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UK CPI will be key for GBP. Watch the US NFIB survey for any signs of wage pressure which could upset stock markets.

By Nick Parsons

By the time London traders headed for the train home on Monday, the DJIA was up almost 400 points and a few hours later it officially closed up 410 points with the S&P 500 index up 1.4% at 2656. Indeed, this was the first time since January 26th that the equity market had spent the entire day in positive territory. Judged against this rally, the pound’s performance was pretty uninspiring. GBP/USD ended the day barely 20 pips higher, with the GBP losing ground against both the EUR and the AUD, though up against the CAD and NZD. Overnight in Asia, GBP/USD has added a quarter of a cent to the mid 1.38’s.

Speaking to MP’s yesterday, BoE MPC member Gertjan Vlieghe expanded somewhat on the conditions that might see a rate hike postponed, saying the Bank of England would likely reconsider its assumption of a “smooth” transition to Brexit if a breakdown in talks between London and Brussels causes big shifts in financial markets and economic indicators. Vlieghe said the Bank would watch surveys of businesses and households for big moves if expectations of a disorderly exit from the European Union became widespread. “And that might be the kind of material change that we’d (need to see to) say our assumption of ... a smooth transition is clearly not tenable any more.”

The big event today in the UK will be the January CPI figures. Inflation last month slowed from 3.1% to 3.0% and consensus looks for another drop to 2.9% in January. With BoE interest rate policy now aligned very closely with current and expected inflation, it should be a straight read-across for the GBP; the higher the number, the more it will raise expectations of a hike in interest rates at the May MPC meeting. Prior to last week’s meeting, the market-derived probability of a 25bp hike was just under 50%. On Thursday it jumped to 70% and today stands around 61%.

The big question for Monday was whether buyers would step into the equity market even after its sharp reversal higher on Friday afternoon in New York. The answer most definitely was ’yes’. DJIA futures were up 175 points by the time of the London opening, 200 points at the opening bell on Wall Street and then closed 410 points higher. Indeed, the Dow Jones is now up more than 1500 points from last week’s low; having regained almost 50% of its entire peak-to-trough losses. Against this background, it could be said that the US Dollar actually did well to limit its losses to less than half a point on its index against a basket of major currencies. The high last Thursday was 90.25 - its best level since before Treasury Secretary Mnuchin’s comments in Davos two weeks’ earlier – and the USD retraced only slightly to 89.80.

US total government debt today stands at $20.49 trillion. The White House Office of Management and Budget yesterday released proposals under which the debt is projected to rise almost 50% over the next decade to $29.9tn in 2028. The annual increases in total debt are sequentially lower but even in Year 10, are projected to add some $352bn to the total stock of debt. The US Government has abandoned all pretence at a balanced budget. Along with the borrowing proposals, the US Administration also published its detailed infrastructure plans. According to Goldman Sachs who have the resources, expertise and connections to know such things, “the low odds of enactment this year have not changed, in our view…in light of the need for 60 votes in the Senate, a lack of bipartisan consensus regarding the appropriate structure for federal infrastructure funds, and political considerations ahead of the upcoming midterm election”. Whilst the odds of enactment are low, the odds of a US debt downgrade seem to be high and rising. Credit ratings agency Moody’s didn’t join S&P in downgrading the US in August 2011 but it seems to be hinting very strongly that it will now do so. Whether or not it actually matters is another question…

Today in the United States we have the NFIB small business survey which contains an important question on earnings. Last month’s Press Release breathlessly said that, “With a massive tax cut this year, accompanied by significant regulatory relief, we expect very strong growth, millions more jobs, and higher pay for Americans… There’s a critical shortage of qualified workers and it’s becoming a real cost driver for small businesses… They are raising compensation for workers in order to attract and keep good employees, but that’s a positive indicator for the overall economy.” The earnings trends number in the December survey was down 5 points to -15. This could be the key data point to watch today, both for equity and currency investors. Overnight in Asia, with EUR/USD back on a 1.23 ‘big figure’ for the first time in six days, the USD index has slipped around another quarter of a point.

Monday was another day when the DJIA moved at least 500 points but, once again, EUR/USD remained firmly on a 1.22 ‘big figure’, albeit the pair ended almost half a cent up from its opening level in Sydney. As the end of the day approached in New York, the EUR had gained against every major currency except the Aussie Dollar and finished in second place on our one-day performance table. Overnight, it has finally moved up to 1.23 and has very marginally outperformed all the other currencies we track closely here.

After all the criticism of the Coalition agreement negotiation by Angela Merkel, in a prime-time ZDF television interview, she defiantly brushed aside any suggestion of quick change. “I ran for a four-year term. I promised those four years and I’m someone who keeps promises. I totally stand behind that decision.” Giving Finance to the Social Democrats is “acceptable” and “European policy will be formulated jointly” within the government, limiting the SPD’s ability to set the agenda, Merkel said. According to the Financial Times this morning, even her allies are talking openly about the post-Merkel era. Speaking on German radio on Monday, Günther Oettinger, the EU commissioner, said it was “clear to everyone” that Ms Merkel was entering her last term. He said she was too “smart and experienced” to repeat the mistakes of previous leaders such as Helmut Kohl, but will “over the next four years initiate the succession”.

