10Y bond spreads have overall widened in the last one week (1W). Central America and LatAm have widened the most, while Asia is the only region to tighten in the last 1W. All the credit rating buckets have widened over the last 1W, with BB rated credits underperforming the most.

10s30s spread curves steepened by 1bp in the last 1W to currently stand at 64bp. On an absolute basis, COL is the steepest curve, while PHI is the flattest. On a 6m z-score basis SOAF and ARG are the steepest curves, while BRA is the flattest.
The CDS-bond basis decreased by 2bp in the last 1W to currently trade at positive 11bp. This leaves the basis close to the 6m average of 10bp. On a 6m z-score basis BRA has the most positive basis, while SOAF, PHI and INDO have the most negative.

The consensus expects the ECB to allocate EUR110bn via its target LTRO after allocating EUR62.2bln at its last operation. Given that this is the last TLTRO allocation, demand could be heavy and should the allocation exceed the EUR110 expectation,excess EUR liquidity will be parked at the front end of the EUR curve pushing rates lower, which at the margin is a EUR negative. However, for developing a more pronounced bearish impact on the EUR the liquidity boostneeds to impact the 2-year EUR swap. A decline of the German Schatz yield is not sufficient for driving the EUR lower. ECB’s Nouy (8am) and Lautenschlaeger (3pm) will speak today.

The Australian bonds traded in a tight range Tuesday as investors refrained from any major activity amid a light trading session. Also, the Reserve Bank of Australia’s (RBA) March monetary policy meeting minutes, painted a mixed picture of the economy, adding sluggishness to market sentiments.

The yield on the benchmark 10-year Treasury note, hovered around 2.82 percent, the yield on 15-year note also traded flat at 3.21 percent and the yield on short-term 2-year remained steady at 1.81 percent by 04:20 GMT.

The minutes of the RBA March board meeting continued to paint the picture of an RBA unwilling to move official interest rates anytime soon. The Board highlighted a range of positives, but concerns were also raised. The central bank was notably more upbeat about the global outlook and the flow on effect to higher commodity prices.

Concerns surrounding the outlook for the labor market were apparent, with the RBA noting that “conditions had remained mixed” and that “momentum in the labor market remained difficult to assess”. A further mixed picture on the labor market leaves the RBA between a rock and a hard place.

Lastly, markets will now be focussing on the RBA Deputy Governor Guy Debelle’s speech, scheduled to be held on March 22 for further direction in the debt market.

UK’s manufacturing output rose by 1.2 percent in the last quarter of 2016. Boost to competitiveness from sterling’s depreciation last year was probably a key driver of this upturn. The underlying trend is clearly upward, as is indicated by the 1.9 percent rise in Q4 production when compared to the same quarter a year ago, says Lloyds Bank.

Official data for the month of January showed a small fall in output in January and the February purchasing managers’ survey showed a modest decline in the level of the headline index from the previous month. Analysts at Lloyds Bank opine that the declines are probably just temporary retreats after outsized gains in previous months.

“With orders as measured by both the PMI and CBI surveys strong enough to point to further output gains over the next few months, the sector still seems on course for further expansion,” said Lloyds Bank in a report.

Fall in manufacturing investment, however, raises concerns about the sustenance of upside in the longer term. UK manufacturing investment probably fell by more than 4 percent last year, its weakest performance since 2009. The start of the Brexit negotiations will likely create more uncertainty which could hamper investments going forward. Continued sluggish investment growth may add to concerns about the UK’s modest productivity performance, adds Lloyds Bank.

The Westpac-McDermott Miller New Zealand consumer confidence index edged slightly lower in the March quarter. Survey showed that people grew wary about the short-term economic outlook, but extended the nation’s run of optimism to six years.

The Westpac McDermott Miller consumer confidence index fell 1.2 points to 111.9 in the March quarter, but remained above the long-run average of 111.4. The present conditions index decreased 0.2 points to 111.2 and the expected conditions index fell 1.9 points to 112.4.

“March’s slight fall in confidence mainly reflected some anxiety about the upcoming election. It might also reflect concerns around housing affordability or political developments offshore, both of which continued to hit the headlines in recent weeks,” said Westpac Banking Corp senior economist Satish Ranchhod.

The latest economic data showed GDP figures showed that on a per-capita basis, household spending rose by around 2 percent last year which reflected a healthy level of spending confidence. With a growing confidence of consumers in their own household financial security, and a positive outlook for the New Zealand economy we could expect continuing positive consumer sentiment to translate into sustained growth.

Growth in Japan is holding up nicely and economic activity has gained momentum since 4Q16 with the pickup in the global capex and manufacturing cycle. Inflation has started to push back above the waterline. But as Governor Kuroda emphasized at a press conference last week, inflation expectations remain stuck, something highlighted by this year’s spring wage negotiation projected to produce only modest wage increases. With price pressures nailed to the floor, the Bank of Japan (BoJ) doesn’t seem to be in a hurry to raise rates.

“With our USD rates forecasts pushed upward, we now expect that the BoJ will taper its asset purchases at a somewhat slower pace than previously and that QE will end in H2 2019, instead of mid-2019. JGB rates unchanged,” said DNB markets in a research note to clients.

There is an ongoing debate whether the BoJ will have to raise its 10-year bond yield cap because of the lack of JGB liquidity. There seems to be still a split of views inside the BoJ on whether the Bank should or should not raise the 10-year yield target when the real interest rates decline further. The longer the BoJ keeps the 10-year yield target unchanged, the more rapidly it will have to adjust the target later.

Analysts expect the BoJ to maintain the current 10-year yield target through year-end, but if it sees greater yen weakness, it would adjust the target in 2H17. BoJ will have to strengthen communication strategy with forward guidance on its yield curve control (YCC) policy to manage market expectations. It would probably provide the conditions under which the BoJ would raise the 10-year yield target.

“While we expect the BoJ to introduce forward guidance on its yield curve control (YCC) policy relatively soon, we think it would do so in July at the earliest, when the BoJ reviews its economic outlook and discusses its monetary policy stance in the Outlook Report. If it may take time to build a consensus among the board members on this issue, delaying its introduction until October,” said J.P. Morgan in a report.

USD/JPY trades below 100-day moving average. The pair is tracking DXY lower, amid holiday-thinned markets (Japan closed for Vernal Equinox Day) and lack of fresh fundamental drivers. Technical studies are bearish, RSI and stochs are biased lower and MACD has shown a bearish crossover on signal line. 112 levels in sight, violation there could see test of 111.60 and then 111 levels.

As expected, the US Federal Reserve hiked interest rate by 25 basis points in its March meeting. However, aside from the rate hike, there were no major changes in the FOMC forecast or statement, except for few minor tweaks. With March meeting gone, there are now seven upcoming meetings this year and the Fed has forecasted hikes in two of them. Let’s look at the market pricing of the hikes, (note, all calculations are based on data as of 16th March)

May 3rd meeting: Market is attaching 94 percent probability that rates will be at 0.75-1.00 percent, and 6 percent probability that rates will be at 1.00-1.25 percent.
June 14th Meeting: Market is attaching 46 percent probability that rates will be at 0.75-1.00 percent, 51 percent probability that rates will be at 1.00-1.25 percent, and 3 percent probability that rates will be at 1.25-1.50 percent.
July 26th meeting: Market is attaching 38 percent probability that rates will be at 0.75-1.00 percent, 50 percent probability that rates will be at 1.00-1.25 percent, 11 percent probability that rates will be at 1.25-1.50 percent, and 1 percent probability that rates will be at 1.50-1.75 percent.
September 20th meeting: Market is attaching 21 percent probability that rates will be at 0.75-1.00 percent, 45 percent probability that rates will be at 1.00-1.25 percent, 28 percent probability that rates will be at 1.25-1.50 percent, 5.5 percent probability that rates will be at 1.50-1.75 percent, and 0.5 percent probability that rates will be at 1.75-2.00 percent.
November 1st meeting: Market is attaching 20 percent probability that rates will be at 0.75-1.00 percent, 43 percent probability that rates will be at 1.00-1.25 percent, 29 percent probability that rates will be at 1.25-1.50 percent, 7 percent probability that rates will be at 1.50-1.75 percent, and 1 percent probability that rates will be at 1.75-2.00 percent.
December 13th meeting: Market is attaching 10 percent probability that rates will be at 0.75-1.00 percent, 32 percent probability that rates will be at 1.00-1.25 percent, 36 percent probability that rates will be at 1.25-1.50 percent, 18 percent probability that rates will be at 1.50-1.75 percent, 3.5 percent probability that rates will be at 1.75-2.00 percent, and 0.5 percent probability that rates will be at 2.00-2.25 percent.
The probability is suggesting,

There hasn’t been much of a change after the FOMC. The market is still pricing a hike in June and a hike in December. It is still not clear why the market is predicting two hikes in H1 and just one in H2. This is probably because the market is pricing the Fed would keep additional room for easing.
We suspect that if the price of oil tumbles further, so would be the hike odds.

The Political establishment in Washington went into a frenzy last year after then-candidate Donald Trump said that he wants to restore relations with the Russians. Every time, Mr. Trump refused to criticize either Russia or Russian President Vladimir Putin, the established anti-Russia establishment in Capitol Hill went after him and that includes several media outlets like CNN, which colluded with the Clinton campaign during the election and more. The skepticism with Russia runs so deep in Capitol Hill and within the establishment that President Trump is considered by many as a Russian spy and they are still looking to prove connections between Trump and Putin.

A recent incident in Capitol Hill proves how deep the hatred runs. Senator John McCain of the Republican Party presented a proposal that envisions bringing Montenegro, a small Balkan country within the umbrella of North Atlantic Treaty Organization and that proposal was rejected by another Republican senator Rand Paul, who did not want to make additional military commitments when the US debt is already at $20 trillion. Russia allegedly took part in a failed coup during last year’s Montenegro election. Mr. Rand Paul’s refusal triggered a furor in Senator McCain, a well-known Russia hawk, who accused Mr. Paul of working with or for the Russian President Vladimir Putin.

