FX Trade Ideas abd Global Trends
The global reflation trade has increased its momentum, but unlike what we saw for the firstnine months of this year when reflation focused on EM asset classes it is now Japan and the US which are in investors’ focus. Meanwhile, the EM currency index has lost 5% since 7 September. Long positions in S&P futures, which fell sharply in early Q3,are now back close to their highest levels of the year. This bullish equity positioning was mirrored by a sharp reduction in long positions in U.S. Treasuries and oil prices reaching a two-year high. mirrored by a sharp reduction in long positions in U.S. Treasuries. In this sense markets have similar characteristics to what was observed late last year when prospects of US tax reform and other regulatory changes pushed the USD higher with the help of widening interest rate differentials, allowing US, Japan and EMU equities markets to outperform the EM markets. Indeed there are signs that foreign investors are rushing in to buy Japanese equities as in 2013 when ‘Abenomics’ lifted off. Nonetheless, there is one big difference. In 2013, Japan’s equity market received its inspiration from a sharply falling JPY. Nowadays, the inverse relationship between the evolution of Japan’s Topix and the performance of the JPY has eased.

ECB succeeds. The ECB has provided a dovish taper with President Draghi stressing that there is still “a large amount of uncertainty”adding that the decision about the asset-buying plan “is for an open-ended program”and it is not going to stop suddenly. His suggestion the ECB may lag the Fed by about 3-4 years pushed long-term yield differentials sharply in favour of the USD. Markets will now have to rebalance, suggesting EURUSD could see 1.1530/10 before stabilising. However,as long as EURCHFremains in a bullish trend we see longterm EUR buyingneeds soon returning, pushing the EUR higher once again.
JPY should weaken. This morning’s release of Japan’s September core CPI (0.7%Y)undershot the median (0.8%) supporting our view of the BOJ maintaining current parameters of its yield curve management for longer. Recently, Japanbased investors have increased their purchases of short-dated foreign currency denominated bonds. Short term bonds tend not be currency hedged, indicating that confidence in foreign currency strength has increased.

US data strength. Today’s US focus will be on the release of the Q3 GDP report. Adverse weather conditions may have depressed activity in Q3(our tracking estimate is at 3.2%) which should be made up by a better Q4 reading. Hence markets may tolerate a weaker GDP reading and put their entire focus on the core PCE. Should the PCE exceed the consensus 1.3%Q estimate, US bond yields may rise further taking USDJPY beyond the 114.40 chart mark, openingupside potential to 116.75. The University of Michigan will provide us first indications concerning the strength of the economy entering November. Latest PMI reports including yesterday’s Kansas City Fed’s October manufacturing index rising to 23, setting a 6-year high, suggest that the economy is in good shape.
AUD in trouble. Australia, which is in the middle of a consumer slowdown, will be exposed to political headwinds as Australia’s High Court invalidated the election of the country’s deputy PM Barnaby Joyce, losing the Turnbull government its majority. There will now have to be a by-election – which Joyce will recontest – but that will be on Dec 2at the earliest. There will be a period of increased uncertainty which should put the AUD under additional selling pressure. The break of AUDUSD 0.7710 has opened downside potential to 0.7340.


EURCHF pressing higher suggests that the German election result has not undermined pro-EUR sentiment, with the initially lower EURUSD entirely due to USD strength. The Social Democrats (20.4%, -5.3%) showing their worst election result since WWII and the CDU/CSU (32.8%, -8.7%) falling back to its second weakest historic result suggest that the episode of strong centralist ‘people parties’ has come to an end in Germany too.

With the SPD ruling out re-entering a coalition under the lead of Chancellor Merkel makes a CDU/FDP/Greens coalition the only option leaving a minority government aside. With the FDP (10.7%, +5.9%) and the Greens (9%, +0.6%) two progressive parties are set to enter the government provided that coalition talks come to conclusive results.