The world’s biggest hedge fund, Bridgewater Associates, disclosed it now has positions valued at more than $14 billion that stocks in the Eurozone will decline. The value of the firm’s short bets in Europe has more than quadrupled this month and as well as selling Italian companies ahead of the March elections, it is also betting against energy, manufacturing and construction firms in Europe. There are no economic statistics scheduled for release in the Eurozone today.

The Australian Dollar actually finished top of our one-day performance table on Monday, though this might tell us more about how surprisingly quiet foreign exchange markets were than anything particularly new or insightful about the AUD itself. The scale of the absolute movements certainly wasn’t very impressive. AUD/USD opened in Sydney a few pips above 0.7800 and closed in New York in the mid 0.78’s. Volatility as measured by the VIX index fell back two points to 25 and US 10-year Treasury yields edged down around 3bp from their 2.89% intra-day high; both of which helped the Aussie a little. It’s probably also the case that market positioning was still net short after the equity market decline of the last 10 days and there may have been some buying to square off these positions.

Overnight, the NAB monthly business survey was released. According to the details on their website, the business conditions index jumped 6pts to a strong +19 index points, which is well above the long-run average of +5 index points. The business confidence index also rose by 2pts to +12 index points, its highest level since April 2017. Business conditions are solid to strong across all major industry groups with the exception of retail. The construction industry in particular is performing well. “The improvement in construction conditions over the last twelve months is due to improved trading conditions, profitability and employment, and probably reflects the still elevated residential construction pipeline, infrastructure construction and the gains in non-residential building approvals last year. The lift in employment is particularly significant given the rising share of employment found within the construction industry.” With the RBA most especially focused on wage growth and household consumption, the softness of the retail sector should be watched carefully as a coincident indicator of consumer confidence. We noted yesterday that CBA have already changed their RBA forecast to no change in rates this year.

In her speech yesterday evening, RBA Assistant Governor Luci Ellis spoke of the three key issues confronting the economy: How much spare capacity it has; how much wage growth and inflation will pick up; and how resilient will consumption growth be if income growth remains weak. She said Australia has “had especially strong employment growth over the past year - more than double the rate of growth in the working-age population… But that hasn’t translated into strong consumption growth. Household income growth has been weak for a number of years, and that has weighed on consumption growth.” As for the current situation, high levels of household debt – around 188% of income – are already weighing down on spending. Ms Ellis noted there are already some signs of this in consumption data as “growth in spending on discretionary items, like travel and eating out, has slowed while growth in spending on essentials has held up.”

On both Thursday and Friday last week, USD/CAD briefly broke through the upper end of its 2018 trading range from the mid 1.22’s to the high 1.25’s. Yesterday, too, it regained 1.26 but this time managed to stay there, as investors began to take notice of a near-10% weekly drop in crude oil prices. This has taken WTI down from a recent high of $66.50 per barrel on January 25th to just under $59.15 this morning. This morning, with the USD again on the back foot, USD/CAD is back on a 1.25 handle.

The Bloomberg Nanos Canadian Confidence Index showed continued negative pressure for the sixth week in succession. The BNCCI, a composite of a weekly measure of financial health and economic expectations, registered 58.59 compared with last week’s 58.98. The twelve-month high stands at 62.17. "While household balance sheets remain better off than last year, consumers are factoring in expectations of slowing growth for the economy and real estate holdings, and slightly more risk to their employment situation. It’s likely that any additional financial stress will have a knock-on effect on household consumption”, said the authors of the report.

Speaking at a White House event on his new infrastructure proposal yesterday evening, US President Donald Trump complained about Canadian trade practices. “We lose a lot of money with Canada. Canada does not treat us right in terms of the farming and the crossing the borders… So, they’ll either treat us right or we’ll just have to do business really differently… We cannot continue to be taken advantage of by other countries.” It was not at all clear what the President meant by “the crossing the borders” or by “the farming.” On NAFTA specifically, Trump said he is willing to give his negotiators time to work rather than quickly initiating a withdrawal from the agreement, though he then suggested immediately that he is not worried about the possible harm of a withdrawal. “Hopefully the renegotiation will be successful. And if it’s not, we’ll be more successful”. No wonder currency traders are confused what to make of this….

The Kiwi Dollar has been pretty much out of the spotlight given the volatility in global equity markets and most of its movement is being driven by the AUD/NZD cross than by any great shift in sentiment or investor appetite elsewhere offshore. Last Tuesday saw the pair hit a 6-month low of 1.0750 but yesterday it rallied more than half a cent to 1.0825. This move helped slow the modest rally in NZD/USD though it is now back in the high 72’s and up almost a cent from last week’s one-month low.

In political news, New Zealand's opposition leader Bill English is quitting after losing last year's election. The former prime minister said he was resigning as leader of the conservative National Party and leaving Parliament. Mr English, a long-serving finance minister who took over as prime minister in late 2016 after the resignation of John Key, led the National party to win the biggest share of seats in parliament in last year’s September election but was then unable to form a government. His statement said, “Now is the right time for me to step aside and embark on new professional and personal challenges. I informed the National caucus this morning that I am resigning as leader of the National party… I believe this will give National’s new leader time to prepare the party for the 2020 election.”

There was no economic data scheduled today but on Wednesday we have food price inflation and the RBNZ’s own quarterly survey of inflation expectations. In last month’s survey the one and two-year expectations were at 1.87% and 2.02% respectively.