Markets on Edge as New Week Begins

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Win Thin
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• The coronavirus death toll is just over 900, exceeding the SARS epidemic; the dollar remains firm
• President Trump will unveil his budget proposal for FY2021 beginning October 1 today
• The faltering eurozone economy comes just as political uncertainty is picking up in Germany
• Norway inflation spiked in January; Turkish local rates spiked after regulators cut the FX swap limits for local banks
• Japan reported December current account data; China January CPI came in at 5.4% y/y in January, higher than expected

The dollar is softer against the majors as the new week begins. Nokkie and Aussie are outperforming, while the yen and Swissie are underperforming. EM currencies are mixed. RUB and CNY are outperforming, while IDR and MYR are underperforming. MSCI Asia Pacific was down 0.5% on the day, with the Nikkei falling 0.6%. MSCI EM is down 0.3% so far today, with the Shanghai Composite rising 0.5%. Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 1 bp at 1.57%, while the 3-month to 10-year spread is down 2 bp to stand at +3 bp. Commodity prices are mixed, with Brent oil down 0.4%, copper up 0.3%, and gold up 0.1%.

The coronavirus death toll is just over 900, exceeding the SARS epidemic. Confirmed infected cases have topped 40,000, but it is showing possible signs of stabilizing. China’s government said it would spend some $10 bln to contain the virus and provide medical care to those impacted. Elsewhere, the PBOC will use nine large national banks and a few local banks to inject liquidity to help selected firms. The funds will come in the form of loans from a special facility at up to 100 bp below the one-year Loan Prime Rate.

The dollar remains firm.  DXY has broken above the November 29 high near 98.544.  More importantly, it has also broken above the 62% retracement objective of the October-December drop near 98.402.  This sets up a test of the October 1 cycle high near 99.667. Elsewhere, the euro is trading at a new low for this move near $1.0940 and the next target is the October 1 low near $1.0880.  Of note, implied volatility in G7 currencies has remained surprisingly tame over the last few weeks. EM implied vol has picked up considerably, but it is still well below levels seen for most of last year.

AMERICAS

The US economy remains strong.  Advance Q4 GDP came in at 2.1% SAAR and that strength appears to be carrying over into 2020. Indeed, the US data last week for largely stronger than expected. The Atlanta Fed’s GDPNow model estimates Q1 GDP growth at 2.7% SAAR, while the NY Fed’s Nowcast model estimates Q1 GDP growth at 1.7% SAAR.  While these early reads are subject to significant revisions, we are clearly far from recession and the Fed is right to maintain steady rates in order to assess how the outlook unfolds in 2020.

As we enter a busy US data week, there are no releases today. There is a full slate of Fed speakers this week. Bowman, Daly, and Harker speak today. Last week, the Fed submitted its semiannual Monetary Policy Report to Congress. In it, the Fed warned that the coronavirus poses “new risks” to global growth and markets. Despite being on hold, it seems that the bias for the Fed is one of easing but we still haven’t seen a “material reassessment” yet that justifies cutting rates again. We’re sure Powell will be asked to clarify when he testifies before Congress this week.

President Trump will unveil his budget proposal for FY2021 beginning October 1 today. Some details have been leaked, including plans to balance the budget by 2035 as well as a planned deficit of -$966 bln for FY2021. Cuts to food stamps and Medicaid are seen saving $292 bln over the next ten years. The budget also assumes that the Trump tax cuts expiring in 2025 will be extended. There will be lots of horse-trading to come, but the broad outlines contained in this draft suggest it’s “steady as she goes” in terms of budget priorities for the Trump administration.

EUROPE/MIDDLE EAST/AFRICA

Eurozone has a busy data week. Italy reported weak December IP today at -2.7% m/m vs. -0.6% expected. This falls in line with data last week from the eurozone that were unequivocally weak, particularly in Germany and France. The weak outlook should continue to weigh on the euro.

The faltering eurozone economy comes just as political uncertainty is picking up in Germany. Chancellor Merkel’s successor as head of the CDU Angel Kramp-Karrenbauer (AKK) announced she would step down and will not run as her party’s candidate for Chancellor. She has had trouble since taking over for Merkel as leader back in December 2018, with the final straw being the recent alliance between the CDU and the right-wing AfD in the state of Thuringia. Those hoping for fiscal stimulus from Germany will have to wait even longer, it seems.

Norway inflation spiked in January. Headline inflation came in at 1.8% y/y vs. 1.2% expected and 1.4% in December, while underlying inflation came in at 2.9% y/y vs. 2.0% expected and 1.8% in December. Yet PPI fell -3.9% y/y vs. -2.2% in December, suggesting little in the way of pipeline price pressures. We don’t think Norges Bank will react to these readings. Yes, it will be on alert but simply put, low oil prices are a strong headwind to the economy and we do not think the policy rate will move from the current 1.5% anytime soon. Next policy meeting is March 19 and no change is expected then.

Turkish local rates spiked after regulators cut the FX swap limits for local banks. The limit was reduced from 25% to 10% of local bank’s equity, impacting the ability of investors to short the lira. The 3-month swap rate, for example, rose to 20%, almost double levels seen last week, making the currency prohibitively expensive to short. The lira has depreciated 12% over the last twelve months, but anecdotal reports suggest that foreign investor participation, and general interest in Turkish, is already very low. Indeed, data collected by Bloomberg suggest that net foreign investment in Turkish bonds has been negative for some time, while equity inflows have turned decidedly negative (on a 12-month rolling basis) this year.

ASIA

Japan reported December current account data today. The adjusted surplus came in at JPY1.71 trln vs. JPY1.68 trln expected. Data last week were disappointing as the economy was clearly already weakening even before the coronavirus impact was felt. This has led some analysts to raise their estimates for recession risk in 2020 despite the fiscal stimulus that’s in the pipeline.

China January CPI came in at 5.4% y/y in January, higher than expected and well above the 4.5% in December. This was the highest reading since late 2011 but was largely due to higher food prices on the back of seasonal volatility and supply disruptions due to the virus. As such, the PBOC is likely to look through the increase and continue to focus on liquidity provisions and downside risks to growth. Note PPI rose only 0.1% y/y, suggesting little in the way of pipeline price pressures.