EUR: Interpreting the German election. The FDP has a reputation for market liberalism, but being cautious on euro-reform. In this respect it was interesting to see its leader Lindner using more constructive language in post-election Sunday evening debates calling the FDP pro-European and open to EU reforms. The Green party program has called for the introduction of Euro-bonds,a position which had been opposed by the previous CDU/SPD government. The AfD (13%, +8.3%)has benefited from its anti-immigration agenda and implicit anti Merkel sentiment witnessed mainly in the east. Our economists have taken a critical view in respect of this new political constellation in Germany. EUR:From theFrench side. The French President Macron will set out his vision concerning necessary EU reforms tomorrow.

Most of his proposals have been adapted from his predecessor Hollande, but the April/May French election campaign with its strong populist showings suggests that this current French government must be a success to avoid the risk of the next French President running on a populist anti-EU agenda. This weekend’s Senate election in France showed Macron’s party only taking less than 8% of the seats and its popularity ratinghas fallen at a faster pace than the popularity of Hollande at this stage of the Parliamentary cycle. Germany showing its securities statistics running excessive peripheral investments may have to opt for a policy of faster EU political integration to keep its investments safe. Even the head of the German employers association (BDI) Dieter Kempf suggested that Germany may have to change its surplus-generating economic model and investment more domestically.

A political EUR. The SPD opting for opposition has reduced Chancellor Merkel’s negotiating options down to one remaining coalition option (CDU,FDP, Greens). Normally, this should increase the pace of negotiations, but ahead of the local election in Lower Saxony on 15 October little will happen. Thereafter we will see if Germany allows the EMU reform agenda to accelerate or not. If not, EMU economic divergence and institutional insufficiencies will persist, leaving the ECB as the only institution trying to keep the EUR together. In this case, EMU spreads would widen, the EUR would decline and German investors would lose out. The alternative suggests not only the opposite; it would also contain the better answer to Brexit, Donald Trump and the risk of populism taking the European project apart.

The USDJPY and USDCHF bull: This EMU view has implications going beyond EUR denominated capital markets. The glut of European savings has been pushing bond yields globally lower. Now this glut of savings may abate with inner EMU investment increasing at a faster pace than the generation of domestic EU savings. We look back to autumn 2005 when, in the aftermath of China’s USD de-peg, Asian savings grew at a slower pace. Back then, global bond yields went higher making the JPY and the CHF good funding currencies. Now it may be the glut of European savings due for a decline which should have similar consequences to what was observed in autumn 2005. The lower savings meets a market where hedge funds have turned negative on the USD while the Fed sounds increasing hawkish. We think this has created an ideal environment for USDCHF and USDJPY to rally . The head of the San Francisco Fed has shrugged off concerns over the recent persistent inflation under-shooting, arguing that the “strong” economy mean the felt confident that prices would rise and justify higher interest rates. Partial USD strength. Finally, New Zealand’s election results were inconclusive with the National Party (58 seats) failing to win an absolute majority (60 Seats), likely to enter a coalition with the anti-immigrant ‘New Zealand First’ (9 seats). There is a chance that NZD rallies when a coalition is ultimately formed but we think it would be a rally to sell into. NZDUSD is one of our preferred pairs to trade the USD higher from ‘oversold’ levels bearing in mind that the highly leveraged NZ economy has developed signs of weakness. We are still long EURNZD. Japan’s PMI rising towards a 4 month high of 52.6 (52.2in August), plus strongly rebounding risk appetite, should leave the JPY offered. USDJPY is set to break higher. Superb liquidity conditions should keep EM supported.


Wednesday’s meeting: ignore at your peril
This week’s FOMC meeting may not be the non-event that many in the market are seemingly viewing it. While the long-awaited announcement of the Fed’s balance sheet unwind will be the main event, there will be keen interest in the new official forecasts. These may be used to reinforce the message that, while there is little need for aggressive interest rate hikes, the market remains too complacent on the prospect of higher interest rates.

