Tumbling Tokyo Prices Gives Ueda Breathing Space

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Marc Chandler
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Overview: Talk from two Fed officials yesterday, which seemed to validate market expectations eased the upward pressure on the dollar and helped equities launch a dramatic recovery. The market is pricing in a terminal rate near 5.50%, a little higher than the median dot in December. The S&P 500 posted a dramatic recover and posted a potential bullish key reversal. Its 0.75% closing gain was the largest advance in nearly three weeks. A large drop in Tokyo's February CPI helped take pressure of Japanese government bonds where the 10-year JGB was pushing through its 0.50% cap. Japanese and Indian equities led the regional equity markets higher. Europe's Stoxx 600 is up 0.7% to bring the weekly gain to around 1.2%. US equity futures also enjoy a firmer bias. This week's rise in benchmark 10-year yields is being pare today. European yields are off 2-6 bp, with the periphery outperforming the core. The 10-year Treasury yield is off 5 bp to return to 4.0%. Two-year yields are also lower but less than the 10-year yields with notable exceptions in Italy and Greece.

The US dollar is trading heavily against the all the G10 currencies. The Swiss franc and sterling are the strongest, gaining about 0.4%. The greenback is set to record a losing week against the major currencies, except the Norwegian krone. The Dollar Index is set to snap a four-week advance. Among emerging market currencies, the South Korean won's 1.1% advance is leading today's move, but the Mexican peso, which set fresh five-year highs today, is the strongest this week, with a 1.8% advance. The heavier dollar and softer rates are helping gold recover from the test on $1800 earlier in the week. It is making a new high for the week near $1848 today. April WTI is consolidating its three-day rally that lifted it to almost $78.60 yesterday, a nearly two-week high.

Asia Pacific

Tokyo's CPI fell to 3.4% in February from 4.4% in January. Fiscal policy, in the form of subsides for households and businesses, was an important driver. It bodes well for the national figures on March 24. Still, somewhat worrisome, or incongruous, is the uptick in the measure that excludes fresh food and energy. That rose to a new high of 3.2% from 3.0%. Separately, Japan reported that unemployment in January unexpectedly slipped to 2.4% from 2.5%, while the job-to-applicant ratio fell to 1.35 from a revised 1.36 (from 1.35) in December. It was 1.20 in January 2022.

The final service and composite PMI for Japan and Australia were revised higher in their final reading. Of note, the pattern among the high-income countries, the service PMI was above the manufacturing PMI. The other pattern is that after falling below the 50 boom/bust level, they have regained the key threshold. Japan's service PMI is at 54.0, better than the 53.6 flash and 52.3 in January. The composite rose to 51.1 from 50.7 preliminary estimate that was unchanged from January. Australia's services PMI improved from 48.6 in January and 49.2 flash to 50.7 in the final reading. The same is true of the composite, which rose to 50.6 from a preliminary estimate of 49.2 and 48.5 in January. It had not been above 50 since last September.

China's Caixin services PMI rose to 55.0 from 52.9, which is the best since last August. The composite rose for the third consecutive month. It stands at 54.1 up from 51.1 in January. It was at 50.1 last February. Next week, China report trade and inflation figures. It will also report reserve figures and given the dollar's recovery last month and the sell-off in bonds, it would not be surprising to see a drop of $50 bln in the dollar-value of its reserves (after a $57 bln increase in January to $3.184 trillion). The National People's Congress kicks-off before markets open on Monday.

The dollar reached a new high for the year yesterday near JPY137.10, holding below the 200-day moving average (~JPY137.30) and the high before the BOJ's December surprise (~JPY137.50). It has steadied today and is trading within yesterday's range (~JPY136.00 low). Softer US rates may have helped bring the greenback off its highs. The dollar settled near JPY136.50 last week, which was the sixth consecutive weekly advance. The streak could be snapped. The Australian dollar is firmer, but it remains in the range set on Wednesday (~$0.6695-$0.6785). However, it looks stretched and may have to retest the $0.6740 area before trying the upside again. Still, the Aussie finished last week near $0.6725, its fourth consecutive weekly loss, which end this week. The greenback is also within Wednesday's range against the Chinese yuan (~CNY6.8625-CNY6.9350). It is trading quietly near the 200-day moving average (~CNY6.8975). Here, too, the dollar's five-week rally is ending. The dollar's reference rate was set at CNY6.9117, tight to expectations oof CNY6.9112 in Bloomberg's survey.

Europe

On the heels of a stronger-than-expected February CPI (8.5% headline, 5.6% core), the eurozone reported January producer prices fell a dramatic 2.8% (-0.4% expected in Bloomberg's survey) to bring the year-over-year rate to 15.0% from 24.5%. Also, the final composite eurozone PMI confirmed the recovery in the region. The 52.0 reading, a little lower than the flash estimate (52.3), is the best since last May. The service PMI is at 52.7 compared with the preliminary reading of 53.0 and 50.8 in January. Drilling down a bit, we note that Germany's composite was above 50 for the first time in 10 months (50.7 vs. 51.1 flash estimate). The services PMI was revised lower from the initial estimate (50.9 vs. 51.3). French service PMI had not been above 50 since last October and rose to 53.1 from 52.8 initially and 49.4 in January. The composite ticked up to 51.7 from 51.6 of the flash estimate. Like was seen with the manufacturing PMI, the Spain and Italy did better than Germany and France. The composite PMI in Italy rose to 52.2 from 51.2 and the Spain's increased to 55.7 from 51.6.  

