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Volatility remains elevated in equities but FX markets quite steady. USD a touch higher with domestic politics weighing on both GBP and EUR

By Nick Parsons

With very real concerns that Tuesday might develop into another bloodbath for US equity markets, the US Dollar index against a basket of major currencies rose as high as 89.70 in the New York morning. This took it right back to the level at which it stood before US Treasury Secretary Mnuchin’s comments in Davos which so enraged ECB President Mario Draghi. As stocks regained early losses, so the USD was sold and the index gave back around half a point even as bond yields began to climb once more. Overnight, with stock markets showing Bitcoin-like levels of volatility, the USD is two-tenths higher at 89.50 although no-one can confidently predict where equities will be over the next few hours, let alone by the end of the day. As we go to print, futures markets are indicating the DJIA around 200 points lower; a fall which would have seemed dramatic before the events of the last four days, but is volatility which we may now have to live with for a while.

St. Louis Fed President James Bullard is not an FOMC voting member this year but markets are looking for any clues they can find. In a speech at the University of Kentucky’s College of Business and Economics, Bullard said higher wages was not a key driver of inflation. “I caution against interpreting good news from labor markets as translating directly into higher inflation… The empirical relationship between these variables [wages and inflation] has broken down in recent years and may be close to zero… Continued strong labor market performance is unlikely to translate into meaningfully higher inflation,” he concluded. We said here yesterday that, “It will be interesting to see if the speakers have soothing words for stock market investors or focus, instead, on the continued normalization of US monetary policy.” There are four more still scheduled this week but the first out of the traps was definitely in market-calming mode.

Messrs. Evans, Dudley and Kaplan are all due to give speeches later today, though there are no top-tier US economic data releases scheduled. After the figures on the merchandise trade deficit were published yesterday, the Atlanta Fed revised down its estimate of Q1 GDP from 5.4% to 4.0%. The USD index opens in North America at 89.50 with 10-year US bond yields at 2.76%.

In the space of just three trading days, USD/CAD rose exactly three cents from a low of 1.2260 last Thursday evening to 1.2560 on Tuesday morning. Mostly this was a story of USD strength, though the Canadian Dollar has also slipped on some of its major crosses with EUR/CAD, for example, up around half a cent over the same period. Taking a bigger picture view, since the beginning of 2018 USD/CAD has been in a range 1.2260-1.2580 and it hasn’t moved out of this band despite a Bank of Canada rate hike and one of the biggest one-day falls in the recent history of the US stock market.

Statistics Canada reported yesterday that the country's merchandise trade deficit increased to $3.2 billion in December as rising imports outpaced export growth. This was at odds with consensus forecasts that the deficit would be smaller than November’s $2.7bn. Total imports increased 1.5 per cent to a record $49.7 billion in December, boosted by higher imports of energy products and industrial machinery, equipment and parts. Meanwhile, total exports rose 0.6 per cent to $46.5 billion driven by higher exports of energy products and metal and non-metallic mineral products. The bilateral trade surplus with the United States rose slightly to $3.42bn with exports and imports both falling a little during the month. Overall, there was nothing to ring any immediate alarm bells over NAFTA.

After the trade numbers, the next big event in domestic economic news this week will be the employment report on Friday, though before then Bank of Canada Senior Deputy Governor Carolyn Wilkins will give a speech tomorrow which could offer the next clues on the outlook for interest rates. The Canadian Dollar opens in North America at USD/CAD1.2525, AUD/CAD0.9845 and GBP/CAD1.7390.

As with most of the non-US dollar currencies, the low point for the EUR on Tuesday came early in the European afternoon as nervousness mounted around what lay in store for US equity markets. As a much-feared third consecutive day of extreme downside pressure failed to materialize, EUR/USD rallied to just about regain a 1.24 handle late in the New York day. The overnight session in Asia was exceptionally quiet with barely 20 pips separating the high and low in EUR/USD, although as investors try to digest news of the new Coalition government in Germany, the pair is down around 1.2340 this morning in Europe.

After protracted talks, Angela Merkel's conservatives have finally made a deal with the Social Democrats over a new coalition contract in Germany. Negotiators from the Christian Democratic Union (CDU), their Bavarian partners the Christian Social Union (CSU) and the center-left Social Democratic Party (SPD) have thrashed out a contract for a new grand coalition government, in all likelihood led once again by Angela Merkel. German news outlets including ARD and Der Spiegel reported just before 10am this morning - the third day of "extra time" - that a final contract had been agreed, to be formally announced later in the day. The SPD leadership confirmed the reports in a group WhatsApp message, which began, "Tired. But satisfied."

At the risk of sounding like a two-handed economist, on the one hand there is some relief that Germany might avoid a fresh, destabilizing Federal Election, but on the other is a concern that Ms Merkel might have conceded too much to the left-wing SPD. Early reports suggested that the SPD would be handed the Finance Ministry - a major victory for the Social Democrats - while CSU leader Horst Seehofer, one of the most conservative figures on Merkel's side, would become Interior Minister. The SPD also look set to keep control of the Foreign Ministry and the Labor Ministry, with party leader Martin Schulz reportedly keen to be Foreign Minister. As all this news is digested, the EUR opens in North America at USD1.2345 and EUR/CAD1.5455.