Don’t rule out a dots downgrade
With just one hike priced in by the end of 2018, the market’s view on interest rates is still worlds apart from the Fed’s June projections, which pencilled in 100bp of rate hikes over the next 18 months.
Some market scepticism is understandable. The Fed has signalled higher interest rates on numerous occasions over the past couple of years, only to then subsequently not follow through with them. But also with several measures of inflation well below 2%, there is a sense that there is little need for tighter policy.

This latter point, in particular, may see some officials becoming less aggressive on their expectations for the path of interest rates. As such, we would not be surprised to see the dot diagram move closer to our forecast of three rate hikes rather than the four previously indicated.

What could seal the deal for a December hike
While there may be some added caution on the dots, the encouraging economic outlook means the core message from the Fed is still that the market remains too complacent on rate hikes. The economy grew 3% in the second quarter, and there will probably only be a marginal slowdown in the third (despite some soft retail sales numbers) given the prospect of a significant inventory rebuild. We don’t see any long-term economic disruption from Hurricanes Harvey and Irma. In fact, in the medium term, they are likely to boost growth due to rebuilding efforts and households and businesses replacing lost equipment and belongings.
We also note inflation could rebound more quickly than the market anticipates. Headline CPI is back to 1.9% and with gasoline prices having spiked, dollar weakness is pushing up import costs, and there are tentative signs that wages are again on the rise given the tight labour market.

We therefore suspect the Fed will keep its positive, longer-term forecasts unchanged and we currently look for a December rate rise followed by two more 25bp hikes next year.

Politics, not data, the main risk to a December hike
The recent hurricanes saw President Trump push and get a three-month extension of the debt ceiling. While this is positive as this allowed relief funding to be released for affected areas but it now means the 13th December FOMC meeting will coincide with a new debt ceiling deadline.

Given the divisive nature of politics in Washington right now, we are somewhat nervous that there could be major market worries about a government shutdown, the furloughing of workers and the potential talk of debt default, although this would be highly unlikely to happen.

The result is that the Fed could conceivably choose to wait until early next year given the potential for a pickup in market volatility – although that is not our base case.

Don’t rule out impact on yields once normalisation begins
In a bid to avoid taper tantrum 2.0, the Fed has for many months made it clear that it wishes to ‘normalise’ (or shrink) it’s USD 4.5 trillion balance sheet. We already know this will be done by a very slow tapering of the reinvestment of maturing assets.
Now we know most of the details, the formal announcement of an October start to the balance sheet unwind should be taken in the market’s stride.

The Federal Reserve decision will be the key scheduled event of the week for the US and should result in a formal announcement of the balance sheet reduction strategy. We have known the structure for a couple of months, which is a very gradual tapering of the reinvestment of maturing assets. The bond market has taken this in its stride so far and we do not expect any major volatility due to this announcement. However, the Fed releases new economic forecasts and there will be significant interest in its expectations for the path of the Fed fund’s target rate. Currently the Fed is anticipating four 25bp rate hikes by the end of 2018, whereas the market is only pricing in one such move. We would not be surprised to see the median forecast to show that the Fed now feels three hikes is the most likely scenario, reflecting the more subdued inflationary environment than anticipated and some near-term uncertainty on growth, as a result of the recent hurricanes. For the UK, we will be focusing on BoE speakers. It appears that the BoE is trying to prepare the market for a potential rate hike in November; so, any direct hints from Mark Carney is clearly likely to heighten such expectations and offer further support to sterling. It will be another calm week in Germany, with all political parties preparing for Election Day. No poll results will be released in the last few days in the run up to the election. It currently looks as if the race for No.3 will be the most important aspect of the election on 24 September.

Momentum trades are in vogue. This week will be about whether a dovish FOMC reinforces the USD bear trend, while the BoE-fuelled GBP rally faces a pivotal test from PM May’s keynote Brexit speech.

Theme of the week: Will a dovish Fed reinforce the USD bear trend?