Germany also reported January trade figures. Exports rose 2.1% and imports fell by 3.4%. Economists had anticipated an increase in Germany imports and slower growth in exports. The trade surplus jumped to 16.7 bln euros from 10 bln. The trade surplus averaged 6.3 bln euros a month in 2022, a sharp fall from 14.3 bln euros in 2021 and 18.9 bln euros in 2019. Germany experienced a terms of trade shock, which is about the relative value of imports and exports. German exports rose by an average of 0.6% (at current prices), while imports rose by 0.4% on average a month. As we have argued (see here), Germany's external position says little about its disparity of power and wealth.  It is a function of numerous forces, including terms of trade and exchange rates. Preliminary January export figures to non-EU countries found a large year-over-year increase to the US (20.8%), Turkey (33.3%), Mexico (34.2%), Australia (28.6%) and India (24.0%). German exports fell to China (-7.1%) and Russia (-57.5%).

The final UK February PMI was a little better than the flash reading suggested. The services PMI rose to 53.5 from 53.3 initially and 48.7 in January. The final composite reading edged up to 53.1 from the 53.0 flash estimate and 48.5 previously. It was the highest composite since last June. Next week, the UK reports January GDP figures and details. The economy is believed to have grown by 0.1% after a 0.5% contraction in December. The swaps market is also comfortable with a 25 bp hike at the March 23 BOE meeting, which would lift the base rate to 4.25%. The peak is seen between 4.50% and 4.75%.

The euro has steadied to hover around the $1.06 area. It has not risen above $1.0630 today nor spent much time below $1.0600. It frayed but held below the 20-day moving average this week (~$1.0665) and has not closed above it in a month. It settled near $1.0550 last week, losing almost 1.4%. It has recouped a little less than half of those losses this week. Sterling's low for the week was set on Monday, slightly below $1.1925. It successfully re-tested it yesterday and has come back better bid today pushing against the $1.20 level. There are around GBP545 mln options at $1.20 that expire today and may be slowing sterling's upticks in the European morning. Sterling will snap a two-week drop with a close above $1.1945 today. 

America

US interest rates continued to rise yesterday and the news of slower than expected productivity and higher unit labor costs in Q4 22 coupled with the lowest weekly initial jobless claims in a month. While unit labor costs rose 3.2% at an annualized rate was stronger than expected, it was the smallest increase since decline in Q1 21. In fact, if one were to exclude the quarters in which unit labor costs fell, Q4 232 was the smallest increase since Q4 2018 and less than half the pace seen in Q2 and Q3 22, and well below Q1's 8.5% increase. The orthodoxy still has wages at the center of the inflation discussion. Yet, labor costs are a minor cost of producing most goods. Consider that the most efficient automakers can manufacture a car in less than 20 hours of direct labor. Assume, generously, that labor costs, benefits, and legacy costs in the US, are $150 an hour, which is $3000 in an average vehicle that costs nearly $50k. Consider retail or fast food, part of core non-housing services. Labor costs appear to be a small part of the overall price. Even in other services, leases, equipment, insurance, other materials, are important inputs. If one accepts that labor costs are driving inflation, either directly or through strong demand, it seems hard to understand the cost-of-living squeeze or the decline in average hourly earnings since the peak last March at 5.9% (year over-year).

Focus ahead of the weekend turns to the final services and composite PMI, and more importantly, the ISM Services Index. It was the January reading of the ISM Services, which was reported on February 3 shortly after the monster jobs numbers, which seemed throw the proverbial gas on the fire and US rates and the dollar have hardly looked back since then. Recall that ISM services jumped from 49.2 in December to 55.2 in January. This was a large increase (12.2%), the biggest since June 2020.  Yet it did not fully recover December's sharp fall and remained below the November reading of 55.5.  The median forecast in Bloomberg's survey is for a modest decline last month to 54.5, new orders and business activity may drag the headline lower. February's flash services PMI rose above 50 for the first time since last June (to 50.5). The ISM Services Index only dipped below 50 last December. Meanwhile, estimates for next week's nonfarm payroll has crept up to 215k in Bloomberg's survey from 200k previously. Still, if true, it would still be the smallest increase since the end of 2020.

Canada reports January build permits (expected to post a small gain after falling 7.3% in December). Labor productivity for Q4 is also on tap. The flat Q4 GDP coupled with the filling of the most full-time positions (~165k) since Q1 does not bode well for productivity. In the three years pre-Covid, Canadian productivity rose by an average of about 1% a year. More recently, Canada's labor productivity fell from Q3 20 through Q1.22 without fail. Next week is more important for Canada. The Bank of Canada meets March 8. StatsCan will report the January merchandise trade figures 90 minutes before the central bank's decision is made and the IVEY PMI, which jumped from 49.3 in December to 60.1 in January. That was the largest advance since January 2021, and the highest since last May.

The US dollar is near four-day lows against the Canadian dollar, helped by the recovery in US equities yesterday and the risk-on mood today. There are options for $405 mln at CAD1.3550 that expire today. Monday's low was near CAD1.3535, which needs to be taken out to signify anything of importance. Below there, support is seen near CAD1.3515, and thee 20-day moving average slightly below CAD1.3490. The dollar is drawing closer to MXN18.00. It reached a new five-year low today near MXN18.0630. The greenback is heavier for the fourth session this week and settled around MXN18.4180 last week. Its nearly 1.8% decline this week is the largest since mid-January. Coming into today, Mexican stocks and (dollar) bonds have outperformed their US counterparts. Ahead of today's local session, the peso is the strongest of the emerging market currencies, though the Chilean peso is a close second. Year-to-date, they are 1-2 among emerging market currencies (7.7% and 4.7%).