Russia-US-Montenegro are part of global geopolitics and there is also nothing wrong being a Russia-hawk but when one accuses a colleague of working for Russia, then probably it’s not just hawkish; it’s a phobia, Russia-phobia.

The real question is, can President Trump overcome these phobics and reconcile with Russia?

New Zealand’s current account deficit narrowed as expected in Q4, leading to the smallest annual deficit (2.7 percent of the gross domestic product) since September 2014. Looking forward, there seem to be risks skewed towards modestly larger deficits on the back of higher global interest rates and a slow closure of the domestic credit-deposit growth gap, but this is not a cause for alarm.

The unadjusted current account deficit narrowed to USD2.3 billion in Q4 (from USD5.0 billion), broadly in line with consensus expectations. In annual terms, the deficit narrowed to 2.7 percent of GDP, which is the smallest deficit since September 2014 and well below its historical average of 3.7 percent.

In seasonally adjusted terms, the current account deficit also narrowed (by slightly more than we expected), printing at USD1.6 billion, down USD0.4 billion from Q3, driven by a further increase in the services surplus to an all-time high of USD1.2bn on increased international tourist spending, offset by a mildly larger goods deficit. The income deficit also narrowed by around USD0.4 billion to USD2.0 billion as income from New Zealand’s offshore investments increased in the quarter.

Further, net external debt of deposit-taking institutions rose a touch in the quarter to just over USD105 billion. However, that was offset by reduced external borrowing from the central government and ‘other’ sectors, meaning that the county’s total net external debt position actually fell to USD143.5 billion or 55.0 percent of GDP, the lowest since 2003.

The Japanese government bonds remained flat Wednesday as investors await to watch the Bank of Japan’s (BoJ) 2-day monetary policy meeting, scheduled to be held on March 15-16, announcing its decision on Thursday.

The benchmark 10-year bond yield, which moves inversely to its price, hovered around 0.09 percent, the long-term 30-year bond yields also traded flat at 0.87 percent and the yield on the short-term 2-year note remained rose by 1/2 basis points to -0.25 percent by 05:10 GMT.

The BoJ is expected to keep monetary policy steady on Thursday and stress that inflation is nowhere near levels that justify talk of withdrawing massive stimulus, as weak consumer spending casts a cloud over an otherwise healthy pick-up in the economy.

Further, at the two-day rate review that ends on Thursday, the central bank is expected to maintain its short-term interest rate target at minus 0.1 percent and a pledge to guide the 10-year government bond yield around zero percent via aggressive asset purchases. Analysts also expect the BoJ to keep intact a loose pledge to maintain the pace of its annual increase in Japanese government bond (JGBs), which is JPY80 trillion (USD696.62 billion).

The Australian bonds jumped Thursday as investors poured into safe-haven assets after reading the higher-than-expected unemployment rate for the month of February. Further, the change in employment dropped steeper than what markets had initially anticipated.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, slumped 11-1/2 basis points to 2.82 percent, the yield on 15-year note also plunged nearly 11-1/2 basis points to 3.21 percent and the yield on short-term 2-year traded 7-1/2 basis points lower at 1.81 percent by 03:20 GMT.

The February labour market report disappointed, with a fall of 6.4k jobs and a rise in the unemployment rate to 5.9 percent. The detail was slightly more positive than the headline with full-time jobs rebounding after the previous month’s sharp fall.

The soft tone to the February report provides further confirmation that the RBA is likely to be on hold for an extended period. Spare capacity in the labour market is taking longer than expected to be worked off, and is weighing on wages growth and pushing out the return of inflation into the target band.

Australia’s February business conditions retraced some of the previous month’s gains, but remain at levels consistent with solid growth. Confidence also eased back slightly. Business confidence also edged down in February, alongside a further deterioration in the Federal Government’s standing in public opinion polling.

The New Zealand bonds nose-dived Thursday, tracking weakness in the U.S. counterpart, with the 10-year yields sinking to over 2-week low after investors crowded demand in safe-haven assets, following lower-than-expected fourth-quarter gross domestic product (GDP).

The yield on the benchmark 10-year bond, which moves inversely to its price plunged 10 basis points to 3.28 percent, while the yield on 7-year note also slumped 10 basis points to 2.85 percent while the yield on short-term 2-year note dived 6-1/2 basis points to 2.12 percent by 05:50GMT.

New Zealand’s economy expanded 0.4 percent q/q over the final three months of 2016. That was below consensus expectations and the softest quarterly growth experienced since Q2 2015. Q3 growth was also revised lower to 0.8 percent q/q (from 1.1 percent previously reported). As such, annual growth eased to 2.7 percent y/y.

On the back of stronger terms of trade, nominal GDP rose 2.1 percent q/q (7.5 percent y/y), while real gross national disposable income (RGNDI) surged 2.8 percent q/q, the strongest quarterly lift since Q1 2010. In per capita terms, RGNDI rose 2.3 percent q/q. The benefits of this real income boost should not be discounted.

WTI dropped more than 9 percent last week as investors fear increased production in the United States and non-compliance within OPEC with the agreed production deal. WTI is currently trading at $48.7 per barrel and Brent at $51.9 per barrel.

Key factors at play in crude oil market –

February report shows that OPEC still remains in full compliance with the deal as a group but many members are yet to adhere to the agreed levels. Iran’s production crossed the agreed level in February but the country is still in compliance based on average monthly production.
Saudi Arabia could be bypassing the OPEC deal by increasing exports of refined products.
US production rose from 8.428 million barrels in last July to 9.09 million barrels per day last week. This is the highest level of production since last year. Payrolls are once again rising in the oil and gas sector according to ADP job numbers.
Some OPEC members are calling for no continuation of the deal when it expires in June.
Backwardation in the oil market extends further, currently at $1.05 per barrel.
API reported a draw 0.531 million barrels of crude oil.
Today’s inventory report from US Energy Information Administration (EIA) will be released at 14:30 GMT. Trade idea –

We expect the WTI to extend gains towards $59 per barrel, and then towards $67 per barrel. However, a decline towards $46 per barrel in the short term can’t be ruled out. We don’t suspect the oil price to break below $42 stop loss area for the long call.

A rate hike from the US Federal Reserve’s Federal Open Market Committee (FOMC) today is almost a certainty. The policymakers would conclude their two days of meeting today and announce the decision at 18:00 GMT, followed by a press conference by the Fed Chair Janet Yellen. As of data available for March 14th, the participants in the financial markets are pricing with 91 percent probability that there will be a 25 basis points rate hike. The market is pricing the next hike to be in June and the third hike to be in December.

We have prepared an FOMC dashboard that segregates members in three distinct groups, Hawks, Doves, and unknowns based on their remarks and commentaries made in public forums, focusing on the March interest rate decision. That dashboard is also suggesting that there will be a hike today. We have found that except for Minneapolis Fed President Neel Kashkari, all the other members are hawkish heading to the rate decision. We also couldn’t confirm the views of Daniel Tarullo, who has recently resigned and this is his last rate decision meeting.

The US dollar index is currently trading at 101.38, down 0.25 percent for the day. The dollar has been struggling to head to higher highs despite a full market pricing (almost) of a hike in March and three this year. So, the dollar index might see selloffs after the interest rate decision if the inflation and interest rate outlooks are not substantially upgraded beyond what was shared in the December projections. In addition to that, the major focus is on the Dutch election this week, for which the results would start appearing after the FOMC meeting.

The Australian bonds traded modestly higher Wednesday as investors poured into safe-haven assets ahead of the February employment report, scheduled to be released on March 16. Also, the Federal Open Market Committee’s (FOMC) monetary policy meeting, scheduled for later in the day will provide further guidance to financial markets.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, fell 1/2 basis point to 2.93 percent, the yield on 15-year note dived nearly 1 basis point to 3.32 percent and the yield on short-term 2-year also traded 1 basis point lower at 1.89 percent by 03:20 GMT.

Australia’s February business conditions retraced some of the previous month’s gains, but remain at levels consistent with solid growth. Confidence also eased back slightly. Business confidence also edged down in February, alongside a further deterioration in the Federal Government’s standing in public opinion polling.

“We expect the February jobs report, out later this week, to show a solid rise in employment, but over the longer term a sharper downtrend in the unemployment rate is likely necessary for a sustained boost to households’ perceptions of their finances,” ANZ Research commented in its latest research report.

Eurozone industrial production growth increased less than expected in January, data from the European Union statistics office Eurostat showed on Tuesday. Industrial production in the 19-member single currency bloc rose by 0.9 percent month-over-month in January and by 0.6 percent year-on-year.

Industrial production data missed expectations in a Reuters poll for an average monthly rise of 1.3 percent and a 0.9 percent increase year-on-year. Higher investment in machinery was partially offset by a drop in the production of consumer goods.

Data for December which initially showed industrial production fell by 1.6 percent on the month, were revised higher to now show a 1.2 percent drop. On a yearly basis, output went up by 2.5 percent in December, more than the 2.0 rise previously estimated.

Non-durable goods output slipped 2.6 percent in January after 1.4 percent gain in December, marking the first decline in three months. Growth in durable consumer goods production also eased to 1.5 percent from 4.3 percent in the previous month.

Capital goods production dropped 0.8 percent following 0.5 percent growth in December. The intermediate goods output slowed to 0.8 percent from 3.6 percent in the previous month. Energy production growth slowed only slightly to 6.9 percent from 7 percent.

The UK gilts slumped Tuesday ahead of the country’s labor market report, due on March 15 and as investors remain cautious ahead of the Bank of England’s (BoE) monetary policy decision, scheduled to be held on March 16.

