Inventory Slide Continues | In search of Alpha

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Overview: Equity markets are vulnerable after last week’s slide, while bond markets have extended their recovery. The dollar is mostly firmer to start the new week. Stocks in Japan, China and Taiwan rose, but not enough to offset weakness elsewhere, and the MSCI Asia Pacific Index lost about 0.75%. It fell 1.7% last week. The European Stoxx 600 fell for the first three weeks of the year and is down another 2.1% today. US futures have given up early gains. Bonds are offered. The 10-year US bond, which was trading at 1.90% three days ago, is approaching 1.70%. European benchmark returns are 2-4 basis points lower and the periphery is outperforming the core. China’s benchmark 10-year yield was around 2.77% at the end of last year and is now at 2.67%. It appears to be heading towards 2.50%. Meanwhile, the dollar is mostly stronger. The yen and the Swiss franc appear to be the most resilient. Australian Dollar and Scandis lead falling currencies. Among emerging markets, the Turkish lira, Philippine peso and Chinese yuan are firm but most others are lower, led by the Russian ruble. It’s down about 5% over the past four weeks and is down another 0.75% today. The JPMorgan Emerging Market Currency Index, which has risen for the past three weeks, falls for the second straight day. As for the commodity complex, gold is stable despite being just below last week’s high of $1,848. March WTI is stable and a bit heavier slipping below $85 after falling for the last two sessions. US natgas prices are about 2.7% lower after falling 6.2% last week. European gas prices are up nearly 12%, fully recovering last week’s 4.9% loss. Iron ore prices make a four-day increase of almost 11%. Copper is about 1.8% softer and has trimmed last week’s gains by more than half.

Asia Pacific

Japan’s flash PMI disappointed, but new quasi-emergency measures amid surge in virus are the main culprit. Manufacturing PMI was firm, rising to 54.6 from 54.3, but services slumped to 46.6 from 52.1. This pulled the composite back from 52.5 to 48.8, below the 50 boom/bust level. Separately, at least five prefectures felt the effects of the 6.6 magnitude earthquake in the southern islands. After a 90-minute phone call ahead of the weekend, US and Japanese officials are finally seeking a “quick fix” on steel and aluminum tariffs the US imposed in 2018 for national security reasons.

Australia’s preliminary PMI also disappointed. Manufacturing PMI slipped to 55.3 from 57.7, but again the virus has hit the services sector. Its PMI collapsed to 45.0 from 55.1. The composite is 45.3, down from 54.9. Australia reports Q4 CPI tomorrow. The year-over-year pace is expected to increase from 3.0% to 3.2%, while the trimmed and weighted average prices (Bloomberg survey) are forecast to rise from 2.1% to 2.3%.

The US dollar tests the monthly low against the Japanese yen near JPY113.50. A break would initially target the JPY 113.00 area but the risk could extend to JPY 112.50. On the upside, the greenback is meeting resistance pre-JPY114.00 where just under a $460m option expires today. the The Australian dollar extends losses today. It peaked at $0.7275 last Thursday and pushes down to $0.7150 in European morning, about halfway through the rally from the December 3 low just under $0.7000. The $0.7115 area is the closest retracement target (61.8%). Note that an A$410m option expires tomorrow at $0.7100. The dollar weakened against the Chinese yuan, falling further to nearly 6.3240 CNY, its weakest since April 2018. The greenback has fallen in 10 of the last 12 sessions. The yuan is also higher against its trade-weighted basket (CFETS) and appears to be at its highest level since August 2015. Record trade surplus and portfolio capital inflows offset policy divergences. The PBOC set the dollar’s reference rate at 6.3411 CNY, slightly stronger than the market (Bloomberg poll) at 6.3407 CNY.

Europe

Germany’s preliminary purchasing managers’ index surprises on the upside. Manufacturing PMI rose to 60.5 from 57.4, well above expectations which had called for a decline. Services recovered to 52.2 from 48.7. The composite rose above the boom/bust level of 50 (54.3) for the first time in three months. France, on the other hand, disappointed. Manufacturing PMI didn’t fall as much as expected (now 55.5 from 55.6), but services PMI fell more (53.1 from 57.0). This pulled the composite from 55.8 to 52.7 (Bloomberg median forecast was 54.7). The aggregate readings were mixed. Manufacturing PMI rose to 59.0 from 58.0, better than expected. Services PMI fell to 51.2 from 53.1 (expected 52.0) and composite PMI fell to 52.4 from 53.3. This is the fifth decline in the aggregate composition in the last six months. It peaked at 60.2 last July. The virus appears to be key and appears to be disrupting economic activity in the first quarter. Geopolitics, European politics and increased energy prices are doing each other no favours.

