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Daily Commentary 27/02/15

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Dollar recovery begins After several weak days following Fed Chair Janet Yellen’s testimony to Congress, the dollar turned around yesterday and gained against all the other G10 currencies and most of the EM currencies that we track. It started strengthening after St. Louis Fed President James Bullard said the Fed should remove “patient” from its statement in March. The dollar gained even more after the core US CPI rate for January came out higher than expected at the same pace as in December (+0.2% mom, +1.6% yoy) suggesting that indeed low energy prices are the main reason behind the slowdown in inflation, as Yellen argued in her testimony. Moreover, the slight deflation in the headline CPI boosted real average earnings, which rose a solid 1.2% mom, which bolsters the Fed’s case that the labor market is improving. Fed funds rate expectations rose 5 bps in the long end and 10-year Treasury yields rose about 10 bps from the lows to once again top 2.0%.

The euro moved lower and many euro bears, who had pared risk and were waiting for the signal to jump back in, decided that the time was right to re-establish their short euro positions. Market participants have probably noticed that the recent pattern is that when the euro falls sharply, it does not recover to its previous level, so they probably figure it’s best to get in at the top of the move rather than waiting for the bounce.

Eurozone economic news yesterday was favourable, with the number of unemployed persons in Germany falling more than expected, consistent with the rise in consumer confidence also reported. Also bank lending, which bottomed out in August, continued to grow modestly. But EURUSD has not been that responsive to European economic news recently, particularly news about growth, probably because there’s no indication that faster growth will translate into higher inflation and thereby influence ECB policy.

Meanwhile, the fact that Bund yields are now negative out to seven years is probably discouraging investment in European bonds. Portuguese yields are below Treasuries out to 10 years! It’s likely that there is some measure of capital flight from Europe as real money bond investors are probably not comfortable at such levels. Equities are another matter, with the Eurostoxx 50 up 13.6% so far this year in local currency terms (5.3% in USD terms) and the S & P 500 up only 2.5%. However I would expect that most of these flows would be currency hedged, for obvious reasons.

Greece confirms reports of capital flight The monthly data on bank deposits from Greece confirms the rumors of capital flight during the recent debt negotiations. Private sector bank deposits fell EUR 12.3bn or 7.7% during the month, a record either way you look at it. This demonstrates why a “Grexit” would be so difficult for the Eurozone as a whole. If Greece did leave, we’d probably see a similar response by savers in other troubled countries, which could spell disaster for the European banking system.

Oil fell sharply on a report in the Wall Street Journal that Iran and the six major powers were nearing an accord over Iran’s nuclear efforts. That would allow some 700k bbl/d of oil into the market, adding to the already-huge glut of oil. However, US Senate Foreign Relations Committee Chairman Bob Corker said he would introduce legislation giving Congress the power to review any nuclear deal with Iran. This makes it much less likely that any deal would get US approval. That doesn’t mean I’m bullish on oil, but there could be somewhat of a bounce today. The technical say the same thing (see below).

Japan’s data shows some recovery The usual end-of-month data deluge from Japan showed that output is recovering, but not because of domestic demand. Industrial production was up a faster-than-expected 4.0% mom, the biggest jump in four years, but retail sales were down a greater-than-expected 1.3% mom and household spending fell. This combination is likely to convince the authorities that export demand is essential and help to keep them firmly in the weak-yen camp, contrary to recent comments (ahead of the elections in April) that they are concerned about the impact of the weak yen on consumers. Meanwhile, the inflation rate was largely unchanged, meaning no immediate reason for the BoJ to get more concerned (or less concerned, either).

Today’s highlights: During the European day, German CPI for February is coming out, after several regional states release their data in the course of the morning. As usual, we will look at the larger regions for a guidance on where the headline figure may come in. Spain and Italy’s inflation rates are also coming out; both are expected to remain in deflation.

In Sweden, Q4 GDP is expected to show an expansion from Q3, which could strengthen SEK a bit.

In Norway, the official unemployment rate for February is coming out.

In the US, the 2nd estimate of Q4 GDP is expected to be revised lower. The 2nd estimate of the core personal consumption index, the Fed’s favorite inflation measure, is forecast to confirm the initial estimate. The Chicago Purchasing managers’ index and the final University of Michigan consumer sentiment for February are coming out. Pending home sales for January are expected to rise, a turnaround from the previous month. The decline in existing home sales on Monday suggest that pending home sales could miss expectations.

As for the speakers: Fed Vice Chairman Stanley Fischer, New York Fed President William Dudley, Cleveland Fed President Loretta Mester, ECB Vice President Vitor Constancio and Bank of Japan Deputy Governor Hiroshi Nakaso participate in the US Monetary Policy Forum.

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