The yield on the benchmark 10-year gilts, which moves inversely to its price, rose 1 basis points to 1.25 percent, the super-long 25-year bond yields also rose 1/2 basis point to 1.88 percent and the yield on the short-term 3-year traded flat at 0.24 percent by 09:50 GMT.

The BoE is expected to maintain its neutral policy stance at the monetary policy meeting, scheduled to be held on March 16. Further, the central bank is also expected to hold its Bank Rate at 0.25 percent while leaving the targets for the stock of government bond purchases (APF) and the stock of corporate bond purchases (CBPS) unchanged at GBP435bn and GBP10bn, respectively.

“In our view, the BoE seems to be more worried about slower growth than too-high inflation if this is only temporary. EUR/GBP has reached our 1-3M target of 0.87 and we are currently reviewing our forecast. We still see risks skewed to the upside for EUR/GBP in the coming months ahead of and after the triggering of Article 50,” Danske Bank commented in its recent research report.

Latest data released yesterday show that the upward march of inflation that continued early last year is still gathering pace in Europe. Spain released its consumer price inflation report yesterday and it showed that consumer prices in February rose at the fastest pace since 2012. In February, Prices were up by 3 percent from a year ago and on a monthly basis it is up by 0.3 percent from January. Two major contributors were transport prices that rose by 8.2 percent and housing prices which rose by 5.9 percent. Furniture and household good is the only sector that took a dip of 0.4 percent compared to the year-ago level. Spanish inflation came in line with that of the entire Eurozone, where the price rose by 2 percent, highest level in four years and above the target of the European Central Bank (ECB).

Data from Poland points that the return of inflation is not just a Eurozone development it’s pan-European and global as well. Inflation in Poland rose by 2.2 percent in February, which is again the fastest pace in four years.

However, one should pay an ear to the European Central Bank (ECB) President Draghi’s comments that the central bank is not worried about inflation as it is being largely driven by an increase in the prices of commodities. Lately, the prices of commodities, especially energy and industrials have taken a hit and it is likely to get reflected in the numbers going ahead. We at FxWirePro expect the European Central Bank (ECB) to continue its easing as declared and throughout the year.

The euro is currently trading at 1.063 against the dollar.

The German bunds jumped at the start of the week on Monday as investors remain keen to watch the European Central Bank (ECB) Governor Mario Draghi’s speech, scheduled for later in the day. Also, the 30-year auction, scheduled to be held on March 15 will remain crucial in determining the teh future direction of the bond market.

Besides, markets shall remain hooked to assess the speeches by other ECB members Sabine Lautenschlaeger, Vitor Constancio and Peter Praet later through the day.

The yield on the benchmark 10-year bond, which moves inversely to its price, slumped nearly 4 basis points to 0.45 percent, the long-term 30-year bond yields plunged over 4 basis points to 1.22 percent and the yield on short-term 2-year bond traded 1-1/2 basis points lower at -0.82 percent by 08:30 GMT.

The ECB kept all policy measures unchanged at last week’s meeting, which was in line with market expectations. However, Governor Mario Draghi had a hawkish tone during the Q&A session as he said the Governing Council discussed whether to remove the ‘lower levels’ from the forward guidance on policy rates.

Further, on the very short-end, German yield curve, Draghi said the ECB was monitoring distortions. The market reacted by sending German government bond yields higher by around 5bp beyond the 10Y point.

Lastly, investors will be closely eyeing February consumer price inflation, due to be released on March 16 for detailed direction in the debt market.

The New Zealand government bonds jumped Monday at the time of closing, following expectations of a drop in the country’s fourth-quarter gross domestic product (GDP), scheduled to be released on March 15.

The yield on the benchmark 10-year bond, which moves inversely to its price plunged 3-1/2 basis points to 3.39 percent at the time of closing, the yield on 7-year note also slipped nearly 3-1/2 basis points to 2.94 percent while the yield on short-term 5-year note traded 2-1/2 basis points lower at 2.64 percent.

The rate of quarterly GDP growth is expected to soften a touch in Q4, partly related to temporary weather influences. Tight supply (rather than meaningfully softer demand) conditions are dominating. The current account deficit should remain at a historically comfortable level, ANZ research reported.

“We estimate that GDP rose by a modest 0.5 percent in the December quarter, following 1.1 percent growth in September. Construction is again expected to be one of the strongest sectors, with primary production and manufacturing likely to be the most significant drags on growth,” Westpac commented in its recent research publication.

President Donald Trump’s Treasury Secretary Steven Munchin has warned the both houses of congress in an open letter of the looming debt ceiling, which is expected to get hit on March 15th. The image of the letter is attached. In the letter he said that the suspension of the statutory debt limit which was done via a bipartisan budget act of 2015 will expire on March 15th of this year and from March 16th, the outstanding debt of the United States will be at the statutory limit. He warns that after that treasury will have to take up extraordinary measures to temporarily avoid defaults on obligations. He adds that after March 15th, it would halt sales of state and local government series (SLGS) and the suspension would continue until the debt limit is either increased or suspended.

Lastly, he encourages the congress to raise the limit at the earliest. President Trump has been critical of debt-ceiling increases in the past. In 2013, he had tweeted the followings,

“I cannot believe the Republicans are extending the debt ceiling—I am a Republican & I am embarrassed! Republicans are always worried about their general approval. With proposing to ‘ignore the debt ceiling’ they are ignoring their base.”

However, this time around, he is likely to support an increase.

President Donald Trump’s Treasury Secretary Steven Munchin has warned the both houses of congress in an open letter of the looming debt ceiling, which is expected to get hit on March 15th. The image of the letter is attached. In the letter he said that the suspension of the statutory debt limit which was done via a bipartisan budget act of 2015 will expire on March 15th of this year and from March 16th, the outstanding debt of the United States will be at the statutory limit. He warns that after that treasury will have to take up extraordinary measures to temporarily avoid defaults on obligations. He adds that after March 15th, it would halt sales of state and local government series (SLGS) and the suspension would continue until the debt limit is either increased or suspended.

Lastly, he encourages the congress to raise the limit at the earliest. President Trump has been critical of debt-ceiling increases in the past. In 2013, he had tweeted the followings,

“I cannot believe the Republicans are extending the debt ceiling—I am a Republican & I am embarrassed! Republicans are always worried about their general approval. With proposing to ‘ignore the debt ceiling’ they are ignoring their base.”

However, this time around, he is likely to support an increase.

Energy • US oil stockpile and production: EIA weekly data shows US oil inventory increased 8.2MMbbls over the week ended 3 March 2017 marking nine consecutive weeks of inventory build-up. The US oil stockpile has gained c.50MMbbls since the start of the year raising some doubts over the effectiveness of OPEC cuts. Crude oil production in the US also increased to a one year high of 9.1MMbbls/d. • China coal output restrictions: China doesn’t intend to reintroduce the mining curbs on coal as long as prices stays within the ‘reasonable range’. Last year, China has introduced certain measures including reducing the operating days for coal mines from 330 days to 276 days pushing coal prices higher. However, these measures were removed this winter as heating demand for coal increased. Reintroduction of these curbs would have tightened market balance significantly.

Metals • Fed rate hike expectations: Bloomberg data shows that the market is factoring in a 100% probability of a Fed rate hike of c.0.25% (to 0.75-1.00% range) at the upcoming 14-15 March meeting. Rising bond yields lower the appetite for nonyielding assets including safe haven gold. • Indonesia nickel ore exports to resume: Indonesia’s top nickel producer, PT Aneka Tambang, could resume low-grade nickel ore exports soon easing the supply tightness in the Chinese market. Indonesia would be restarting nickel ore exports after nearly three years of gap and would offset the supply disruption from Philippines on environmental concerns.

Agriculture • Rubber output drops: Association of Natural Rubber Producing Countries (ANRPC) data shows global natural rubber output dropped 2.2% YoY to 1.71m tonnes over the first two months of 2017; demand has increased 3.3% YoY over the same time period tightening the physical market balance. However, ANRPC estimates the supplies to improve in key growing areas over the March-May 2017 with full year production likely to increase 4.2% YoY to 11.2m tonnes • Vietnam coffee exports: coffee exports from Vietnam increased 4.3% MoM (23% YoY) to 146.4k tonnes in February 2017. YTD exports are still down 2.6% YoY at 286.6k tonnes.

The Japanese government bonds traded flat Wednesday as investors digested the upswing in the country’s fourth-quarter gross domestic product (GDP).

The benchmark 10-year bond yield, which moves inversely to its price, hovered around 0.07 percent, while the long-term 30-year bond yields jumped 3 basis points to 0.87 percent while the yield on the short-term 2-year note traded flat at -0.28 percent by 06:40 GMT.

Japan’s GDP gained 0.3 percent on quarter in the fourth quarter of 2016, the Cabinet Office said in Wednesday’s final revision, missing forecasts 0.4 percent and was up from last month’s preliminary reading of 0.2 percent. GDP gained 0.3 percent in Q3.

On a yearly basis, GDP was revised up to 1.2 percent from 1.0 percent, although that also missed forecasts for 1.5 percent. GDP gained 1.4 percent in the three months prior. Nominal GDP was bumped up to 0.4 percent on quarter from 0.3 percent in the third quarter. That missed forecasts for 0.5 percent but was up from 0.2 percent in the three months prior.

The Australian bonds continued to slump Wednesday as investors cashed in profits after the Reserve Bank of Australia (RBA) remained on hold at the latest monetary policy meeting held yesterday, hinting at no further policy easing in the near-term.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, jumped nearly 5 basis points to 2.87 percent, the yield on 15-year note also climbed nearly 5 basis points to 3.28 percent while the yield on short-term 1-year traded 1 basis point lower at 1.61 percent by 05:00 GMT.

