Overview: The Federal Reserve’s failure to respond more strongly to the market outlook and easing financial conditions fueled risk-on trading, sending the dollar and yields lower, while stocks rallied. There was limited further selling of the dollar today and a small recovery ahead of the Bank of England and European Central Bank meetings. Intraday momentum indicators suggest that the US dollar is likely to be weaker in North America this morning. Despite talk of a petro-yuan and the like, most Middle Eastern countries, except Qatar, have raised interest rates behind the Fed and the Hong Kong Monetary Authority.
Most Asia-Pacific stocks were mixed, but the South Korean and Taiwanese markets continued to rise and lead the region. Europe’s Stoxx 600 signs a three-day decline and fully recovers with a 0.75% advance. U.S. futures are mixed, with Meta’s earnings helping lift the Nasdaq. S&P 500 futures are slightly firmer and Dow slightly softer. The rise in US Treasuries has extended and is lifting European bonds today. UK Gilts, which have seen strong foreign demand, are on fire. The 10-year yield is 10 basis points lower today, falling to 3.20%. March WTI posted an outside day of decline yesterday, falling to nearly $76 a barrel. Today it is consolidating at the lower end of yesterday’s range. Meanwhile, the US natural gas futures price is at its lowest level since the start of the second quarter of 21.
Asia Pacific
After buying about ¥1.8 trillion (~$14 billion) of foreign bonds in the first two weeks of January, Japanese investors continued to sell off in the second half of the month. They have sold about ¥1 trillion in the past two weeks. Meanwhile, the Bank of Japan bought a record amount of JGB last month (~¥23.7 trillion or about $180 billion). The previous record was just over ¥16 trillion in June last year.
In addition, the focus this month is likely to be the appointment of the two deputies to the BOJ and the replacement of Governor Kuroda. Former Deputy Governor Hiroshi Nakaso, who was considered a gubernatorial candidate, was appointed to the APEC Financial Advisory Body today. Nakaso recently presented an exit strategy from the BOJ’s emergency policy. That seems likely to put him out of the race. Ironically, Deputy Governor Masayoshi Amamiya’s absence from public statements appears to swing the pendulum in his favor to replace Kuroda. Many see it as indicating greater continuity at the outset. Former Deputy Governor Hirohide Yamaguchi has been more vocal in his criticism of the BOJ’s policies. His appointment would likely prompt the biggest market reaction, as many would see it as a clearer sign of a fundamental change in BOJ policy.
The dollar traded near ¥130.40 yesterday and fell to ¥128.55 in response to the Federal Reserve. A combination of broad-based dollar weakness and a sharp drop in US yields supported the yen, with further selling of the greenback falling slightly below ¥128.20 to its lowest level since January 19. Last month’s low was set a few sessions earlier around almost a full yen lower. The dollar recovered above JPY 129 in late Asian trade and is consolidating in the European morning. Intraday momentum indicators point to likely fresh dollar selling as the North American session opens. The Aussie fell to around $0.6985 on Tuesday and rebounded quickly to $0.7145 yesterday, a new high since last June. It rallied a bit more today to reach near $0.7160. The central bank meets next week, and the market is trending higher by 25 basis points. The Australian dollar is back to near $0.7120 in Europe. Intraday momentum indicators are becoming stretched, suggesting that fresh selling of the US dollar in North America is likely here as well. The greenback eased against the Chinese yuan to close at CNY 6.7065 before rebounding. However, the gap to yesterday’s low (~6.7395 CNY) has not been closed. Today’s high was around CNY 6.7260. Instead of relying on dollar weakness (yuan strength), the PBOC set the dollar reference rate lower than the median projection in a Bloomberg survey (CNY 6.7130 vs. CNY 6.7147).