The Sep FOMC meeting will be the main event of the week (Wed), with investors looking to see if there is any change in policy bias in light of the recent negative developments in the US economy. We think this may be one of the more difficult meetings and press conferences for Chair Yellen to navigate, not least because of the growing dichotomy within the FOMC over the appropriate near-term policy approach. Our base case is for the doves to prevail, with a lower conviction over the pace and extent of future policy tightening visible in the Fed’s dot plot. While the median 2017 dot is still set to tentatively pencil in a Dec rate hike, we expect to see more members calling for a pause for the remainder of the year; anything more than five would suggest that hopes of a Dec hike stand on a fragile footing. More telling of a dovish shift would be if the 2018 dot also moves lower; here we require five or more members to downgrade their views over future policy hikes, a scenario that cannot be ruled out given the softer US inflation dynamics. What is highly likely is that we’ll see the 2019 and longer-run dots moving lower – with Fed officials acknowledging that a 2% handle for the terminal Fed funds rate is more realistic in the prevailing US economic environment.
While we do not expect US yields or the USD to move much on what would be a well-telegraphed balance sheet announcement this week, there is a slight risk of the Fed delaying the start of this process. This would be indicative of the Fed’s more pessimistic view of the US economy and we would expect this tail risk scenario to be outright USD negative – more so through the sentiment channel, rather than any major move lower in US yields.

Majors: Dovish Fed to trump cautious ECB & BoE
While a dovish FOMC could reinforce the USD bear trend, ECB officials will look to keep their QE taper cards close to their chest this week. The BoE-fuelled GBP rally faces a big test from PM May’s keynote Brexit speech in Florence on Friday.

EUR: Dovish Fed confirmation could see a 1.20 handle again
• The September FOMC meeting is the main focus this week (Wednesday) and we will be looking to see how Chair Yellen manages the two emerging camps within the committee – that is those members looking for a continuation of the current normalisation cycle and those looking for an extended (or even permanent) pause in hikes until there is greater confidence in the US inflation outlook. We note that it’s typically hard for the dollar to rally post-FOMC meetings and this time may not be any different; any hawkish Fed cries could again fall on deaf ears given the lack of convincing economic evidence to point to. Moreover, we do not expect to see US yields or the USD moving much on what would be a well-telegraphed balance sheet announcement this week – especially as offsetting this will be a downshift in the distribution of Fed dots and signs of less conviction from the committee over the pace and extent of future monetary tightening.

• While Fed officials will also follow up the meeting with their own views (Williams, George and Kaplan all on Friday), the focus in the European calendar will be on ECB talk – including two speeches by President Draghi (Thursday and Friday). We would expect much of the same script as the September ECB meeting, with Mr. Draghi likely to keep his QE taper cards close to his chest. Our economists also expect no change in the final release of EZ CPI data (Monday).

Despite tension in the Korean peninsula, global asset markets continue to perform well. The S&P 500 is quietly edging up to its highs of the year and forward looking measures of volatility, e.g. the CBOE’s VVIX, are declining to levels last seen in early August. Unless there is fresh news from Korea, today’s events look set to extend this benign run. There is no US data of note, but the Fed speakers (Brainard at 1330CET and Kashkari at 1830CET) are certainly on the dovish end of the Fed spectrum. As an aside today, we see the news that Norges Bank is proposing to cut its EM bond investments (currently 12%) from the nation’s fixed income portfolio. The rationale is that diversification in fixed income is not delivering the same benefits as the diversification in equity investments. The market may choose to ignore this news today, but Norway’s government pension fund has been one of the most forward-looking Sovereign Wealth Funds over recent years and the news looks certain to prompt a debate. DXY to drift to 92.00, since it is heavily weighted to safe havens of EUR & JPY.

ECB will struggle to generate a lasting correction in the buoyant EUR. For today, EUR/USD may well trade inside a 1.1850-1.1950 range. Elsewhere, Swiss 2Q17 GDP disappointed and with what should be a low CPI figure released later (0.4% YoY) should serve as a reminder that the SNB will ‘out-dove’ the ECB. Korean-triggered weakness in EUR/CHF looks a buying opportunity in the 1.1300/1350 area.