The RBA has left the official cash rate on hold for a sixth straight meeting on signs the economy is strengthening and business investment has picked up. The decision to maintain rates at current levels comes as the labor market, inflation and wages growth continue to stutter at the same time that growth has recovered, housing prices continue to surge and business and consumer confidence hover around multi-year highs.

Further, the central bank expects the economy to grow around 3 percent annually over the next several years on steady consumption growth and expanding resource exports.

The Japanese government bonds traded narrowly mixed Monday as investors wait to watch the super-long 30-year auction, scheduled to be held on Tuesday. Also, the fourth-quarter gross domestic product (GDP), due to be released on March 7 at 23:50GMT, is closely eyed by market participants as well.

The benchmark 10-year bond yield, which moves inversely to its price, rose 1/2 basis point to 0.08 percent, while the long-term 30-year bond yields fell nearly 1 basis point to 0.84 percent while the yield on the short-term 2-year note traded 1/2 basis point lower at -0.28 percent by 05:30 GMT.

Japan’s economy is likely to have grown faster in the fourth quarter than initially reported, as companies ramped up investment in plant and manufacturing equipment, a latest Reuters poll showed. GDP growth for the October-December quarter is expected to be upwardly revised to an annualized 1.6 percent from a preliminary 1.0 percent, according to the median estimate of 20 economists.

Separate data from the finance ministry is expected to show Japan’s current account surplus in January narrowed to 239.0 billion yen (USD2.09 billion) from JPY1.1 trillion in the previous month due to a slowdown in exports, Reuters reported.

Trump’s plans for fair trade sound like a border tax adjustment President Trump’s address to Congress contained much of what we have come to expect: i) tax cuts for businesses and the middle class ii) $1trn worth of infrastructure spending (financed by public and private partnership) and iii) fairer trade. Last year’s near US$800bn US trade deficit is very much in focus and Trump’s remarks last night regarding unfair international tax structures point to growing acceptance of Paul Ryan’s border tax adjustment (BTA) plan. Beyond the touted benefits of encouraging onshoring and discouraging corporate tax inversions, the BTA is also ear-marked to generate US$100bn of increased tax revenue – which seems essential to pay for corporate tax cuts elsewhere. There is much literature on why a 20% border tax adjustment necessitates a 25% rally in the dollar. The magnitude of the impact will be disputed, but the direction of travel should be pretty clear and keep the dollar supported into key Trump speeches (talk of tax details being released March 13th). The dollar is also being supported by the now 78% probability of Fed March hike – after Fed insider Dudley said the case for a rate hike had become ‘a lot more compelling’. A strong ISM and the Fed’s preferred measure of inflation, headline PCE, pushing to 2.0% today both point to further dollar strength. DXY to 102.05/10.


h2>GBPUSD and Scottish Referandum, Trump and the FED

Thin Asian markets allowed GBP to come under selling pressure on a report in ‘The Times’ suggesting that the Scottish government might call a second independence referendum to coincide with the triggering of Article 50 next month. It was only last week when the ‘Independent’ came out with a similar suggestion. This morning’s GBP dip should be viewed as providing a buying opportunity as a hypothetical Scottish referendum would likely only be held after having concluded Brexitnegotiations. In this sense, prospects of a Scottish referendum could potentially have a moderating impact on the negotiation position of the British government which could aim to achieve as much EU market access as possible to encourage Scotland to stay within Britain. Note that latest polls in Scotland do not suggest there would be a clear majority for independence today.

Moreover, the latest by-election results are likely to have consolidated the power of PM May within the Conservative Party but also, according to the Sunday press, may have put the Conservatives in one of the strongest positions they have enjoyed in the last 30-odd years. The Sunday Times suggests that the by-election results which saw weaker results from UKIP and Labour would allow the Conservatives to increase their current 17 seat majority in the Commons if there were early General election held in the UK. The poorer showing of UKIP may have reduced the risk of seeing the Conservatives undermined via the euro-sceptical wing of the political spectrum. This risk now appears lower compared to last autumn. It was the radical speech held at the Conservative Party conference in Birmingham which pushed GBP markedly lower at that time. This speech may have helped to undermine UKIP, but with UKIP now apparently in a less strong position, it could be argued that PM May may now be in a better position to steer upcoming Brexitnegotiations with the aim of keeping Britain closer to Europe than is currently priced into markets. Viewing the current low GBP valuation in comparison with the size of the Brexit related ‘cliff edge’ has been the main reason for our GBP bullishness. We regard GBP cheap relative to the size of the possible cliff edge.

Looking at the other side of the political spectrum, the weaker performance of Labour in the by-elections and the current make-up of the Labour leadership would suggest that the political middle is left to the Conservatives, despite speculation in the Sunday times of a new centrist pro European grouping possibly taking shape. This position for the Conservatives might, in line with this thinking, allow them to take a more pragmatic Brexit stance. Scottish referendum talk, the political debate concerning PM May’s next political move plus the extreme GBP short positions currently held by market participants suggests to us we should remain GBP constructive.

This week will focus on the Fed and US politics. Today the Fed’s Kaplan (a voter) is likely to reiterate his hawkish stance. It will be difficult to make the March 15th meeting a live one for a hike, i.e increasing market probability much beyond the currently priced 28%. In particular, February NFP will only be released 5 days ahead of the Fed and the Feb CPI will be released on the second day of the Fed meeting. Combined with the pre-Fed grace period, that leaves little opportunity for the Fed to increase hike probabilities. Effectively, March is off the agenda, but that does not mean the USD selling off. Thursday’s Beige Book release should illustrate increasing capacity constraints. Fed’s Yellen speaking at the Executives Club of Chicago on Friday may find it difficult to ignore a strong Beige Book read. All this will hit a market which has trimmed leveraged dollar longs for seven straight weeks bringing them down to below their five-year average.

On Tuesday, PM Trump will address the Congress, with markets looking for him to lay outhis budget plans. The New York Times suggests that the new budget will assume a 2.4% GDP growth rate. Treasury Secretary Steven Mnuchin said Trump’s first budget won’t touch entitlement programs such as Social Security or Medicare. It will instead focus on ways to produce long-term economic growth by cutting taxes, thus being bullish for risk appetite and a bullish steepening of the US yield curve. The USD should receive a bid against low yielding currencies, while high yielding EM should remain bid.

Mexican Central Bank, Inflation and Outlook

According to news reports, central bank governor Agustin Carstens will stay in his current position until the end of November 2017, as opposed to leaving at the end of June. He was set to join the BIS as General Manager on 1 October 2017. At the time of writing, neither the central bank nor the office of Mexico’s President had confirmed this delayed departure. If confirmed, the change in his departure date would give more time for the President to consider submitting an initiative to Congress to change the central bank law to remove the requirement that all members of the board have to be born in Mexico. The main beneficiary of this change would be, in our view, Alejandro Werner, current Director of the Western Hemisphere at the IMF. Results from the latest Citibanamex inflation survey will be released today at about 3:00pm EST. We estimate that headline and core consumer prices rose 0.15% mom and 0.37% mom, respectively, in the first half of February versus the second half of January. If our estimates are accurate, annual headline inflation would stand at 4.5%, down from 4.7% in January, while annual core inflation would be 4.0%, unchanged compared to last month. The government will report consumer price figures for the first half of February on Thursday at 9:00am EST. We expect annual headline inflation to remain above the central bank’s inflation target (3% ± 1p.p) upper limit throughout the year. We estimate that agricultural prices fell by close to 1% in the first half of February, relative to the second half of January, accounting for most of the gap between the headline and core inflation prints. Finally, in a TV interview central bank deputy governor Alejandro Díaz de León said that the central bank’s main job is that inflation expectations remain well-anchored and that price formation in the economy also remains adequate. In his view, the central bank’s interest rate increases are creating a more orderly outlook for inflation. He said that future interest rate increases will be contingent on several items, including relative monetary conditions vis-à-vis the US Federal Reserve, upcoming inflation numbers and the output gap. These are the main factors the central bank has mentioned in its most recent monetary policy statements. On currency interventions he said that the goal has been to foster good liquidity in the market and intervene only in a few instances when liquidity dries up.

USD Strength, European Political Outlook and EURUSD

Low yielding currencies should come under renewed pressure against the USD with the release of the Fed minutes of the 31 Jan/01 Feb and upcoming Fed speeches working in line with better global data releases as the catalyst. Overnight, it has been Fed’s Harker (voter) saying that he won’t take a March hike off the table, pushing US yields higher. Harker will speak again today joined by San Francisco Fed’s Williams (non-voter). However, the US 5-year inflation swap has eased by 22bps from its December highs despite commodity prices moving higher, the USD trading sideways and US data coming in on the strong side. Accordingly, US financial conditions have eased over the course of the past couple of months lending further support to the reflation trade. While US equity valuations have reached high levels, technical factors such like the advance/decline ratio and the continued relative advance of cyclical shares suggests that the risk outlook is likely staying supported for now.

Apart from political uncertainties there are almost no headwinds to the global economy. Global trade seems to be expanding rapidly as confirmed by South Korea’s 26%Y export gain reported for February. Last year, it was global economic headwinds combined with a sharp USD appreciation weakening the US growth and inflation outlook and convincing the Fed to reduce rate hike expectations. None of these headwinds have emerged this year. In contrast, strengthening US financial conditions have turned into a powerful tailwind which could unleash pent-up demand. Creating animal spirits pushing investment activity up will increase US capital demand, which suggests either a higher USD generating move capital imports or US bond yields breaking above the 10-year 2.51% technical resistance. Note it was the Fed’s Harker who talked about increasing signs of pent-up demand within the US economy.

