Photo by Roméo A. on Unsplash
 

Overview: Rising rates and falling stocks provided the backdrop for the foreign exchange market this week. The dollar appreciated against all the G10 currencies but the Swedish krona, which is still correcting higher after the hawkish pivot by the central bank. The market looks for a later and higher peak in the Fed funds rate. This coupled with the risk-off sentiment helped the dollar extend its recovery after falling since last September-October. The yen's weakness on less than hawkish comments from what is most likely to be the BOJ's new leadership helped lift Japanese stocks today and pared with the week's losses. Most of the other large bourses in the Asia Pacific area fell today and this week. Europe's Stoxx 600 is slightly firmer but is also paring this week's losses. US index futures point to a lower opening. European benchmark yields are mostly softer, led by a 2-4 bp decline in peripheral yields. The 10-year US Treasury yield is firmer to approach 3.90%. It was near 3.33% before the employment report on February 3 and stalled this week ahead of 4.0%.

Gold was unable to resurface above $1850 this week and made a new low for the year near $1817.60 yesterday. It is virtually flat today. Higher yields and a stronger dollar weigh on the yellow metal. Despite another large build of US oil stocks, reports of stronger demand from China helped underpin crude prices. April WTI is trading higher for the second consecutive session after snapping a six-day swoon yesterday. US natgas prices have stabilized in recent days, while Europe's benchmark has risen every day this week for a roughly 4% advance. 
 

Asia Pacific

Japan's January CPI was as expected following the Tokyo figures. The headline accelerated by 4.3% year-over-year from 4.0%. The underlying measures also increased, but slightly less than projected. The measure excluding fresh food rose to 4.2% from 4.0%. Excluding fresh food and energy the year-over-year increase was 3.2% compared with 3.0% in December.

Separately, as we have noted, talk of Japanese being sellers of foreign bonds is a well-known story from last year, not this year. The Ministry of Finance reported that last week, Japanese investors bought JP2.7 trillion (~$20.1 bln) of foreign bonds, which is practically what they bought in the first six weeks of the year. Japanese investors have replaced about a fifth of the bonds that are sold all last year. Last week's purchases appear to be the second highest behind the record set in March 2020 (~JPY4.2 trillion). 

The nominees to the BOJ's board answered questions before the lower chamber of the Diet earlier today and will do so for the upper house on Monday. Ueda endorsed the current framework, including the joint statement with the government to achieve the 2% inflation target "at the earliest possible time." Ueda lent support to two of our contentions. First, a policy review will be conducted earlier in his tenure. There will be no immediate reversal or adjustment to the Yield Curve Control or the negative policy rate. Ueda was very clear that current price pressures were cost-push and not strong demand. Second, Ueda noted that inflation is likely to begin falling with the February prints. He observed that wage growth was important but pushed back against ideas that it ought to be a policy goal. Ueda, like the two deputy nominees, recognized unintended consequences from the policy setting but seemed to suggest that the benefits outweighed the costs. Separately, BOJ Governor Kuroda hinted at no action at his last meeting on March 10. The takeaway is that today's signals are not as hawkish as many expected.

There was some volatility around Ueda's appearance before Japan's parliament. The dollar initially fell to a four-day low near JPY134.00, b but quickly recovered to trade mostly between JPY134.60-80 until late in the Asia Pacific session and early European turnover, when it ran up to JPY135.25. Recall that yesterday's high was slightly above JPY135.35. Option expires today (JPY134.50 for $1.7 bln and JPY135 for $1.2 bln) may have contributed to the price action. The intraday momentum indicators are stretched. Note that outside of Tuesday, when the dollar settled at JPY135.01 (according to Bloomberg), it has not closed above JPY135 since the day before the December 20 surprise widening of the 10-year JGB band. The Australian dollar is extending its recent loss. It reached a high at the start of the week near $0.6920 and reached a low today slightly below $0.6780. The 200-day moving average is around $0.6800 and it has not closed below it since January 5. There are options for nearly A$1.6 bln struck at $0.6750 that expire today. Still, the intraday momentum indicators are oversold and a bounce in early North American activity seems likely. Initial resistance may be seen in the $0.6810-20 area. The greenback gapped higher against the Chinese yuan and reached CNY6.9450, its best level since late December. The next important chart area is CNY7.0. The PBOC continues to set the dollar's reference rate tightly against expectations. It was set at CNY6.8942 compared with the median in Bloomberg's survey for CNY6.8946. We note that China's 10-year bond yield discount to the US is hovering near 100 bp the most since January 2. 
 

Europe

The ECB acknowledged that for the first time in 15 years, it will not be able to share its profits with its member central banks, who typically pass it to their governments. Indeed, it has a "small" loss of 1.6 bln euros. It has a capital cushion that could absorb the loss. It reports 6.6 bln euros of provisions, 8.9 bln euros of capital, and 36 bln euros of revaluation accounts from unrealized investment gains. The ECB does not market is bond holdings to market but values them at cost, subject to annual impairment review. The Eurosystem owns nearly 5 trillion euros of bonds. Of course, various assumptions about interest rates in the coming years will impact the losses (or gains) that the Eurosystem incurs. 