Europe
Today it is the Bank of England and the European Central Bank. The Bank of England is most likely to raise 50 basis points. As we have seen, several major banks have switched their calls to 25bp. If the BOE were to achieve this, the pound would likely be under pressure for the same reason the dollar was yesterday. In the swap market, the final interest rate is between 4.25% and 4.50% from the current 3.50%. A quarter point increase may cause the market to adjust to a lower terminal rate. As a result, the ECB is positioned as the most hawkish of the three. ECB President Lagarde pre-committed to a 50bp hike today, and a sticky January CPI core rate (although German data was notably missing) keeps expectations high for a 50bp move in March (around 75% chance). Downside risks to the euro area have eased, helped by warmer winters, lower energy prices and what appears to be a resilient labor market. The December unemployment rate in the euro area stood at 6.6%, which is the cyclically lowest rate that was first reached last October. In the fourth quarter of 19, it was 7.5%.
The Euro jumped out of the consolidation zone it had been stuck in and hit $1.10 yesterday. Subsequent buying lifted it to nearly $1.1035 today, but it was re-offered in Europe. It is trading near session lows in the European morning near $1.0980. There are massive $1.10 options expiring today and tomorrow (~€900M and €1.4B respectively). While the three-day upside retracement targets are near $1.0945 and $1.0920, intraday momentum indicators have stretched, pointing to a likely recovery after the ECB meeting. For its part, the pound remains within established ranges. Although it posted an outside day yesterday with trading on both sides of Tuesday’s range, it held below $1.24 and posted the smallest subsequent buy (1/100th of a cent) today. It has been offered again and is among the weakest G10 currencies (down ~0.40%). Intraday momentum indicators are stretched as support nears $1.23.
America
The pattern holds true. The market initially read the statement as rude, mainly based on the reference to future increases, as in the plural. However, Chairman Powell did not convince the market and it quickly reversed, with yields and the dollar lower and stocks higher. Unlike his prepared remarks at a December news conference, Powell did not mention financial terms. When the issue was raised in Q&A, he barely responded, noting that conditions had “tightened significantly” over the past year and had not changed significantly since the December meeting. This means that Powell did not strongly resist market developments and expectations. The implied yield on June Fed funds futures actually fell a few basis points. Two-year Treasury yields fell nine basis points (to ~4.11%), the biggest move since dismal retail sales and industrial production data on January 18. Moreover, when the dust settled, the market was (slightly) more confident of a rate cut before the end of the year. The implied yield on December Fed funds futures fell to 31bp below the September contract from 28bp at the end of last week and at Tuesday’s close.
The US reports fourth quarter unit labor costs and productivity today. These come from the GDP report and are likely to show a slowdown in unit labor costs and an increase in productivity. Economists seem to pay more attention to them than to the market. Durable goods and factory orders are also available. We already know that Boeing orders and military aircraft orders helped lift durable goods orders in December, but without the transportation order, it slipped. That leaves weekly jobless claims unexpectedly below 200k over the past two weeks. However, with the national employment report due tomorrow, a significant market reaction is unlikely. Canada reports December building permits expected to fall after a 14.1% jump in November. Mexico reports January domestic auto sales and December leading indicators. Neither is a market factor.
Yesterday’s broad drop in the US dollar after the FOMC reached almost CAD 1.3265, the lowest level since mid-November last year. Today, it edged slightly closer to CAD 1.3260 and bounced back to near CAD 1.3295. A move above CAD 1.3300 could reach CAD 1.3330-50. The Bank of Canada said it was on hold and the exchange rate still appears to be sensitive to overall risk appetite, if a little less than at the start of last month. The Mexican peso is a different story. It is trading at its best level since Covid hit. The US dollar was ahead of MXN 18.8730 and the 20-day moving average and crashed below MXN 18.60 yesterday. Further selling in the dollar pushed it to nearly MXN 18.5250 today. The next target is in the MXN 18.40-50 area and a break of this indicates a move towards the MXN 18.00 area, last seen in 2018. Of course, the intraday momentum indicators are stretched here as well.