When it comes it political risks all eyes are on Europe where government bond spreads are widening at a significant pace. Yesterday, an Ipsos poll showed Le Pen on 26%, compared with 19% for Macron and 18.5% for former PM Francois Fillon in the first round. That poll appeared to be driving markets but other recent polls have shown a wide range of possible outcomes, adding to market uncertainties. The focus may be on the political left in France, where a potential alliance between two parties could suggest a possible scenario of a left-wing candidate standing against the Front National’s Le Pen in the last round of the Presidential election, an outcome which would not be seen by markets as positive for future EMU reforms.

The market may react to the news that investigators have looked into the use of funds by some Front National candidates. However, if polls remain unaffected and Le Pens’ rating high, then investors may lighten semi and peripheral bond holdings further which should not bode well for the EUR. Ahead of the Netherlands general election due on the 15 March these pressures may even intensify. A good result for Geert Wilders from the Freedom Party could make it difficult for EMU-supportive parties to build a functioning coalition. It was only yesterday that EU’s Dijsselbloem, in respect of the ongoing Greek negotiations, said that creditors will focus on “moving away from austerity and focusing more on deep reforms, which was also a key criterion for the IMF.” Such deep reforms could be more difficult to implement in a potential scenario of increasing influence for European populist political movements.

Against this background we stay EUR negative. Next to political risks we underline the importance of Italian data when judging the EUR. Over the past few years there had been two periods when we saw the Italian economy improving. The first wave came along with the fall of BTP spreads, the second wave came when the EUR declined from 2014 onwards. It seems that Italy does need easier financial conditions to improve its domestic outlook. However, Italy’s financial conditions have recently tightened, not boding well for its economy.

Italy: Risk of imminent snap elections reduced

The PD party will hold a congress after Renzi’s resignation as party leader. Should the PD split, government activity could be possibly negatively affected. The publication of the motivation of the Constitutional Court ruling on the Italicum, the electoral system for the Lower House, was seen as a crucial passage towards the end of the current legislature. As a reminder, the ruling yielded a trimmed-down version of the Italicum, proportional in nature, which the Court itself reckoned already usable. The ruling of the court added that different electoral systems in the two branches of the parliament are acceptable, provided that they do not prevent the formation of “homogeneous parliamentary majorities”. As the electoral law of the Senate is also proportional in nature (with a different entry threshold and no majority bonus), most observers read the qualification of the Court’s motivation as an implicit recognition that a viable, if imperfect, electoral system is in place and ready to be used in case of snap elections. As many key actors on the political scene had been vocally pushing for snap elections, the risk of a vote in June was then seen as increasing. However, developments within the Democratic Party (PD) over the last couple of weeks have mixed up the cards. First came some statements from a couple of ministers, originally in favour of a rush to the polls, who had apparently changed their mind, and started suggesting that a better electoral law should be sought in the Parliament and that the current Gentiloni government should be given some time to complete unfinished work. The second, more powerful, turning factor was the meeting of the steering committee of the PD party, the senior party in the current government alliance, which was held last Monday. The debate, opened by Renzi as the party’s leader, highlighted once more that strong divisions between Renzi and the leftist minority persisted. During the discussion Renzi proposed that a party congress should be called soon and that this should be concluded with a primary election to nominate the new party leadership. The leftist minority refusal to accept Renzi’s candidacy as leader of the party, not to mention the imposition of any short deadline for the congress, opened the door to the possibility of a party split. The issue was tackled again during the assembly of the PD party held yesterday in Rome. Divisions were confirmed as was the scarce willingness to bridge the gap on both sides. Yesterday Renzi formally resigned from his leadership, technically paving the way to the party’s congress, whose timetable will be set tomorrow in the meeting of the steering committee. The risk of a party split now looks very high. In principle, the perspective of a PD congress held over the spring should substantially reduce the risk of a June snap national election. Should a split of the PD party actually materialise, the risk of political instability would likely increase, and PM Gentiloni’s government action could be weakened as a consequence. Not only would it be harder to assign priorities to left-over reforms (the new Gentiloni government is de facto a continuation of Renzi’s government), but chances of reaching an agreement on a parliamentary modification of the electoral law would also be reduced

FX Update- European Politics and the UK

It will be hard for markets to get away from discussing political developments in the Eurozone this year. Friday’s risk off market, driven by what appeared to be shifting probabilities for the French election, is showing just how vulnerable the EURJPY cross has become. The Japanese investor owns 12% of the French OAT market, mostly accumulated in the past 2years. This large asset position is now at risk should volatility in this EUR bond market increase. The Japanese have been net sellers of foreign bonds since the middle of January. While Japanese lifer hedge ratios for EUR assets is generally high (82% in 3Q16), the liquidation pressure and, more importantly, sentiment, will still affect FX markets, we think. The risk of EURJPY falling has increased and so we have chosen to sell as a tactical play for our trade of the week. The next support area is around 119.30.

Markets will watch efforts of the French left combining to bring one of its candidates into the 2nd round. A possible scenario of a 2nd round vote between a hard left and a hard right candidate may increase the chance of the Front National’s Le Pen becoming President. Her agenda to leave the EU and the EUR would require Parliamentary approval and hence represents an unlikely outcome. However,a potential scenario of a hard left or hard right future French President could perhaps reduce Franco-German co-operation which could potentially disrupt EMU for years, leaving the ECB in charge, which might win time by introducing a policy of prolonged period of negative real rates and yields.

The 15 March General Election in the Netherlands could increase jitters further should the outcome point towards increasing populism. Polls over the past week show a tight race, with the PVV party (Geert Wilders) only on a narrow 3-4 point ahead of the VVD party, relative to the 9 point lead seen at the start of the month. Since 8th February,3m implied volatility for EURUSD has diverged from USDCHF, which we think needs to play catch up. The SNB’s sight deposit volumes will be watched again today.

A lot of the anticipated weaker economic data in the UK appears to be in the price for GBP.Friday’s miss on retail sales (0.2%M) showed consumers may have brought forward spending ahead of anticipated price hikes, causing GBP to weaken as markets priced out some probability of a hike by the BoE this year (currently around 3bp). The impact of UK data on GBP goes as far as that. We think that it will be loose global liquidity conditions, increased political uncertainty in the Eurozone, combined with an undervalued GBP which will drive the EURGBP pair lower. The Brexit debate will continue with the FT reporting today on Michel Barnier’s (EU’s Brexit negotiator) proposal that any trade EU-UK talks be denied until progress is made on a EUR60bn exit bill, which could make progress difficult for the UK after they trigger article 50 this quarter. We think however that GBP could be driven higher as global reserve managers start to reallocate into GBP assets.

Monthly Global EM Outlook, Trump Policies and Inflation

From the current starting point, the near-term inflation outlook is generally unthreatening in most markets that have a large weight in the international benchmark indices for EM local currency debt.

Inflation has risen in some EM countries during the past half year in response to currency depreciation and increases in global oil prices; but the CPI impact of exchange rate weakness has in most cases diminished and the oil price effect is probably about to peak. Beyond the group of EM countries that now have large weights in the EM debt indices, it is notable that core inflation is on the rise in China.

 The current level of core inflation (2.2% year-on-year) is not seriously disconcerting but if it continues to creep upwards then it will eventually become a constraint on China’s monetary policy. This represents a risk for the entire EM/commodities complex, but it is more likely to be a risk for the second half of 2017 than a focal point in the next few months. More imminently, the main risk of abrupt policy rate increases in the EM universe comes from the US in the form of the possibility of a surprisingly large batch of Fed rate hikes during the remainder of the year and/or a border adjustment tax. Either of these shocks could force a swathe of EM central banks to choose between raising their policy rates substantially or having to live with undesirably steep currency depreciation.

Given the current predominantly unthreatening EM inflation trends and residual labor market capacity slack in many countries, a large share of the EM central banks – especially in Asia – look set to be able to leave their own policy interest rates unchanged if the Fed keeps raising rates at a gentle pace and if the US border adjustment tax fades away.

An important source of inflation volatility in the EM world in recent years has EM currency depreciation (in nominal trade-weighted terms) that has led to increases in prices not only for imports, but also for those domestically produced goods that compete against foreignproduced items either in the domestic market or the export market. However, this problem dissipated in most of the EM world during the course of 2016, and only a few of the large EM countries – Mexico and Turkey to be precise – are seeing this problem unfold right now

Two other large EM countries – Brazil and Russia – are in the opposite camp. Inflation has fallen sharply in both countries in the past year. This reflects in part a swing from large-scale currency depreciation in late 2015 and early 2016 to equally forceful currency appreciation during the past 12 months. Deep recession, widening output gaps, and cautious monetary policy in both countries have also helped contain inflation. The view of our Brazil-based economists is that recent currency appreciation will continue to help drive down the country’s inflation in the present year whereas the main drivers of last year’s fall in inflation were a large decline in the pace of adjustment in government controlled prices (in part reflecting currency dynamics and a big change in global oil price inflation), the depth of the recession and, related to this, weakened wage pressure in the labor market.

To be sure, the behavior of EM currencies, inflation and policy rates would be highly likely to become much messier if the Fed were to accelerate the pace of its rate hikes substantially beyond what is currently priced into the US rates curve, perhaps in response to stronger wage data or aggressive future plans for unfunded US tax cuts. There is also, in our view, a very real risk to EM investors associated with the plan of Republican members of US Congress for border adjustment taxation (BAT), or from the possible imposition by the US of other types of import taxation. As we have argued multiple times on these pages, the BAT and import tariffs are likely to be highly dollarsupportive. If Trump’s decides to support either, and if he secures congressional approval, dollar-based holders of EM local-currency-denominated assets are likely to take a hit.

