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Overview: The US dollar is mostly trading with a downside bias today against the G10 and most emerging market currencies. It had begun the week extending the gains spurred by the dramatic jump in nonfarm payrolls and the strong ISM services survey. Market expectations for the trajectory of Fed policy in the first part of this year converged with the Fed's December dot plot. The market now leans toward two more quarter-point hikes this year. The bulk of the adjustment now seems in place, and the greenback has lost its strong bid seen. The yield on the two-year note rose from almost 4% before the jobs data to approach the upper end of its two-month range near 4.50% and has steadied. A consolidative one is emerging, even if fragile. 

US equity indices closed firmly yesterday after a volatile reaction to Fed Chair Powell's comments, which did not seem to break new ground. The Nikkei, Hong Kong, and Chinese mainland shares struggled but Taiwan and South Korean equity markets rallied more than 1% today. Europe's Stoxx 600 is extending yesterday's recovery and is up about 0.8% near midday. It is higher on the week now and has only had one losing week in the first five weeks of 2023. US futures are nursing modest losses. (~-0.20-0.30%). European benchmark 10-year yields are slightly higher, while the 10-year US Treasury yield is off two basis points to 3.65%. After selling off almost 4.5% last Thursday and Friday, gold is edging higher for the third consecutive session. News of the possible first drawdown in US oil inventories in seven weeks is helping March WTI extend its recovery. It recorded the year's low on Monday near $72.25 and it is trying to secure a foothold above $78 today.
 

Asia Pacific

Japan's Ministry of Finance has provided an outline of this year's tax reform bill. Four elements stand out. First, the government seeks to raise corporate taxes to help fund the increase in defense spending. A tax increase will not be enacted until at least next year. The government will propose a 4%-4.5% on corporate taxes. Second, the bill will allow the implementation of international tax reform. In particular, the focus is on the so-called Pillar Two, the 15% global minimum tax. Third, the bill expands incentives for increasing research and development expenses. It also provides new incentives for start-ups. Fourth, the tax reform implements Prime Minister Kishida's vision by introducing a new minimum tax on high-income earners (2025) and an expansion of the Nippon Individual Savings Account for small savers.

Taiwan will hold presidential elections in early 2024. China is likely modifying its behavior ahead of it as one way to try to influence the outcome. In this vein, we note that Beijing has announced it will resume importing around five dozen Taiwanese food products that it had banned last year. Separately, but related, the vice chair of the opposition party, the Kuomintang (KMT) is starting a nine-day visit to China today. One hurdle is that the Republican leadership in the US House of Representatives is reportedly planning to take a bipartisan delegation to Taiwan this spring. Separately, Taiwan reported a sharp fall in exports last month. The 21.2% decline from a year ago was led by an 18.3% drop in semiconductor exports. The PMI out last week warned of further declines in output and new business. Imports fell 16.6% year-over-year, a little less than expected. The net result was a $2.34 bln trade surplus, less than half of the surplus recorded in January 2022. 

The dollar filled Monday's downside gap in yesterday's sell-off and recorded a low slightly below JPY130.50. It is consolidating today (~JPY130.60-JPY131.40) in the lower end of yesterday's range. Barring a new shock, it might remain in that range in the North American session. A move above JPY131.50 would improve the technical tone. The Australian dollar approached our target near $0.6850 on Monday and recovered to almost $0.6990 yesterday. It edged fractionally higher today but has held below $0.7000. Options for almost A$710 mln expire there tomorrow. That area also corresponds with the halfway point of the slide that began on February 2 near $0.7160. The next retracement (61.8%) is seen at around $0.7145. The Chinese yuan is little changed in a narrow range against the dollar today. The greenback held above the CNY6.7710 low set on Monday, even if it slipped through yesterday's low (~CNY6.7745) briefly. It reached a high near CNY6.8060 on Monday, its highest since January 9, but recorded a lower high yesterday (CNY6.7935) and today (CNY6.7870). Today's fix was in line with expectations (CNY6.7752 vs. CNY6.7755). Lastly, we note that as was widely expected, the Reserve Bank of India slowed the pace of its tightening and lifted the repo rate by 25 bp to 6.50%.
 

Europe

The UK economy appears to be in the worst shape of the G7 and the IMF thinks that could persist for two years. The central bank itself warns of a five-quarter recession beginning now. In fairness, the economy contracted in Q3 22 (-0.3%). The first estimate of Q4 GDP is due Friday and the median forecast in Bloomberg's survey is for a flat quarter. Prime Minister Sunak announced a small cabinet reshuffle and a reorganization of the Department for Business, Energy, and Industrial Strategy. It will not capture any imagination as the Tory Party continues to lag by around 20 percentage points in the polls. Sunak's allies talk about how he has had to clean up from his immediate predecessors Johnson and Truss, while his critics see strikes, scandals, and several government policy reversals. The cabinet reshuffle may not be the last this year, but the impact on investors may be marginal. From the outside, there seem to be more substantial challenges. There seems to be space for Sunak to still make his mark, like achieving some closure on the Northern Ireland protocol before the 25th anniversary of the Good Friday Agreement this spring.