Noise-levels regarding Brexit remain elevated and look set to extend further. Brexiteers are once again pushing for a Hard Brexit (no deal with EU) and there is now focus on a potential speech from PM May on Sep 21, where we doubt she takes a harder line. PMI services is the focus today, but we doubt GBP finds much solace from the data over coming months. EUR/GBP looks steady nr 0.92.
The trade weighted index for the CNY (CFETs) yesterday rose to the highest level since mid-June 2016, briefly coming out of an ~3% trading range ithas been in for that whole period. USDCNH has now caught up with the weakness in the DXY index seen since the start of the year. What will be important is whether the basket stays lastingly above the historical range. We remain long CNH, supported further by China’s Financial News suggestingFX reserves should be kept steady to stabilize market expectations and that “Regulators should continue to guide market expectations and prepare for yuan appreciation”


FX Outlook: USD headwinds, debt ceiling, Bannon, Jackson Hole
The departure of President Trump’s chief strategist Steve Bannon from the White House last week has been flagged by media as an apparent victory for market-friendly “globalist” figures such as NEC Director Gary Cohn as well as traditionalist security figures such as National Security Advisor McMaster. The former concept so far has its best evidence in the form of the Cohn’s feared resignation not transpiring. The latter idea is best represented by Monday night’s speech by President Trump outlining recharged and indefinite US troop commitments to Afghanistan, a move that “alt-right” media has been quick to label a betrayal of Trump’s base.

While signs of Republican civil war may be welcomed by the political left in the US, which is more focused on the bigger and older Civil War, it is not helping investor sentiment as arguably it suppresses the energy available for a new Trump rally. The post-Bannon departure rally in stocks has been somewhat tepid so far, and notable investors have been on the wire signaling that they continue to de-risk as a function of disharmony in Washington DC. Markets are caught between optimism raised by the likes of Cohn and Treasury Secretary Mnuchin that tangible progress can be made this year towards delivering a tax cut and other pro-growth measures, and the reality that delivery on pro market policies has been weak so far, with the debt ceiling issue still unresolved and likely to hit a crescendo in about 5-6 weeks from now.

Nonetheless, from an FX market perspective, if these developments are sufficient to give rise to hope that at least there is some chance that the White House will be stable, unified and pro-market enough to deliver results, we would expect a lower volatility environment characterized by a subdued VIX Index. This would back our decision last week to keep key forecasts such as USDJPY unchanged for now despite the noise of recent weeks, and to look for a more stable (though not materially stronger) USD after the generalized losses of recent weeks. The key risks to our view are as follows:

1. more unexpected domestic incidents along the lines of the Charlottesville theme that illicit controversial messaging from President Trump and raise doubts about how tenable the support base from his current cabinet and other senior Republicans can be going forward,
2. a clear sign that the debt ceiling issue may not be easily resolved (which would be a large shock given that Senate majority leader McConnell said this week there is “zero chance” Congress does not raise the debt limit),
3. dovish statements by Fed chair Yellen or other senior Fed officials that cast further doubt on whether more rate hikes can materialize in 2017, or limit the market’s scope to see a sustained hiking cycle next year and beyond. As far as the third point above goes, the market is heavily focused on Friday’s speech by Yellen scheduled for 10:00 a.m. EST at the Jackson Hole symposium.

Given that the latest Fed minutes pointed to an emerging debate about the validity of more traditional Phillips Curve approaches in today’s global economy amid a backdrop of seemingly persistent low inflation, the market will be keen to see if Yellen can provide more color on whether this debate is material enough to require a repricing of US rates expectations. We note, though, that markets need to be careful about the risk of other Fed speakers speaking to the media around the same time and creating noise, as happened in 2016 when Fed vice chair Fischer made comments soon after Yellen to the media that were deemed more hawkish. Given the low level of US rates going into Jackson Hole, it would likely take a consistent and relatively direct set of statements from Fed officials highlighting issues such as low productivity, low inflation and a weakened Phillips Curve to lead to a break of key supports (e.g., 2.12% in 10-year Treasury rates) and lead the greenback lower across the board.