It might seem inviting to think that the BAT would help curb inflation in the EM world, because it would be likely to drive down the dollar price that EM-based importers pay for goods from the US (as US exporters would be entitled to a new subsidy) while also driving down the dollar price that EM-based exporters would obtain from sales to the US (because their sales would be subject to taxation at the US border). But the inflation “benefit” would be eroded by EM currency depreciation against the dollar. EM currency depreciation would most likely be sufficient to drive the local-currency prices for EM countries’ exports and imports (in trade with the US) almost all the way back to their pre-BAT levels.

 

Carry Trade outlook, VIX lower and risk assets higher, Yellen keeps March alive

Selling EUR and JPY vs EM. As the VIX is approaching the lows again, and with iron ore prices bursting 10% higher over recent days, we continue to see risk currencies performing well, particularly vs the EUR. The drivers of risk support are emanating from the DM world, as China’s monetary conditions are tightening. After Yellen only marginally changed market pricing for hikes this year (52bp to 55bp), the sweet spot of low US real yields, with rising growth expectations, remains, helpinghigh yielding EM currencies to outperform. Our own portfolio includes long MXN, TRY and INR. Even Australia’s data is outperforming, with consumer and business confidence rising. Today’s US retail sales data are expected to be strong on the control group measure. While the USD has become less sensitive to US economic surprises, the data point will still add to the long term picture of an economy that is closing its output gap and so could see higher inflation down the line if companies increase capital expenditure.

China is tightening monetary conditions. New CNY loans grew in January (CNY2.03trn) but were lower than market expectations after the Jan 24 10bp rise in the Medium-term LendingFacility (MLF). The gap between M1 and M2growth has also narrowed for a seventh consecutive month to 3.2% last month from 10.1% in December. The result appeared in property sales data which slowed in January after tightening measures and potentially the Chinese New Year holiday. Data from local housing developers shows that average weekly property sales by area in Tier 1 cities in January fell more than 30%Y and more than 10% week over week. Shanghai and Shenzhen fell even more, according to the China Index Academy.

Cash ready to buy risk. The global impact of China’s tightening of monetary standards may not be seen in FX markets straight away as it is masked by still expanding balance sheets at the ECB and BoJ, rising commodity prices helping growth and now a newly developing point, cash ready to be deployed into assets. The FT is reporting on Swiss banks seeing increasing questions from private wealth on where they can invest cash in a rising inflation environment. Surveys among affluent US investors show they held 28% of their portfolios in cash in 2015,up from 25% the year before. Cash holdings in Europe and Asia are much higher at 40% and 37% respectively. The EUR may weaken in this environment as political risks may increase caution in investment into this region. EURGBP is about to break below its 200DMA at 0.8455.

Yellen did little to change our outlook on the USD, so staying positive vs the low yielding G10 and seeing high yield EM outperforming. The market is now pricing 55bp of hikes this year, including 6bp for March. Interestingly, historical G10 currency sensitivity to US front end yields played out exactly with the JPY and NZD under-performing, while GBP stayed flat. There was perhaps a hawkish tilt to the speech, with our economists noting that Yellen didn’t want to send a signal for a March hike by saying they will assess at upcoming “meetings” rather than “meeting”. Reiterating the FOMC’s stance that they will incorporate fiscal policy when details become more evident was a clear sign that the Fed, like the markets, will be waiting for details on Trump’s tax plans expected in coming weeks. Trump’s meetings and interactions with world leaders over recent days appear to be risk supportive as there has been less emphasis on increasing trade tensions. On the politics front, market focus may now turn to the G10 foreign ministers meetings in Bonn on Thursday and Friday. Market is long SEK. On Monday we outlined some scenarios on the details to watch for in today’s Riksbank Monetary Policy Statement (Krona and repo path). Since we think neither of the “hawkish” surprises are likely and that the market appears to be long SEK into the meeting, we worry that there could be a shock in store that would weaken SEK as markets unwind. We are not however saying that the Riksbank isn’t going to be optimistic, just that markets appear to be getting ahead of themselves, with the setup appearing to be very familiar to those who watched the RBNZ recently too. Swedish data may have improved but the fact that the SEK is now at the Riksbank’s year end forecast, the likelihood that enough members propose a rate hike sooner than mid-18 is low. EURSEK should see support around the 9.41 low and resistance around 9.50.

European Bonds and Credit, spread tightening across the board

Yesterday saw some semi-core and peripheral spreads tightening pretty much across the board versus core EGBs, with especially PGBs putting in a strong performance, outperforming 10yr Bunds by more than 10bp. GGBs bucked the tightening trend after ECB’s Stournaras told Greek MPs that the bailout was at a “critical” stage, and that any future PSPP-eligibility of GGBs would be contingent on the completion of the bailout review and a legally binding agreement over specified medium-term debt relief measures (which doesn’t seem imminent to say the least).

A remarkable feature of yesterday’s price action was the further widening of Bund ASW spreads, with the futures-implied 10yr Bund ASW hitting 50bp. It now exceeds our estimate of fair value – which is based off 2s10s, BTP/Bund spreads, 6M Libor-repo spreads and implied volatility – by more than 10bp. ECB weekly data on PSPP showed that purchases slowed marginally to €16.9bn in the week ended 10 February from €17.3bn the week before.

Corporate and covered bond purchases also slowed, but the overall €20.1bn bought across all asset classes still leaves the ECB on track to buy more than €80bn in February. Today’s main event will be Fed Chair Yellen’s testimony to the Senate Banking Panel. If she want’s March to be a live meeting as other Fed officials have suggested it is, she will have to adopt a more hawkish tone beyond the usual reference to data dependency. Currently we calculate a market implied probability of around 17% for March rate hike. Supply. No EGB supply is scheduled for today.

In SSA space KfW has used this opportunity to announce the launch of a new 10yr KfW EUR benchmark. Wide Bund ASWs currently render the agency relatively cheap versus the sovereign. The KfW 3/26 which was launched last year currently trades at a pick-up of 30bp versus the DBR 2/26 – its widest level to date. We think these levels are starting to look attractive for switches into KfW. Not only do our models for the Bund ASW suggest that it is currently much too wide but we also think that the Bundesbank is at the point where it has to increasingly look into the option of sub-depo buying – and also agency- or regional bond alternatives to Bunds.

 US Financial and Monetary Conditions, Yellen, Inflation & Oil, China and RMB

US financial and monetary conditions continue to improve as market indicated real yields remain muted while stocks and other real assets break into higher valuation territory. The S&P 500 has exceeded the 20trn market capitalisation mark on the day when all four major US equity indices reached new historic highs. The advance seems broad-based with cyclicals like financials taking the lead. The stock market trades reflation and, with US markets leading, markets seem to be taking the view that global reflation is centered in the US.

Against this background the Fed’s Yellen will appear before the Senate Banking Committee at 3pm (Ldn) today and the House Financial Services Committee tomorrow. A prepared testimony will be the same both days and will probably be released when the Senate hearing starts but sometimes gets released earlier by the committee. Here Yellen will have to present the Fed’s view which at times has differed from her more dovish attitude. Hence, it is not surprising to see markets walking into these risk events with a relaxed attitude, seeing the Fed hiking only cautiously and not as aggressively as signaled by the median Fed dots. Should Yellen divert from the moderate projection of the interest rate path as currently priced into the market, the USD may rally. This risk is asymmetrically priced leaving us comfortable with our USD long positioning against low yielding currencies EUR and JPY.

Animal spirits are now often mentioned in press reports. The last time the US was experiencing animal spirits goes back to the 90s when James Rubin ran the US Treasury. Then it was the high tech boom driving many asset classes. The stock market started to correlate with retail sales as wealth effects kicked in. We have not yet seen this effect in the US, but with the continued asset rally the likelihood of animal spirits taking over is not insignificant. Last year, it was the shaky international background pushing the USD sharply lower as the Fed eased the markets’ rate expectations via dovish talk. Today even the global environment looks better with EMU economic and political divergence providing the exception.

Inflation and oil. This morning saw China’s PPI growth beating market estimates by a wide margin with rising commodity prices and a strong January base effect providing the main catalysts. US bond yields coming down faster than the Japanese yields may dampen USDJPY, but it does not generally weaken the USD. As long as the reason for lower oil prices is due to higher US oil output the decline of oil may even work in favour of the USD in the long term. Yesterday the US (EIA) reported its oil output increasing by 80k. Oil rigs are on a fast rise as shale companies experience better funding conditions and the ability to sell oil at higher prices.

RMB in focus. According to the WSJ, President Trump’s administration may be considering alternative strategies with regard to currency issues with China. “Under the plan, the commerce secretary would designate the practice of currency manipulation as an unfair subsidy when employed by any country, instead of singling out China, said people briefed on or involved in formulating the policy.” There are two issues coming into our minds. First, the administration hoping China may push USDCNY lower via using its reserves or tightening its own monetary conditions. This strategy comes at relative costs to China and is beneficial for the US. Should this scenario work out then China may switch some of it FX reserves into JPY or EUR even if this comes with potential future FX reserves valuation losses. Secondly, China may turn into an infrastructure investor into the US. Japan seems to already be leaning in this direction. It would help the US in creating jobs while giving China a good investment return for its foreign-held assets. In this scenario the US yield curve would stay steep and the USD strong.

FX Positioning for the week of January 23rd

Since Monday, January 23, positioning is relatively unchanged. In the majors, the largest short is still in GBP; the largest long is still in CAD. USD positioning was reduced to its least long level since the US election. Non-commercial IMM accounts were decent sized sellers,net sellingnearly $5b to bring positioning to +$22.3b.

Positioning for this community is at its least long position since shortly after the election. Similarly, sentiment remains moderately bullish butnear the lower end of the range since the election. However,global macro funds remains very long. We see scope for USD long positions to build from here and like buying USD ahead of the Fed meeting this Wednesday.

GBP positioning was unchanged in short territory. Non-commercial IMM accounts marginally reduced their short positions but remain more short than their pre-Brexit positioning. Similarly, macro funds marginally reduced shorts but still retain large net short positioning. We think shorts can still unwind and are long GBPJPY.

