Drivers for the week ahead: 13 Jan 2014

Price action:  The dollar is largely mixed as the market does not appear to have yet decided what to make of not only the poor US jobs data, but also the initial reaction to it.  The euro and sterling are consolidating the pre-weekend gains, with the former faring a bit better.  However, the dollar has had its losses extended against the Japanese yen without the help of the Tokyo market, which was closed for a national holiday (Coming of Age Day).  The Australian and New Zealand dollars are also outperforming.  EUR/USD is trading near $1.3650 and GBP/USD near $1.6450, while USD/JPY is just below the 103.50 level.  AUD is testing the 0.9050 level against the USD.  In the EM space, IDR is outperforming, while ZAR and TRY are underperforming.  The MSCI Asia Pacific index was up 0.7%, led by the Indonesian and Thai indices.  EuroStoxx and S&P futures are little changed.

• At the risk of oversimplifying, there seems to be a single overriding driver of the global capital markets in the coming days.  It is how investors see the implications of last week’s dismal jobs data.  In particular, many observers are suggesting that it raises doubts over the Fed’s willingness to continue to pull back from its asset purchases, as generally outlined alongside last month’s tapering decision.  Some observers have linked it to arguments that the economy has become dependent on QE and at the first sign of withdrawal, there is a loss of activity.  
• The immediate response was to send US Treasuries broadly higher and the dollar lower, against nearly all the major and many emerging markets currencies.  The main exception was the Canadian dollar, which was weighed down by its own poor data and the beginning of market speculation that the Bank of Canada may cut interest rates.  
• The weakest monthly jobs report in a couple of years spurred speculation that the Federal Reserve may postpone the next tapering move.  It was expected to be announced at the month-end FOMC meeting, and would have brought the Fed’s asset purchases down to $65 bln a month, which, incidentally, is lower than the BOJ’s own QE program.  For some others, who had begun playing with scenarios about the possibility an  upside surprise for the US economy this year and the risk of an earlier Fed rate hike, the jobs data was also a blow.
• We expect the Fed to go ahead with slowing of QE purchases.  Fed officials have argued that there has been a cumulative improvement in the labor market.  A month’s disappointment will not change that understanding, though a second dismal report may be harder to shake off.  Moreover, one does not have to venture much beyond the weather is seen mitigating factors.  
• That said, the market’s apparent lack of conviction may be an important signal in its own right.  Specifically, as we have argued, the Fed’s recent decisions, and especially the forward guidance, was issued by, for the lack of a better term, a lame duck Federal Reserve chairman. Moreover, as Obama’s nominations of two new Fed governors (and renomination of Powell, currently a governor), including a new vice-chairman to replace Yellen, before the weekend, underscores just how much the seven-person Board of Governors is also changing.  The fact that the Federal Reserve that provided the forward guidance is not the same Federal Reserve that is to implement it simply cannot be as credible is the same personnel doing both.  “There’s many a slip twixt the cup and the lip”, the English proverb teaches and investors beware.  
• Nevertheless, the jobs data and this uncertainty, means that the market will pay extra close attention to the Fed officials that speak and data in the week ahead.  Half of the twelve regional Fed presidents will speak during the week, as will Bernanke.  The Fed will also release the Beige Book, ostensibly used for the next FOMC meeting.  The same considerations that have prompted many economists to revise up their forecasts for Q4 GDP (due the day after the next FOMC meeting) may see a relatively upbeat report.  
• Separately, the US real sector data, like retail sales, industrial production, and housing starts, risk being on the soft side.  These reports, like the jobs data, suggest that even if Q4 GDP is in the 2.50%-2.75% range, the quarter ended with poor momentum (and this was before the polar vortex).  We already know that auto sales were poor and weakness in brick-and-mortar sales may be partly blunted by growing internet commerce.  It is notable that household consumption is steady and this is with limited new credit card usage.  The employment data and weather suggest some weakness in industrial production, though maybe mitigated by greater utility output.  The outsized 22.7% jump in November housing starts and the weather factor highlights the downside risk to the December report.
• If the real sector bias is on the downside, the bias on the price metric, import prices, producer prices, and consumer prices is on the upside.  This may in part be due to higher energy prices. However, given that the Fed chose to taper despite the lack of evidence that its preferred measure of inflation, the core PCE deflator was moving back toward the 2% target, means that barring new weakness, inflation measures are not very helpful in determining the near-term course of Fed policy.  