The UK flash PMI also disappointed. Manufacturing PMI slipped to 56.9 from 57.9, shuffling median forecast (Bloomberg survey) of 57.6. Services PMI slipped to 53.3 from 53.6. Optimistic economists had forecast a slight increase. The composite rose to 53.4 from 53.6, defying expectations for a small gain. It is the third straight decline in the composite PMI and the sixth in the past eight months since it peaked at 62.2 last May. Meanwhile, the market is bubbling with talk of other failures by the Johnson administration, and Gray’s report on her internal investigation is awaited.

Italy begins electing a new President today. Every day, 630 MPs, 321 Senators and 58 regional representatives have to cast a ballot. In the first three rounds, a 2/3 majority is required for victory. From the fourth ballot, only a simple majority is required. Berlusconi withdrew at the weekend. The risk is that if Draghi becomes the next president, efforts to appoint a new prime minister could fail, forcing snap elections. Traditionally, Italy is seen as a weak presidential model, but the president has the power to appoint a prime minister (which got Draghi the job), force parliament to consider laws, and can appoint 1/3 of the constitutional court. European politics is a focus in the first half of this year. We talked about developments in the UK and Italy. Portugal goes to the polls in a few days and April’s French presidential election is already on the radar screens as the latest polls show Macron’s support waning, falling to 37% (from 41%) and 60% in December. rejection rating.

The euro will not go any further so quickly. The fourth straight session is blocked by offers in the $1.1360 – $1.1370 range. Bids near $1.1300 were found in the second half of last week. A nearly €1.1 billion option at $1.13 expires tomorrow. We see the technical factors favoring a downside break and see initial potential towards $1.1255. From a technical perspective, sterling looked particularly vulnerable late last week and today’s follow-up selling has seen it near the $1.35 mark. It peaked at $1.3750 on January 13th. The $1.3460 area is the next target. It is the (50%) retracement target of the rally that started around $1.3175 on Dec 20th. Also note that the five-day moving average will fall below the 20-day moving average for the first time in a little over a month.

America

With sharp price losses on the stock markets, talk of the “Fed Put” has been reignited. In fact, last week Fed fund futures had started pricing in the risk of a fifth rate hike this year and about a 1 in 3 chance of a 50bp move in March. The stock decline has brought the market’s aggressiveness to a halt. But also note what a self-correcting mechanism is. A sharp fall in equity prices has boosted private sector demand for US bills and bonds and has spoken of a business downturn. We have argued that between expected rate hikes, balance sheet shrinking, fiscal tightening and more than doubling in oil prices, there are strong headwinds for the economy whose cumulative effect may not be fully appreciated. Note that a third of the S&P 500 by market cap is reporting gains this week.

Additionally, the tightening is taking place as the US economy loses forward momentum. US see flash PMI today. It is expected to have softened. The composite PMI has declined in six of the past seven months since peaking at 68.7 last May. The median forecast in the Bloomberg poll is for it to fall below 57.0. Mid-week FOMC meeting is the highlight but first look at Q4 GDP is next day. Estimates have been revised downwards and risk appears below the median forecast (Bloomberg survey) of 5.3%.

The Bank of Canada also meets on Wednesday. Economists see standpat politics in Bloomberg’s poll. The swap market has almost a 73% chance of a discounted rate hike. Participants should be prepared for increased volatility. We stand on the side of the market and are inclined to see a hike. They’re not the only ones in America likely to rise this week. Chile is expected to hike 125 basis points to bring interest rates to 5.25%. It would be the first consecutive hike since July-August and the third move of 125 basis points. Colombia is expected to raise its repo rate to 3.75% from 3.0%. It also raised rates by 50 basis points in December after the first move in the cycle by 75 basis points in October.

The US dollar bottomed at CAD$1.2450 last week and rallied to nearly CAD$1.26 ahead of the weekend. This is the previous cutout of a head and shoulder topping pattern that we observed. We have been looking for a countertrend bounce and in Europe it is testing CAD1.2615. Initial resistance stands around CAD1.2630, a short-term retracement target and the 20-day moving average. Above that, the potential lies at CAD1.2650-CAD1.2675. The dollar hit a low near the 200-day moving average of the Mexican peso (~MXN 20.28) last week and traded as low as MXN 20.5665. It’s knocking on that area now. A move higher could result in initial gains towards MXN 20.65. Momentum indicators are in favor of the US dollar

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Publisher’s Note: The summary bullet points for this article were selected by Seeking Alpha editors.

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