CAD positioning moved further into long territory. Despite the dovish BoC, non-commercial IMM accounts were CAD buyers in the days following to bring positioning to its most long level since last September. Sentiment remains somewhat bullish.Long CAD positioning is another factor supporting our bearish CAD view.

US Bond Yields and USDJPY, US Risk Premium, BoJ Meeting Notes, BoC and EURUSD

US bond yields and USDJPY have scaled back to levels drawing a technical dividing line between a bull and a bear market interpretation. US political volatility seems on the rise in the aftermath of the recent imposition of immigration controls, possibly giving markets the impression that the rules could change quickly for anyone dealing with the US. Our global risk demand index (GRDI*)has scaled back from levels above 2 which is generally associated with markets runninghigh levels of complacency. GRDI was at 1.07 at market close yesterday. Precious metals have turned higher with Silver building a key reversal formation. Today Trump is expected to announce the new Supreme Courtnomination.

Certainly, the risk premium to hold USD denominated assets has increased as US politics have become more difficult to predict. However, we regard the glass still as half full and differentiate USDJPY driven in the near term by risk sentiment, while in the long term higher US capital demand should drive rate and yield differentials in favour of the USD. US December consumer expenditure rose by the highest rate in three months suggesting that the US economy has entered 2017 with strong momentum. The Fed statement tomorrow may reflect recent data strength. Seeing US nominal GDP expanding at a faster pace compared to the rise of US rates seen over the past year plus accelerating credit creation by US commercial banks suggests that US monetary conditions have eased. The Fed may like to reduce accommodation from here which should put the current USD downward correction to rest.

Today’s outcome from the BOJ meeting underlined their firm commitment to managing the yield curve (policy rate at – 0.10%, 10yr JGB yield target at 0%, 80tln annual bond buying). The statement underlining downside risk to inflation indicates that there is little risk of seeing the BoJ moving away from keeping 10-year JGB yield near zero. Interesting are comments from PM Abe’s economic adviser Kozo Yamamoto calling the 5-8% VAT increase of 2014 a mistake, suggesting Japan may operate a new round of fiscal stimulus to ensure the country overcomes inflation. The text book would suggest fiscal expansion supporting the currency, but this interpretation requires the central bank to turn less accommodative in response to the fiscal stimulus. However, Yamamoto has clarified that Japan can only then engage in a fiscal stimulus under conditions of debt sustainability suggesting funding costs staying south of nominal GDP expansion. When the three pillar ‘Abenomics’ kicked in in 2013 with Japan engaging in monetary easing, fiscal stimulus and structural reform, the JPY sold off hard. The JPY is driven by real yield differentials. Japan staying accommodative via its monetary policy and easing fiscally may (via rising inflation expectations) push Japan’s real yield level lower which, in turn, should support Japan’s equity market and weaken the JPY. Note, Japan inflation expectations (10y breakeven) are on the rise again and are thus ignoring recent risk volatility.

BOC’s Poloz will speak today and we think he will present a dovish message in line with yesterday’s comments from the Deputy Governor Sylvain Leduc highlighting the level of household indebtedness and elevated housing prices unlikely to withstand a persistent spike in unemployment. The fact that indebtedness is rising for the most indebted households is ‘really worrisome’ according to the BoC. The employment data for Canada are going to be important to watch for the CAD. The CAD should come under selling pressure today and this selling pressure has the potential to add momentum should oil prices extend recent selling pressure. Oil has broken lower on reports suggesting US rigs reaching their highest level since November 2015.

We remain EUR bearish with potential selling pressures coming from two sides. First, the new US administration focusing its new trade policy on areas running pronounced surpluses against the US may drag EMU into the trade debate. EMU’s crisis response was to consolidate fiscally and to seek higher employment via increasing net trade, allowing the EMU to convert its 2008 current account deficit into a 3% surplus. Secondly, EUR hedging costs have declined as shown in the chart below, which in light of current inner-EMU spread widening could lead to EUR selling. As JPY hedging costs have remained high EURJPY could turn as a catalyst for EUR weakness.

 

Turkish Central Bank Governor Speech, Fitch downgrade and S&P action

Central Bank Governor Murat Cetinkaya will present the bank’s new quarterly inflation report at a press conference tomorrow. The press conference will start at 7:30am London time. The bank will have to raise its previous end-2016 inflation forecast of 6.5% considerably higher given the sharp depreciation of the lira since the end-October inflation report. Cetinkaya is likely to maintain the monetary policy committee’s (MPC) hawkish stance in its post-meeting statement on 24 January which kept the door open for further monetary policy tightening. Cetinkaya’s comments on the lira’s exchange rate and the central bank’s liquidity policy will also be closely watched by the market.

The central bank’s effective funding rate was 10.27% on Friday (27 January), up from 8.28% on 6 January before the sharp sell-off in the lira started. The central bank released on Friday (27 January) the calendar of its MPC meetings this year. The central bank reduced the number of its meetings to 8 from 12 previously. Following the first meeting of the year which has already taken place on 24 January, the MPC will hold meetings on 16 March, 26 April, 15 June, 27 July, 14 September, 26 October and 14 December.

The Statistics Office will release the December foreign trade data tomorrow and the January inflation data on Friday (3 February).  We forecast that the foreign trade deficit was $5.6bn in December, in line with the preliminary estimate and the Bloomberg consensus forecast.  We forecast that the January CPI inflation was 1.4% mom, compared to the Bloomberg consensus forecast of 1.8% mom. If January CPI inflation turns out to be less than 1.8% mom, the year-on-year headline will decline from 8.5% in December due to favorable base effects. We think the margin of error around the January forecast is quite large given the uncertainty around the extent of the pass-through from the lira’s rapid (and somewhat unexpected) depreciation in early January.

Fitch downgraded on Friday Turkey’s long-term foreign currency issuer default rating to BB+ from BBB- and assigned a “stable” outlook to it. Turkey’s previous BBB- rating – the lowest investment grade rating – was placed on “negative” outlook following the failed coup attempt in July 2016, and Friday’s downgrade was widely expected by the market. The main driver for the rating decision was Fitch’s assessment that “political and security developments have undermined economic performance and institutional independence” and that “while the political environment may stabilize, significant security challenges are set to remain.” The rating agency also opined that if the constitutional reform is approved in a referendum, it “would entrench a system in which checks and balances have been eroded.” Fitch also noted that the scope of the “purge of the public sector of the supporters of the group that the government considers responsible for the coup attempt in July” has “extended to the media and other groups” and has “unnerved some participants in the economy.” Additionally, the rating agency said that “high-profile terrorist attacks have continued, damaging consumer confidence and the tourism sector.”

As a secondary driver, Fitch noted that “the failure to address long-standing external vulnerabilities has been manifest in a sharp fall in the currency” and that although the rating agency “does not expect systemic problems that would jeopardize financial stability or trigger a balance of payments crisis,” it “does assume a detrimental impact on the private sector.” Fitch noted that “evolving domestic and external conditions bring the potential for further tests of Turkey’s ongoing resilience in external financing.” The rating agency expects real GDP growth “to average 2.3% between 2016 and 2018, compared with an average of 7.1% over the five years ending 2015 (based on new data after a credible GDP revision).” As for the banking sector, Fitch noted that “sector capitalization, supported by adequate NPL reserve coverage, is sufficient to absorb moderate shocks, but sensitive to further lira depreciation and NPL growth” and added that “refinancing risks have increased, although foreign currency liquidity remains broadly adequate to cover short-term sector wholesale funding liabilities due within one year.”

As for possible rating actions in the future: Fitch said that the country’s sovereign credit rating could see further negative action if, individually or collectively, it observes “heightened stress stemming from external financing vulnerabilities”, “weaker public finances reflected by a deterioration in the government debt/GDP ratio” and “a deterioration in the political and security situation”. For the possibility of a positive rating action, the rating agency has to observe, individually or collectively, “implementation of reforms that address structural deficiencies and reduce external vulnerabilities” and “a political and security environment that supports a pronounced improvement in key macroeconomic data.”

Also on Friday, S&P revised its outlook on Turkey’s unsolicited sovereign credit ratings to “negative” from “stable”. The rating agency affirmed Turkey’s BB long-term foreign currency sovereign rating. S&P said that since it last revised Turkey’s rating on 4 November 2016, “the lira has depreciated by 18% against the US dollar and 15% against the euro”, and that “the monetary policy response to currency and inflationary pressures of Turkey’s central bank may prove insufficient to anchor its inflation-targeting regime.” According to S&P, “given the large-scale dollarization of Turkey’s economy, a weaker exchange rate erodes corporate balance sheets, financial sector asset quality, and growth. “ The rating agency said that the decision reflects “what we consider to be rising constraints on policy makers’ ability to tame inflationary and currency pressures, which could weaken the financial strength of Turkey’s companies and banks, undermining growth, and fiscal outcomes, during a period of rising global interest rates.”