• While we expect a mostly US-centric week, there are a few economic reports from other countries to note.  In light of recent Canadian developments, the central bank’s senior loan officer survey, to be released Monday, may be important in assessing the financial conditions.  On balance, we think the recent sell-off has been too much too fast and anticipate some consolidative, short-term gains in Canadian dollar, perhaps fueled by a bout of short-covering or exporter purchases.  
• Australia’s December employment report will be released early Thursday in Sydney.  The Bloomberg consensus calls for a 10k increase after the 21k rise in November.  We suspect the risk is on the downside.  A combination of firmer currency (back-to-back weekly gains and now more than 2% above the multi-year lows) and a net loss of jobs might be enough to revive speculation of an RBA rate cut.  
• A current account deficit for November, on a seasonally adjusted basis, would the Japan’s third in a row.  The depreciation of the yen may boost exports, but it is also boosting the cost of imports, especially energy.  What is driving the yen, however, is the not its external position, but the US-Japan 10-year interest rate spread and Japanese equities.  The yield differential narrowed sharply after the jobs data to 215 bp, its lowest level in a month and below its 20-day average for the first time in more than two months.  
• We note that the tight link between dollar-yen and the Nikkei has lessened.  The 90-day correlation between the percent change of the two is a little over 0.42.  The 60-day correlation is near 0.37 and the 30-day correlation is 0.35.  This can also be seen in correlation on simply the level of dollar-yen and the level of the Nikkei.  The 60-day correlation is 0.94, while the 30-day correlation has fallen to a still lofty 0.75.
• With the ECB and BOE meetings last week not adding much to the current information set or expectations, this week’s data is unlikely to be very inspirational.  The euro area is expected to report a solid increase in industrial output in November. The euro zone appears to have grown around 0.2-0.3% in Q4 (not due until mid-February).  It will also release its final estimate on the harmonized CPI measure.
• The UK reports December inflation readings and retail sales.  Bolstered by energy, the headline CPI may rise by 0.5% on the month, but due to the base effect, it may still leave the y/y figure at 2.1%.  However, even if this measure does not increase in December, it may do so this month as last January the CPI fell 0.5%.  The Bloomberg consensus has UK retail sales rising 0.3% on both the headline and ex-auto measures.
• Despite the growing tensions in Thailand and the risk of military involvement, the SET index bounced higher today by 2.2% and the THB is roughly stable. There is some optimism that a delay to the February 2 vote will could open up space for some sort of compromise. But with major roads in Bangkok being blocked and protests gaining momentum again, we are less sanguine.
• Brazil’s central bank is expected to continue to tighten monetary policy this week.  Previously, many observers expected a 25 bp rate hike, but over the past week or so, the pendulum of market sentiment appears to have swung to another 50 bp move.  The Selic rate currently is set at 10.0%.  A local press report over the weekend suggested the government also expects a 50 bp move.  
• After weeks of blaming negative sentiment towards Chinese stocks on the IPO pipeline, the Shanghai Composite failed to react to the delays for new listings and more stringent approval rules.  Overnight, the CSRC (regulator) said it would strengthen supervision, delaying the approval of 5 IPOs.  One would think that this would have provided at least a temporary boost to equities.  The real estate sector was a major drag on the index today following a local article saying the government intends to reduce land availability for construction in the Eastern region, and cities with a population of over 5 million will not be allowed more building projects.  There was also talk that private companies (e.g. Vanke, -1.9%) may be required to participate in socialized housing projects. Meanwhile, USD/CNY continues to grind lower to 6.0434 today.
• Indonesian stocks rallied nearly 3%, the most since September and IDR is outperforming after the government decided to soften rules on the mineral export ban.  In short, the idea behind the ban is to increase the value added component of exports and to boost government revenues in the process.  At the last minute, however, the government provided a temporary exemption to the two biggest miners, Newmont and Freeport – large producers of copper and iron ore.  So the squeeze is mainly on nickel and bauxite, worth some $2 bln annually.  This means that other large nickel exporters such as Philippines’ Nickel Asia Corp are rallying, up 6% today.  Nickel futures are up over 3% on the day.
• Here is a quick preview of the week ahead for EM (full report to follow).  Chinese new yuan data will be in focus this week, expected to have fallen in December to RMB 570 bln.  Turkey reports November’s current account data on Tuesday, and the deficit is expected to widen considerably.  Hungary reports December CPI Wednesday, expected to have moderated from November.  South Africa reports November retail sales and manufacturing PMI on Wednesday. Poland reports December CPI on Wednesday.  Brazil central bank announces its rate decision on Wednesday, with the market split between a 25 and 50 bp hike.  Chile central bank holds policy meeting Thursday and is expected to keep rates steady at 4.5%.  Singapore reports December trade data Friday.

BBH Global Currency Strategy Team