Dollar Licks Its Wounds in Currency War

Wednesday February 1: Five things the markets are talking about

Words do hurt, just ask all the dollar ‘bulls’ – the ‘mighty’ buck has just completed its worst January in thirty-years after President Trump complained that every other country lives on “devaluation.”

Nevertheless, the dollar is managing to drift a tad higher on the first trading day of a new month in anticipation of a ‘hawkish’ tone from the FOMC statement this afternoon (2pm EST). Yesterday, the greenback came under extreme pressure amid administration comments suggesting officials would prefer a weaker dollar.

In reality, verbal intervention alone should not have a lasting impact; it’s the U.S economy that will eventually set the dollar’s course.

Even the world’s most powerful central bank requires greater clarity on Trump’s economic policies and reason why the Fed is expected to keep interest rates unchanged this afternoon – the accompanying statement will be analyzed by the market for any reading on Trump’s impact thus far on the world’s largest economy.

1. Equities see the light

In Asia, equity prices stabilized overnight after two-days of declines, as investors position themselves ahead of the Fed’s policy statement (no press conference).

Korea’s Kospi’s gained +0.5% amid stronger-than-expected trade figures, while Australia’s S&P/ASX 200 was up +0.4%, and Japan’s Nikkei finished trading flat after opening lower.

Nevertheless, investor caution does persist. New Zealand’s NZX-50 was down -0.3%, and Hong Kong’s Hang Seng dropped -1.1% in its first session of the week after the Lunar New Year break – it’s catching up with weakness seen in Asian stocks the prior two days.

Note: Markets in China, Taiwan and Vietnam remained closed for the Lunar New Year holiday.

In Europe, equity indices are trading sharply higher as positive sentiment continues after a raft of good earnings reports pre-market. Banking stocks are trading higher across the board, while pharmaceuticals support both the Eurostoxx and FTSE 100. Commodity and mining stocks are also trading notably higher as copper prices consolidate around contract highs.

U.S futures are currently trading in the ‘black’ (+0.2%).

Indices: Stoxx50 +0.7% at 3,264, FTSE +1.0% at 7,168, DAX +1.0% at 11,646, CAC-40 +1.0% at 4,803, IBEX-35 +0.6% at 9,373, FTSE MIB +0.7% at 18,724, SMI +0.9% at 8,369, S&P 500 Futures +0.2%

2. Oil heads higher, gold consolidates

Oil prices are edging up supported by signs that Russia and OPEC producers are delivering on promised supply reductions, although yesterday’s API report which showed a large rise in U.S. crude inventories is limiting these gains.

Note: Russia cut production last month by around -100k bpd.

Brent crude futures are trading up +25c at +$55.83 a barrel, while U.S. light crude (WTI) is up +26c to +$53.07.

Expect dealers to take direction from today’s U.S EIA inventory figures (10:30am EST). The market is expecting crude stocks to rise by +3.3m barrels.

Gold slipped overnight (down -0.2% to +$1,208.67) as the ‘big’ dollar recovered from its two-month lows and as the market waits to see what the Fed has to say.

Note: Spot gold rose over +5% in January, its best month since June 2016. On Monday, it touched a one-week high of +$1,215.37. Silver rose over +2% to an 11-week high of +$17.61 on Tuesday and over +10% in January, its best month also since June 2016.

3. Sovereign yields look for support

Currently, sovereign government bond yields seem stuck in a tug of war between inflation data and risk factors, resulting in volatile trading sessions.

Investors should expect the choppy trend to continue even after the Fed announcement. In Europe, dealers are looking to open tactical short positions in the 10-year German bund (+0.46%). Many believe that they have backed up too quickly over the past three-month on the Trump reflation trade.

In the U.S, data yesterday shows that the negative sentiment toward Treasury’s has reached the highest in more than a month, but fence sitters still dominate.

The share of investors expecting higher bond yields rallied to +27%, while those expecting lower bond yields is down to +14% from +16%. However, those staying ‘neutral’ account for the bulk, holding steady at +59%. U.S 10’s are at +2.457% and are likely to continue to gyrate in the +2.3%-2.6% range they have been trading in 2017.

Elsewhere, long-term JGB prices have weakened, pushing the benchmark 10-year yield up to +0.09% as some risk-on sentiment returns.

4. Dollar licks its wounds in currency war

2017 currency moves have not been for the faint of heart.

A barrage of FX verbal intervention has dominated the market this week. The USD weakened yesterday after President Trump and his Director of the National Trade Council Navarro accused Germany (€1.08) and Japan (¥113.34) of weakening their respective currencies for trade advantage.

The replies from G7 official continue to be swift and defensive. Chancellor Merkel, Japan’s PM Aso, Cabinet Sec Suga, Japan Fin Min Aso, Vice Fin Min of International Affairs (currency chief) Asakawa all defended their respective central bank and trade policies noting that they continue to follow G7 and G20 communiqués.

Note: USD/JPY continues to build technical support above the psychological ¥112.50 level – Overnight, the BoJ’s Kuroda helped to weaken the yen after he noted his monetary policy was aimed at domestic price stability (not devaluing currencies to gain a Trump trade advantage). Sterling (£1.2622) has found further support from this morning U.K manufacturing data (see below).

5. U.K, China and Japan manufacturing expand

Data this morning revealed that U.K. manufacturing activity grew strongly in January, slowing only slightly from a two-year high in December – 55.9 vs. 56.2 prior.

The expansion was supported by a solid increase in new order intakes, mainly from the domestic market. Improving global market conditions and a weaker sterling is also driving a modest increase in new export orders.

Overnight, Japans Jan Final PMI Manufacturing was revised a touch lower, but still registered its fifth month of expansion and the highest level since Mar 2014 – 52.7 vs. 52.8 prelim.

In China, its Jan PMI Manufacturing (Govt. official) saw a slight slowing of momentum, but still registered its sixth-month of expansion, but at a three-month low – 51.3 vs. 51.4 prior.

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