Global Rates, 5-30 Spread Widening, Jackson Hole
BTP/Bund spreads experienced increased widening pressure yesterday, with investors appearing to unwind some of their summer carry trade positions. 5-30 spreads over Bunds widened by c.7bp, while the concession versus Bonos was c.3-4bp. The upcoming weeks and months hold quite some headwinds for BTPs: the resumption of supply pressure, with BTP auctions slated for Wednesday next week, an ECB QE taper decision pending this autumn and the general elections looming early next year. That this is not yet a classic flight to safety episode is underscored by the fact that 10yr Bund yields were unchanged at 0.40%. Moreover, semi-core spreads were little changed, even though 10s30s in OLOs and OATs steepened by more than 1bp. Meanwhile, equity markets (outside of the FTSE MIB) seemed more preoccupied with regaining some of the lost ground over the past weeks.

Ahead of the Jackson Hole symposium kicking off tomorrow, ECB Draghi’s opening speech at the Lindau Nobel laureates meeting on economic sciences today will be followed closely. But it would be an unusual choice of venue and timing to provide new policy guidance. Elsewhere, flash Eurozone PMI data should confirm the ongoing recovery across the currency bloc. EGB & SSA supply. Today Germany will tap the 10yr benchmark DBR 8/27 for €3bn. Absolute 10yr yields are relatively low given that levels around 0.60% were seen a little more than a month ago.

The recent richening of 10yr Bunds is also evident in the 5/10/30yr fly valuation, which is back near the levels prevailing before Draghi’s Sintra speech. The auction may nonetheless be supported by its timing, with the carry trade unwind seemingly having started. Moreover, repo specialness (c. 25bp in s/n yesterday) remains a strong selling point of the 10yr Bund. In SSA space UNEDIC has mandated banks for a tap of the 4/32, thus following in the footsteps of NWB bank and Rentenbank yesterday. The former priced a €600mn 30yr social bond NEDWBK 1/48 at MS+19 versus an initial guidance of MS +22. The latter launched the 8yr RENTEN 8/25 at MS -23 coming from an initial guidance of MS -21. We are also still waiting for an RfP from the EFSF ahead of next week’s auction slot.


• A solid US jobs report has dented any immediate prospect of EUR/USD hitting 1.20 and we think a little more downside could be seen this week. Driving this should be firmer US price data (PPI Thu, CPI Fri), where PMI indices are starting to warn of a slight uptick in US pricing power. • Some modest uptick in US rates (and quite a negative patttern on the weekly candle chart), warns that EUR/USD could make a run to 1.1650/80. Yet what should be good German IP data should keep the downside limited.

• $/JPY remains key vehicle to play both: (i) Trump’s political travails and (ii) the US growth/rates story. On the former, it’s hard to know when the bad news will hit, but on latter, this week should prove +ve for the USD. The US rates curve is very flat & higher US prices should steepen the curve. • In Japan this week, we’ll see surveys on activity (Mon & Tue), June trade & regular portfolio data. We’re still of the opinion that Japanese residents should be accelerating foreign bond purchases around now.

• The combo of a dovish BoE disappointment and a slightly rejuvenated USD has seen GBP/USD fall back to 1.30; we see near-term risks of a move below here as the BoE’s patient policy approach could see GBP take on more of a funding currency role in a diverging monetary policy environment. • Expect GBP to remain sensitive to UK data outcomes as markets continue to reassess 2017 BoE rate hike odds; Jun industrial production and trade (Fri) to note this week, with both important for any 2Q UK GDP revisions.

• The Aug RBA meeting noted greater concern over the recent AUD rise (albeit USD related), though the central bank’s slightly more optimistic projections have limited any meaningful fallout below 0.80. • We think a neutral RBA policy bias will remain in place and see limited scope for AUD rates moving higher. Focus will be on speeches by the RBA’s Kent (Tue) and Lowe (Fri) for clarity on the inflation outlook, while the data docket sees the latest consumer and business confidence indicators.