Having broken down through USD1.40 on Friday evening, the Pound’s fall accelerated in Europe on Tuesday, reaching the mid 1.38’s during the London afternoon immediately prior to the opening of the US stock market. After a very sharp initial decline, equities were soon trading in the green and the strong bid to buy USD quickly disappeared. Though the pound ended the day down against the AUD, NZD, CAD and EUR, the so-called ‘cable rate’ was marginally up even though it couldn’t get back on to a 1.40 big figure. This morning in Europe, GBP has had another failed attempt at 1.4000 but could get no higher than 1.3995 before falling over a cent as political uncertainty in the UK continues to weigh on business and investor sentiment.

The Guardian newspaper last night splashed an exclusive report – followed by others this morning - that, “Brussels will have the power to punish the UK at will during the Brexit transition period by closing off parts of the single market to British companies, according to a leaked legal document drawn up by the EU.” The leaked position paper, entitled Transitional Arrangements in the Withdrawal Agreement, lays out in legal language the EU’s terms for the transition period and says use of focused sanctions to “suspend certain benefits ... of the internal market”, would give the EU the freedom to punish the UK without prematurely terminating the transition period and risking damage to its economic interests. With the various pro and anti-Brexit factions in the UK Government already publicly fighting amongst themselves, this latest news is hardly likely to lower the temperature.

There are no top-tier UK economic data today though the average price of a home in Britain fell 0.6% last month to £223,285, according to the mortgage lender Halifax. It followed a 0.8% drop in prices in December, and drove down annual house price growth to 2.2%; the slowest rate in six months. The British Pound opens this morning in North America at USD1.3880, GBP/AUD1.7655 and GBP/CAD1.7370.

As the trading ranges in equity markets progressively narrowed through the Northern Hemisphere day on Tuesday, so too the non-USD currencies then stabilized and even found a bit of support. The low for AUD/USD in Europe was above the Sydney low and during the New York session the AUD managed to rally around half a cent. This brought to an end a run of six consecutive declines for the AUD/USD pair which had dropped almost 3 cents from its high back on January 26th. Having very briefly recovered on to a US 79 cents handle in Asia, however, the AUD has now given back most of yesterday’s gains.

Bloomberg reports this morning that Commonwealth Bank of Australia – the nation’s largest bank - has reduced its exposure to apartment developers by more than A$1 billion ($789 million), or 23%, according to data included in its first-half earnings report, released today. It’s also pulling back on loans to property investors, which rose just 0.5 percent compared to 7.5 percent growth for owner-occupier loans. Data released last week showed Sydney house prices, which surged 75% between February 2012 and July, have now dropped 3.1% from their peak. As the other major banks report their numbers over the next few weeks, analysts will be looking for any further signs of caution on the property market which has been a major driver of household consumption and consumer confidence over the past few years.

The main event for the rest of this week is on Friday when the RBA releases its latest Quarterly Statement of Monetary Policy, but before then in Sydney on Thursday evening, Governor Phil Lowe is scheduled to give a speech. He is usually full of interest and insight and this first set-piece event since the summer holidays at the A50 Australian Economic Forum dinner is sure to be closely-followed. The Australian Dollar starts in North America this morning at USD0.7860, with AUD/NZD at 1.0750 and AUD/CAD0.9840.

The NZD jumped to the top of the one-day performance table on Tuesday even as markets locally were closed for the Waitangi Day holiday. The outperformance was driven by a sharp drop in the AUD/NZD cross rate which fell a full cent to a 6-month low in the mid 1.07’s on talk of stop-loss orders being triggered on the break down from technical support around 1.0850. This morning in Europe, NZD/USD is around a quarter of a cent off from its Asian high of 0.7345 but is still holding onto its gains against its Aussie cousin.

New Zealand’s fourth quarter labour market report was released this morning. The seasonally adjusted unemployment rate fell to 4.5% in the December 2017 quarter, down from 4.6% in Q3; the lowest since the December 2008 quarter, when it was 4.4%. Although good news, the unemployment rate for the December 2017 quarter remains considerably above New Zealand’s lowest unemployment rate, which was 3.3%, recorded a decade ago in the December 2007 quarter, immediately before the global financial crisis. The employment rate held steady at 67.8 percent, the equal highest rate since the series began in 1986, as employment kept pace with the expanding working-age population. Women also remained at their highest ever rate of employment at 62.4 percent.

Ahead of the first RBNZ policy meeting of the year, it was interesting to see the official statisticians point out prominently in their data release that, “the underutilisation rate was just over 12 percent - reflecting about 340,000 New Zealanders with potential to work more. This measure is just as important as the unemployment rate”. Analysts are unanimous that there will be no change in interest rates tomorrow and the markets’ view on the timing of the first hike in early 2019 is a bit later than the RBNZ has so far penciled-in. The New Zealand Dollar opens this morning in North America at USD0.7315 and NZD/CAD0.9155.