Euro Déjà vu Again

Capital markets’ slated agenda for the next five days will be considered rather boring compared to the events that kept all asset classes jumping last week. The U.K. and France report their December consumer-price index (CPI) and producer-price index inflation estimates this Tuesday and Wednesday, respectively. Analysts expect that the continuing drop in energy prices to pull down both headlines, similar to the recent European CPI outcome. By midweek, the market will be looking for an improvement in Japan’s machine orders after they slipped badly after the various tax hikes nine months ago. Down Under, the Aussies release their December unemployment report. At the moment, the trend remains the market’s friend. Australian unemployment has been on a rising trajectory for the past 18 months against an environment of sub-par growth and lackluster job creation.

A Tough Act to Follow

Global bourses were racked with volatility last week, as competing economic themes contested for supremacy. The increasing risk of deflation and the eurozone potentially unraveling over a renewed ‘Grexit’ dominated the first half of the week. Risk trading was restored midweek after German Chancellor Angela Merkel insisted that Germany wanted Greece to remain within the eurozone fold. Janet Yellen reinforced the Federal Reserve’s stance of “patience,” while a few newish doves’ voices grew a tad louder. Chicago Fed President Charles Evans declared introducing higher U.S. rates this year would be a catastrophe. Risk on and off, coupled with low inflation and the possibility of deflation has been playing havoc with global yields. U.S. 10’s seem to be caught within a narrow range (+1.83% to +2.10%), while German Bunds, especially five-years, straddle negative territory as crude hit fresh multi-year lows and the U.S. jobs report revealed December’s signs of emerging wage inflation had evaporated and in fact retracted.

Payrolls Headline Looks Good

Friday’s headline U.S. jobs data showed better-than-expected payrolls gains and another tick down in unemployment to +5.6%. Nevertheless, the market dug deeper and ended up focusing on the discouraging hourly earnings component that did away all the good achieved in the previous month. Monthly revisions halved the previously robust November wage gain (+0.4% to +0.2%), while December entered into negative wage growth territory (-0.2%, month-over-month). This collectively managed to pull down the year-over-year growth rate to its lowest level in 24 months (+1.7%). Yellen and company desire wage growth to accelerate to +3%, year-over-year, to help the Fed achieve its +2% inflation target. The Federal Open Market Committee minutes established that if the U.S. labor market continues to heal, then the Fed is likely to raise rates in the middle of the year even as it remains “patient” on hikes for now. There is a growing consensus that growth in inflation is not necessarily required.

Draghi Remains on Course

The market continues to price in a eurozone quantitative easing (QE) program. An overwhelming majority expect the European Central Bank (ECB) to swing into action at its January 22 meeting, backed by ongoing disappointing data euro-region wide. German, French, and U.K. industrial production numbers all failed to meet market expectations, while dreaded inflation numbers supported the disinflation fears within the region (European CPI at its lowest level in six years, -0.2% in December). For surety purposes, the market awaits this Wednesday’s European Court of Justice decision on the Outright Monetary Transactions (OMT) bond-buying scheme. A negative assessment has the potential to lead the market to assume the flexibility and the scope of any ECB QE could be limited. With so many in the market already pricing in QE, price action could get very messy quickly.

U.S. Dollar Does Not Miss a Beat

The mighty dollar remains the dominant currency across the board. There are many positives supporting it whether it’s U.S. growth, rate divergence, an upbeat Fed or jobs. All are making U.S. assets attractive and a rising greenback adds to that appeal. The market’s consensus believes that we are in the early stages of a secular bull market for the U.S. dollar. Nevertheless, Friday’s U.S. nonfarm payrolls data triggered some dollar profit-taking outright. The EUR stood firm below €1.1790 and closed out the weekend with a bid tone (€1.1847). The 19-member single unit failed in its attempt during the Asian session to take on the plethora of stop-losses located around the €1.19 handle. This forced the weaker Asian longs to exit after this failed attempt. Europe has since applied further pressure on its own currency, opening up the way for the market to once again test last week’s low €1.1754/62. The strong decline from the overnight session high technically keeps the €1.1885 resistance protected. A break through the lows with some momentum certainly opens the gates for the market to test its decade lows at €1.1640. Expect market participants to reassess their options once there.

Putin’s Russian Sees Red

It was no surprise; Fitch Ratings last week downgraded Russia to BBB- with a negative outlook. This now puts President Vladimir Putin’s homeland one notch away from losing its investment grade. There are rumors that S&P is expected to push Russia into non-investment grade (speculative) in a matter of weeks. These possible collective actions are beginning to renew a strongly bearish outlook for the country. Russian equities and debt seeing red, coupled with falling crude prices, continue to weigh on the RUB. For now, the market is trying to anticipate what the knock-on effect is going to be. Cornering a Russian bear is not very healthy for Europe.

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