• A small miss in both Canadian job gains and the Ivey PMI has added to the fading CAD optimism. We see scope for a bigger USD/CAD correction higher as markets have got ahead of themselves in pricing an extensive BoC hiking cycle. Lower short-term CAD rates would fuel a move back to 1.27-1.28. • The domestic calendar in the week ahead is sparse, with only housing data to note. CAD vulnerable to noise around the OPEC meeting (Mon-Tue) – but oil stuck in the $45-$55/bbl range won’t be a big catalyst for the pair.


Global FX: USD weakness, EUR strength and GBP hike bets.
USD: Hoping for some payrolls lovin’… or least signs of wage inflation. Betterwage growth data in today’s US jobs report may not change the market’s cautious outlook on the Fed. However, it could prove to be a saving grace for a beleaguered $ in need of some love from the US data. With the US 10-year yield at 2.2%, we would expect confirmation of a 0.3% MoM average hourly earnings print to see rates moving higher. It will be interesting to see if a steepening bias helps the USD to recouple with interest rate differentials, in particular those crosses where the decoupling has been notable.

EUR: Ain’t no stopping us now…Though we continue to view this as a near-term overshoot. Saying that, sentiment towards the euro has changed so much in recent months that it may not take much to break the psychological 1.20 level (even if bund yields are stable); the run-up to President’s Draghi Jackson Hole speech (end-Aug), rising QE taper speculation ahead of the ECB meetings in Sep and Oct and risks of a sustained slowing of the US economy are potential catalysts. The spillovers from the EUR rally are clear; we expect European FX (both within the G10 and EM space) to benefit vis-à-vis their USD-bloc peers.

GBP: £ vulnerable again as BoE said it best, when they said nothing at all In keeping with our Game of Thrones preview, the takeaway for markets from the Aug BoE meeting was “brace yourselves, winter is coming”. Admittedly, this statement is a light-hearted embellishment of the more tame reality. But relative to what markets had been expecting, the 6-2 MPC split vote – with no new rate hike dissenters – can be seen as a dovish disappointment, with some hoping for greater hawkish gestures from the Bank this week. The slightly more cautious growth projections, the dichotomy of MPC views and a lack of coherent policy bias mean the bar for a 2017 policy move still remains pretty high; we continue to see a credible BoE rate hike debate being more of a 2018 story. Although the immediate fallout for GBP has been contained, the BoE’s patient policy approach does now mean that GBP will be bucketed into those currencies at risk of being sold in the current theme of monetary policy divergence.


European Bonds and Global Bond Indices
While European equities received uplift from encouraging Eurozone GDP data, a risk-off mood took hold across Eurozone bond markets, especially after weak US auto sales data send US Treasury yields sharply lower. Core curves bull flattened and the recently launched 10yr Bund benchmark, which will be re-opened today (see below), closed 3bp lower at 0.49%, marking the low end of the range it has traded over the short course of its life thus far.

EGB peripheral spreads saw an initial widening yesterday led by 5-10yr SPGBs – on Thursday Spain will tap the 5yr, 9yr and 25yr segment. Into the market close especially longer dated spreads were able to reverse the widening. In the end, only 3-7yr SPGB and PGB/Bund spreads stood wider – the latter by c. 3bp, although these hit fresh one-and-ahalf year lows yesterday. 10yr and longer BTP/Bund spreads were around 2bp tighter. In terms of today’s dataflow, the main focus is on the US ADP report, which is expected to hint at a solid payrolls report due on Friday, albeit it will be the hourly earnings growth figures that will shape the market’s reaction (here the consensus is for a pick-up in the MoM rate to 0.3%). EGB supply.
Today Germany will tap DBR 8/27 for €3bn. Outright yields don’t look that unattractive, as 0.49% still marks the upper end of the 0.15-0.50% range for 10yr German yields that prevailed in the run-up to Draghi’s Sintra speech on June 27. Moreover, the 10yr Bund also looks relatively appealing on a cross-markets basis, with DSL/Bund and OAT/Bund spreads at around their tightest levels in 12 months. The repo specialness of the DBR 8/27 (-1.32% s/n yesterday), also compared to other 10yr core paper, is another reason why we would expect the auction to get done at reasonable levels.