The ECB announced it will reduce the interest rate it pays on government deposits. The new rate will be the short-term rate minus 20 bp as of May 1. The arrangement that expires in April pays either the short-term rate (ESTR) or the deposit rate, whichever is lower. ESTR is about 1.90%. The new remuneration scheme is more generous than some feared. Previously, government deposits earned no interest. This was lifted last September and expires at the end of April. Government accounts have about 350 bln euros at the ECB. Those government funds will have to find a new home, and the hope is that it takes place gradually. The market responded favorably to the announcement in a way that suggests hope that the new rate will encourage intermediation and help ease the chronic collateral shortage. Swap spreads tightened to short-term German rates, for example.

The euro's losses were extended to $1.0670 yesterday before the volatile reaction to Fed Powell's comments drove it to new session highs near $1.0765. The surge was not sustained and saw the euro quickly return to slightly below $1.0680. Still, the euro climbed back today and tested the $1.0760 area in late Asia Pacific turnover and in early European activity. It is encountering resistance there and initial support is seen near $1.0720. After yesterday's wild swing, consolidation would not be surprising, especially given the light calendar. Sterling approached its 200-day moving average yesterday (~$1.1950), and like the euro, spiked higher on Powell's comments to new session highs (~$1.2095). It retreated and slipped slightly below $1.20 before finding its footing again. It reached $1.2110 in early Europe today, which seemed to have exhausted the buying. Initial support now is seen in the $1.2040-60 area. Lastly, Poland's central bank meets today but no change is expected. Its reference rate was raised from 1.75% at the start of last year to 6.75% in September, where it has remained.
 

America

The market's reaction to Fed Chair Powell's comments injected volatility into the capital markets. However, the Chair did not break new ground. Perhaps, that is part of it: the January jobs data that prompted the market to move expectations closer to the Fed's December dot plot did nothing for Powell. It confirmed his perception, he said, that disinflation has barely begun. Powell avoided answering the question about if he would have hiked by 50 bp on Feb 1 if he had known the Feb 3 jobs report. Like Atlanta Fed President Bostic on Monday, Powell said that IF (our emphasis) such strong job growth persisted, the Fed may conclude it needs to raise the rate more to get price pressures down. The Fed chair seemed to push against a "pause" because of the difficulty in re-starting if necessary. 

The Fed funds futures strip has two 25 bp hikes priced in to be delivered in March (22) and May (3). Still, the implied yield of the December Fed funds futures is about 24 bp below the September contract's implied yield. Still, we suspect that many are underestimating the base effect. Consider that IF every month in Q1 23 the CPI rose by 0.5% (not a forecast but a thought experiment), the year-over-year pace would fall toward 5% in March. IF this pattern were repeated in Q2, CPI at mid-year would be slightly above 4.0%.

Those concerned about the US headed for a recession have not been dissuaded by the jobs report. Many of the arguments, leaving aside the ninth consecutive decline in the Leading Economic Indicators in December 2022, rest on financial variables, such as various measures of the yield curve and the contraction in M2. On top of that, Monday's Senior Loan Officer Opinion Survey, conducted by the Federal Reserve found a continued tightening of lending standards and a broad softening of demand. The consumer pulled back in December. Consumer credit grew at its slowest rate in nearly two years in December. Total credit rose by $11.6 bln, though the November series was revised to $33.1 from almost $28 bln initially. Revolving credit (think credit cards) rose by $7.2 bln while another $4.4 bln non-revolving credit (this auto and student loans) was extended. These are the smallest since August 2021 and August 2020, respectively.

For the first time, the Bank of Canada will publish a record of last month's central bank meeting. It will draw attention, but it is clear that the central bank will be on hold at next month's meeting (March 8). The Canadian dollar tracked the US stock market swings yesterday. The greenback held below Monday's high (~CAD1.3475) and settled near CAD1.3400. It has slipped to CAD1.3360 today, which is a little beyond the (50%) retracement of the bounce from the February 2 low around CAD1.3260. The next retracement (61.8%) is found by CAD1.3345. The intraday momentum indicators favor a push higher in early North American activity and the CAD1.3400-20 area may attract prices. The US dollar stopped just short of the MXN19.30-50 band we thought was a reasonable target for the upside correction. It was offered back to MXN18.8730 yesterday and has extended the pullback to MXN18.8425 today. The 20-day moving average comes in slightly below MXN18.83 today and the (61.8%) retracement of the dollar's surge from the Feb 2 low (~MXN18.5080) is found near MXN18.8070 today. Note that Mexico and Brazil report January CPI figures tomorrow. 

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