg median forecast -0.2%) offset n full the 1.3% (initially 1.0%) gain in October.  A decline was seen in memory chips and smartphone output.   Investment in facilities and construction also weakened.  

On Christmas Day, the dollar reached JPY110.00 in Asia, a four-month low.  It bounced to JPY111.40 the next day as US stocks rallied strongly.  Yesterday’s late recovery in US stocks failed to lift the greenback against the yen, though it closed near JPY111.00.  It was sold off again in Asia, which consistent with the idea that Japanese institutional investors are raising hedge ratios.  It is pinned near its trough in the European morning near JPY110.30.  There is a nearly $450 mln option expiring today struck at JPY110.00. The spike low in late August saw the dollar test JPY109.80.  The Australian dollar made a marginal new low for the year yesterday a little below $0.7020.  It was not confirmed by the technical indicators, leaving a bullish divergence in its wake.  A move above $0.7080 is needed to confirm a low has been forged.  


The drop in oil prices will cut headline inflation measures.  Spain and Germany report preliminary December readings.  On the EU-harmonized basis, Spanish CPI eased 0.5%, and the year-over-year pace fell to 1.2% from 1.7%.  Several German states have reported and most reported sharp declines in the year-over-year pace. Five states have reported. The year-over-year pace was all north of 2.0% in October, now only one (Bavaria) is above 2.0% (2.2% vs. 2.7%). Baden-Wuerttemberg is at 2.0% (from 2.7%).  The risk is that the national figure, due later today comes in softer than the 1.9% that the Bloomberg survey median forecast.  

There have not been additional developments on Brexit to note.  Prime Minister May appears to be successfully blocking efforts to provide an alternative to the negotiated deal and a Brexit with no agreement.  The way the controversial Withdrawal Bill may pass, the reasoning goes, is if there is no choice but a chaotic departure or the May/EU plan. A serious game of brinkmanship appears to be unfolding.  

The euro is approaching last week’s highs seen near $1.1485.   The intraday technicals warn of additional gains in North America today.  The 610 mln euro option struck at $1.1450 is still in play. The euro has not traded above $1.15 since October 22.  In these holiday and volatile markets, it cannot be ruled out.   Above there, the next technical inflection point is seen closer to $1.1550. Sterling is uninspiring and going nowhere quickly.  A break of $1.2680 could spur a move toward $1.2720, but there seem to be better ways to express a view than playing cable. The euro remains firm against sterling and appears poised to challenge the GBP0.9070-90 peak from earlier this month.   

North America

Many observers are suspicious of the V-shaped bottom in the S&P 500 and recognize that such strong bounces often are associated with bear markets. Still, a move above 2500 is seen as constructive, and a move above 2600 would help lift the tone.  With parts of the government still closed, official economic data will be sporadic at best.  Today private sector data is on tap in the form of the Chicago PMI and pending home sales.  The Chicago PMI is likely to drop, but recall what has happened.  It surged to 66.4 in November from 58.4 in October.  Some pullback seems almost inevitable.  It has averaged 61.7 over the past three months and 62.2 this year.  Lower interest rates may see pending home sales pick up. 

The US dollar continues to trade in narrow ranges near CAD1.36. It reached a new high for the year yesterday near CAD1.3660.   Initial support now is seen near CAD1.3580.  The dollar was sold through the shelf yesterday near MXN19.80, apparently mostly on sentiment.  The leveraged community is thought to be long peso through the options market and in holding cetes.   The next important chart point is near MXN19.50.  Mexico reports its November trade balance today, and a small surplus is expected. 


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