Russia Rate Meeting, Sanctions and FX Interventions

The main event this week is the central bank’s (CBR) rate-setting meeting on Friday (3 February). We expect the CBR to leave the policy rate unchanged, at 10.00%. This is in line with the Bloomberg consensus forecast. Although the majority of respondents to the Bloomberg survey expect the policy rate to remain unchanged, some expect a 25-50bps cut. It is worth highlighting that the CBR is no longer committed to keeping the policy rate unchanged (in contrast to its message in September 2016) and the government has recently decided not to spend extra oil and gas revenues. We see a number of other arguments in favor of a policy rate cut, but none of these is strong enough for the CBR to act at this week’s meeting, in our view. In particular, we would like to highlight the favorable inflation data in January and weak consumer demand indicators in December. We strongly believe that the decision of the Finance Ministry to introduce regular FX purchases is neutral for the prospects of policy easing. We believe this will be explicitly highlighted in the CBR’s post-meeting statement this week. Although the CBR will not hold a press conference or release a monetary policy report (with updated forecasts and assumptions – pretty important in light of rising oil prices) this week, we expect some comments from the CBR officials as 3 February is also the day when the Finance Ministry will reveal its daily FX purchase volumes, according to the intervention mechanism. We expect the CBR to cut the policy rate at its next meeting on 24 March. On Thursday (2 February), Rosstat will reveal the preliminary estimate of real GDP growth in 2016. We estimate real GDP was down 0.4% in 2016 (after a drop of 3.7% in 2015). A Bloomberg consensus forecast for this variable was not available at the time of writing. On Saturday (28 January), Russia’s President Putin had a phone call with US President Trump. It was the first official call among the two leaders. According to a press release by the Kremlin, the two leaders discussed the crisis in Ukraine and the situation in the Middle East, their countries’ cooperation in fight against global terrorism, Iran’s nuclear program and other international issues. The Kremlin concluded that the call was “positive and productive”. On Friday (27 January), the rally in the Russian local markets was driven by comments from US Presidential Adviser Kellyanne Conway, who noted that rolling back of US sanctions against Russia may be discussed between Putin and Trump on Saturday. Although Kremlin’s press release did not refer to this issue, it does not mean that the issue was not discussed. In our view, the current backdrop may be challenging for those investors who are short Russian assets due to a potential positive headline risk as was the case on Friday

European Fixed Income Markets

Risk assets and EGB spreads decouple. Equity markets hit fresh highs this week, while the iTraxx Senior Financial index touched a 5-month low. In this context, safe havens underperformed, with 10yr Bund yields rising to the highest level in 12 months (i.e. 0.50%).

The risk-on mood, however, did not extend to EGB spreads, which have remained under widening pressure (new issue concessions notwithstanding). This is not just political risk premia creeping into markets such as France (where underperformance versus Germany is now also showing up in equities), or Italy (where the Court ruling has paved the way for possible snap elections in late Q2/Q3). Also Irish and Belgian spreads over Bunds have remained on a widening trajectory, suggesting that ECB tapering fears may also be in play.

That said, 10yr Bono/Bund spreads have continued to buck the widening trend (Figure 1), and accordingly 10yr SPGBs now look more than 30bp overvalued on a RV basis according to our fair value model. We suspect that at some point, either risk assets will struggle to make new highs or EGB spreads will start to re-tighten. We deem the former slightly more likely, although we do see value in EGBs which are less exposed to political risk (for example Ireland). Alternatively, we would suggest to go long Ireland versus Austria.

In money markets, meanwhile, we find the 1-month Eonia forward for mid-2018 having risen further, to 8bp above the current fixing – even more at odds with the ECB’s forward guidance that policy rates won’t go up until “well after the horizon of the net asset purchases”. EGB supply to remain above €20bn (Figure 20). On Monday, the Tesoro will launch a new 10yr BTPS (€3.5-4bn) as well re-open the BTPS 0.35 11/21 and CCTS 2/24. The new 10yr is trading 2-3bp cheap on the low-coupon curve in the grey market, and as highlighted above, has lost significant ground versus Spain, which should support demand at the auction. The CCTs 2/24 trades a tad rich relative to the low-coupon BTP curve, but at a juicy 19bp pick-up to the adjacent CCTS 7/23. Elsewhere, Germany will issue a new 5yr OBL, while markets are still awaiting a syndicated deal from Finland (10yr or 30yr). For a complete overview of next week’s supply and rating reviews please see pages 5 and 6.

 

USD divergence from bond yields, US savings, JPY curve

Accordingly, the current divergence of USD from US bond yields should not stay for long. It will be the steepening of the US yield curve reducing the relative attractiveness of taking advantage of the wide USD-JPY cross currency base. Otherwise, real yield differentials should be watched closely. It is the 10-year real yield differential and not the front end that matters here. The 10-year real yield differential leads USDJPY while 2-year real yield differentials and USDJPY follow a random pattern. With DM reflation gaining momentum and the BoJ keeping the JGB curve controlled, the real yield differential should soon pointhigher again, taking USDJPY with it. Moreover, the 40-year JGB has reached 1%, which may be too high for the yield curvecontrolling BoJ. Rinban operations emphasising long-end JGB purchases may be the next event to push USDJPY up.

Since the summer, the US savings ratio has declined from 6.2% to 5.5%,and with the government considering tax cuts and public sector spending programmes, US aggregate savings are set to decline. This is important should the economy enter self-sustaining growth with private investment picking up. Private investment increases capital demand which, in the context of lower aggregate US savings, must lead to a higher yield unless a higher USD and related capital inflows do not moderate this effect. We emphasise that the US has the choice between higher bond yields and a higher USD. The vacuum of US economic data this week gets filled today with a flurry of reports on jobless claims,new home sales, the trade balance, wholesale inventories, leading indicators and the services sector. Another set of better US data releases should work via higher yields into support for USD.

 

Global equity rally fueled by the US, reflation trade sets in 

The anticipated reflation tradehas set in, with shares and DM bond yields breakinghigher, but USD has not participated in this move. Instead, USD has decorrelated from the performance of the US bond market, drifting lower while the US 10-year bond yield has breached the 10-year 2.52% technical barrier. The government’s monthly sale of US$34 billion in five-year notes drew the weakest demand since July, based on the number of bids received relative to the amount offered, seeing investors switching into equity holdings. Cyclicals such as transportation and financials have led to the upside, suggesting the market making bets on US economic expansion gaining momentum. In this sense the current equity market rally is different to the liquidity-induced, dividend-focused rally seen for most within the post Lehman world. The new structure of this equity market rally makes sense for an economy having closed its output gap now entering into a new area of re-building its capital stock.

Mexico: Sharply higher inflation adds to thelist of central bank concerns.

In the firsthalf of January,headline CPI rose much more than expected in Mexico,up 1.51%M vs 1.27%M consensus. On an annual basis, inflation surged to 4.78%, its highest level since September 2012,and substantially higher than the central bank’s 3% midpoint target. The culprit was higher energy prices – on the back of gasoline price liberation that kicked in at the beginning of the year – as well as pass-through to inflation from the depreciation of the MXN. Such price pressures offer Banxico very little room for maneuvering,at a time when Mexico is already facing extreme uncertainty from the north. We see the central bank restricting monetary policy further in its February 9 meeting and expect another 50bp, taking the Fondeo rate to 6.25%. While such a move is already increasingly priced in and local rates are arguably cheap, we stay cautious in the near term on the back of no positive anchor yet in place.

Russian USDRUB Intervention Mechanism, FX Purchases explained by CS

? In our view, it makes sense to resume regular FX purchases due to (1) the strengthening of the rouble in REER terms, (2) the decision of the government to save windfall oil and gas revenues, and (3) higher oil prices.

? We expect the mechanism of regular FX purchases in 2017 to replicate the fiscal rule (which will be approved by parliament in 2018), with the parameters of the FX purchase mechanism being reset on a monthly basis.

 ? The CBR is likely to be in charge of regular FX purchases in 2017, while the Finance Ministry is likely to take over in 2018-2019, if the Brent oil price stays above $50/bbl.

 The rouble’s response to the announcement of the details of FX purchases will depend on the amount of daily FX purchases. In our view, a daily volume of $50mn (as was noted by unnamed government officials on Bloomberg today) would not have a major negative implication for the rouble in 1Q due to the expected favorable balance of payments dynamics during that period.

? In the longer run, during the course of this year, we expect the rouble to converge towards our annual average forecast of 62.5 against the dollar.

? We also expect the intervention mechanism to reduce the rouble’s volatility, which would make it even more attractive as a carry trade, in our view.

 ? The decision on interventions will be either neutral or marginally more favorable for the monetary policy, in our view. We are not changing our expectation for a policy rate cut by the CBR at the second meeting of 2017, on 24 March.

Russian USDRUN Intervention Mechanism, FX Purchases explained by CS

? In our view, it makes sense to resume regular FX purchases due to (1) the strengthening of the rouble in REER terms, (2) the decision of the government to save windfall oil and gas revenues, and (3) higher oil prices.

? We expect the mechanism of regular FX purchases in 2017 to replicate the fiscal rule (which will be approved by parliament in 2018), with the parameters of the FX purchase mechanism being reset on a monthly basis.

 ? The CBR is likely to be in charge of regular FX purchases in 2017, while the Finance Ministry is likely to take over in 2018-2019, if the Brent oil price stays above $50/bbl.

 The rouble’s response to the announcement of the details of FX purchases will depend on the amount of daily FX purchases. In our view, a daily volume of $50mn (as was noted by unnamed government officials on Bloomberg today) would not have a major negative implication for the rouble in 1Q due to the expected favorable balance of payments dynamics during that period.

? In the longer run, during the course of this year, we expect the rouble to converge towards our annual average forecast of 62.5 against the dollar.

? We also expect the intervention mechanism to reduce the rouble’s volatility, which would make it even more attractive as a carry trade, in our view.

 ? The decision on interventions will be either neutral or marginally more favorable for the monetary policy, in our view. We are not changing our expectation for a policy rate cut by the CBR at the second meeting of 2017, on 24 March.

Hungary Central Bank

Speaking yesterday, National Bank Deputy Governor Marton Nagly said: “We are in an easing cycle; the word tightening doesn’t even arise in our thoughts.” He also said that the country faces less of a risk of a jump in inflation than regional peers, according to the Bloomberg report. Nagly said that the Bank remains ready to use unconventional tools to ease monetary conditions if needed and that the MC would decide in March whether the three-month cap on deposits with the Bank was still sufficient. The MC next meets on Tuesday (24 January)