As market participants were just getting their sea legs back after the start
of the year, it was hit by a one-two punch of ideas that BOJ policy was turning
less accommodative and that Chinese officials were wary of adding to their
Treasury holdings. Then late yesterday, a news wire reported that Canada
suspected the US was going to withdraw from NAFTA.
Today, however, the markets have stabilized. First, in today's
operations, the BOJ maintained its purchases of short- and medium-term bonds
today. This helped ease some fears and the 10-year benchmark yield
slipped back. In our view, the purchases of fewer bonds by the BOJ was
evident last year and is a consequence of the shift to "yield curve
control" by targeting the 10-year yield rather than the quantity of
Second, China's State Administration of Foreign Exchange (SAFE) pushed
back against yesterday's news wire report about its wariness to buy
Treasuries. The official suggested that "wrong sources"
were used, and went on to say that China's demand for Treasuries depends on
market forces. That is exactly our point. China is not homogeneous
even if it is a one-party state. There are natural difference
of views and interests. For example, the PBOC often seems more open to
market reforms than say the Commerce Ministry. From the news wire
account, that some many other reporters and observers took at face value there
was no way of telling how representative the view was or the gravitas of the
Also, our point is that if China wants to rebuild its reserves, like it
has for the past 11 months after drawing them down by $1 trillion, it must buy
foreign assets by definition. It can change the allocation of its
reserves, of course, by this is not done by whim and there are many
considerations, including alternatives. Some argue that China is trapped
in Treasuries. That is not our point. China only faces the dilemma
because it insists on amassing stock pile of reserves, in part because of its
reluctance to embrace to fully embrace the best practices as defined by the G20
of letting market forces drive exchange rates.
Amid this concern about the shift in BOJ policy and China's appetite for
Treasuries, the reception to yesterday's $20 bln US Treasuries was unexpectedly
strong. The backing up of yields (2.579%) saw the bid-cover rise to
2.69, the highest since mid-2016. Indirect bidders (which includes asset
managers) took down 71.4% of the new supply, the most since August 2016.
This means the primary dealers absorbed a little more than a fifth, the least
since March 2017. The US 10-year yield, which approached 2.60% yesterday
is now back to 2.53%, down a couple of basis points today.
The White House says that the US position on NAFTA has not changed.
While that sounds encouraging, the status quo may not have been particularly
encouraging. The US has made substantive demands like curtailing the
dispute resolution mechanism, and a sunset clause (that would end the treaty in
five years unless the three parties explicitly endorse it) that some suspect is
a poison pill. There is a negotiating round this month and next.
Whatever low hanging fruit there might be, it is often picked at the start of
the negotiations to show early success and create a good atmosphere of
cooperation. The tougher issues come last.
The Canadian dollar is near yesterday's lows. The US dollar has
been trending lower since mid-December. The market anticipates the Bank
of Canada to hike rates next week. However, even before yesterday, the US
dollar began correcting higher. The CAD1.2570 area corresponds to some
highs from last week and the 38.2% retracement of this last leg down. The
50% retracement is near CAD!.2640, which also is near the 20-day moving average
(~CAD1.2630). The Mexican peso is little changed.
The Australian dollar is the best performing major currency today.
It is up 0.4% and making new three-month highs. The driver was a sharp
1.2% jump in November retail sales, which was three-times more than economists
expected. It is the strongest four and a half years.
Household goods rose 4.5%, and these were fueled by a 9.3% rise in electrical
and electronic products, which could prove to be one-off. The
Australian dollar has approached a key (61.8%) retracement of the drop from
mid-September. It is found near $0.7885.
The euro returned to where it was yesterday before the Chinese story
broke. The euro continues to hold the 20-day moving average (now
~$1.1925). It takes a break of the $1.19 area, and probably $1.1865 to
signal a proper correction as opposed to the consolidation. There is a
660 mln euro option struck at $1.20 that expires today. Another 2.0 bln
euros expire with the same strike tomorrow. In contrast, sterling's
support near $1.35 is fraying.
Sterling has slipped through last week's low briefly yesterday on the
back of the disappointing trade figures, but snapped back on the broader dollar
weakness. It has pushed a little lower today (~$1.3475), but the
break is not clean or convincing yet.
The dollar reached a low near JPY11.25 yesterday. It has
stabilized, but so far, the recovery is unimpressive. It has been up to
almost JPY111.90 and we suspect that will not be the high of the day. The
JPY112.10 area corresponds with a minimum retracement of this week's slide and
JPY112.35 is the 50% retracement and roughly the five-day moving average.
There do not appear to be important option expiry today, but tomorrow there is
$1.2 bln dollar on a JPY11.75 strike that expires.
The US reports PPI and weekly jobless claims. These
reports do not draw the interest as tomorrow's CPI and retail sales will.
Near the close of the markets, NY Fed President Dudley speak on the outlook for
the US economy. The market remains fairly confident of a March
rate hike (~82%).