It is a known risk of quantitative easing and critics have not yet devised a compelling alternative when the zero-bound is approached. Whether it becomes a permanent feature seems to be a function of how often the zero-bound is approached and alternative strategies. The ECB (and the BOJ) have also tried long-term loans at attractive interest rates, which also expands the central banks' balance sheets. Other central banks have to wrestle with the same issue of buying long-term bonds at very low-interest rates and dealing with the consequences when yields inevitably rise. For example, the Federal Reserve confronted a similar issue after the Great Financial Crisis. In early 2011, it adopted an important accounting rule. The rule basically allows the Federal Reserve to recognize the loss as a liability to the Treasury rather than a loss of its capital. Future profits would be used to offset the liability.

The downward revision in Germany's Q4 GDP to -0.4% from -0.2% has done the euro no favors. The single currency is a 15-20 pip range on either side of $1.06, trading within yesterday's range. The euro needs to settle above roughly $1.0595, or it will have fallen every session this week, which it has not done since last April. Yesterday's low was a little above $1.0575. A break of this could spur a push toward $1.0535, where options for 1 bln euros expire today. Sterling is trading quietly in about a 40-pip range above $1.20, inside yesterday's range (~$1.1990-$1.2075). Recent data have been mostly better than expected and the sterling is practically flat against the dollar this week and is up about 0.80% against the euro.
 

America

The US has three sets of economic reports today. Personal income and consumption, alongside the deflator, are the first set. Personal income since March last year has been fairly steady, rising by about 1.2% per quarter. It is seen jumping by 1.0% in January. Consumption slowed since Q1 22 when it averaged a monthly gain of 1.1%. It gradually slowed to an average of 0.2% in Q4 and declined outright in November and December. In yesterday's Q4 GDP, consumption was revised sharply lower (1.4% from 2.1%) warning of downward revision, but it looks to have snapped back dramatically in January (when retail sales soared by 3%). The median forecast in Bloomberg's survey calls for a 1.4% increase. The deflators are expected to be little changed. The headline rate may stick at 5.0%, while the core rate is expected to slip to 4.3% from 4.4%. 

The second high-frequency data point is January's new home sales. New home sales are faring considerably better than housing starts. It is a volatile series but has been improving. In Q1 22, they fell by an average seasonally adjusted annual rate of 5.5%, and 6.6% in Q2. In Q3 22, existing home sales fell by an average of 0.3% a month and in Q4 they rose by an average of 3.9%. A small increase is expected last month, which would be the third consecutive monthly advance, the longest since May August 2020.

Third, the University of Michigan gives the final February readings of consumer sentiment and inflation expectations. Like the PMI, the preliminary estimate is usually "close enough" and captures the signal. Finally, we note that several Fed officials speak, and Mester, Bullard, and Waller as seen as among the more hawkish members now. Jefferson and Collins are seen as more in the middle, and therefore their comments may provide more information. Of the Fed officials, Governors Waller, and Jefferson voted, while none of the regional presidents speaking voted this year. However, as the recent FOMC minutes make clear, non-voting members are still an important part of the discussions.

Mexico revises Q4 22 GDP, but more interestingly also reports Q4 current account balance. There are strong seasonal factors and for the last seven years, the current account has improved in Q4 (while deteriorating for the last 11 years in Q1). True to the pattern, the median forecast (Bloomberg survey) is for the current account to swing from a $5.5 bln deficit in Q3 to a $3.4 bln surplus in Q4. It would be the only quarterly surplus last year.

Investors will also be interested in Brazil's IBGE inflation measure and the January current account and foreign direct investment reports. While inflation may have accelerated on the month, the base effect means that it may still fall on a year-over-year basis. It peaked last May at 12.20% and finished last year at 5.90%. It was slightly lower in January and is expected (median forecast in Bloomberg's survey) to have fallen to about 5.60%, which would be the lowest since March 2021. A cut in the fuel tax in addition to lower commodity prices has eased price pressures. Brazil's current account typically deteriorates in January, but economists project an improvement this year ($8.2. bln deficit down from $10.9 bln in December). It seems premature to read much into the January foreign direct investment into Brazil, Lula's first month back into the presidency. Perhaps, the only thing to note is that it is expected to have been in line with last year's $7.5 bln a-month average. 

The US dollar is firm against the Canadian dollar at the upper end of this week's range as it edges closer to CAD1.3600. It has held slightly below yesterday's high around CAD1.3580. The greenback has not traded above CAD1.36 since early January and a move above there would target the year's high (~CAD!.3685). A soft risk-taking environment coupled with the central bank's pause while expectations ratchet up elsewhere is taking a toll on the Loonie. It has fallen for three of the past four weeks after rising for the previous six weeks. Although the US dollar set a marginal new five-year low against the Mexican peso yesterday (a fraction below MXN18.30) it has spent the week consolidating, even if choppily, below MXN18.50. Note that the dollar settled near MXN18.3720 last week. For carrying strategies a steady currency does not hurt. The US dollar has traded heavily against the Brazilian real since the markets re-opened on Wednesday. The greenback finished last week around BRL5.1625 and settled yesterday close to BRL5.1320. Latam currencies account for three of the top four emerging market currencies this week (Peru, Colombia, and Brazil, joined by the Philippines), while most emerging market currencies lost ground this week. 

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