Elsewhere, Austria announced taps of the RAGBs 2/47 and 10/23 (€1.1bn in total) for its 8 August reserve date. The last time it did not make use of the reserve date was in 2014. Also note that Ireland’s NTMA yesterday cancelled another €500mio of the IRISH 2045 floater, held by the Central Bank of Ireland (CBI). These holdings are also relevant for the issuer limit of 33% for the PSPP, and as such the cancellation frees up room for the Irish central bank to conduct more PSPP purchases. Ireland is among the jurisdictions where the Eurosystem PSPP purchases undershoot the target implied by the capital key.


Global Yields, Asian Currencies, USD weakness vs JPY weakness
Yesterday saw one of the rare occasions when European 10- year real yield fell faster than nominal yields. Data wise, there was little to explain this move as data globally have stayed strong. US Senator Lindsey Graham not ruling out the US going to war with North Korea had little impact on Asian currencies and, with investors happy to buy risk-related higher yielding assets, we instead attribute current market behaviour to strong liquidity conditions and Secretary of State Tillerson’s more conciliatory tone towards North Korea. US banks deploying their balance sheets to reach for higher yields, plus the US Treasury reducing its cash balance ahead of reaching the debt ceiling in September, have pumped additional funds into the system, keeping risk assets supported. After a meeting with Minority Leader Schumer and Treasury Sec Mnuchin, Senate Majority Leader McConnell said there will be a vote on the debt ceiling ‘next month or so’ suggesting that the US should ‘never ever’ default on its debt. USD cross-currency basis spread arbitrage seems to be working again, converting onshore USDs into offshore USD liquidity, which we view as an important condition for keeping the risk rally alive.

The US auto cycle seems running tired with yesterday’s car sales data (moderately) disappointing again. Consequently, the Dow Jones transportation index – a bellwether of the equity market – has fallen 6.4% from its June top. However, a similar signal emerged in March and did not prevent the equity market from continuing to work higher. This is because European and US equity markets continue to be supported by strong earnings releases. Yesterday’s sharp 3.5% fall in oil prices tells a similar story. API inventories released overnight showed a surprise 1.8m barrel rise in US crude inventories, and OPEC output was reported to have risen in July, according to Bloomberg and Reuters surveys. The commodity market seems split between those commodities facing inventory and overcapacities (such as energy) and other industrial raw materials (such as copper and iron ore) where recent growth in demand have led to higher prices. For risk markets to turn lower we need inflation to pick up, which we only expect late this year going into 2018. Yesterday’s core PCE release coming in at 1.5%Y is consistent with the risk rally extending further from here.

With real DM yields falling rapidly, narrowing interest rate differentials, one would expect the JPY to continue its recent rally. Instead, the JPY has weakened overnight with EURJPY trying to break above its 200-week MAV. EURJPY is one of the currency pairs most sensitive to trends, rarely spending too much time within a corrective pattern. Over the past 10 years EURJPY has crossed its 200-week MAV only three times; all occasions were followed by significant moves. Important to the future path of the JPY will be the policy stance of the BoJ. Some market participants view the JPY as the next EUR with respect to the BoJ changing its stance in light of economic recovery. We disagree with this view. Overnight it was the BoJ’s Funo suggesting the BoJ must maintain its aggressive monetary easing stance to achieve stable 2% inflation, which would create room for lowering real borrowing costs when the economy slumps. USDJPY has formed a tradable bottom and is expected to rally from here.


Global FX, USD, FED and China
Ahead of tomorrow’s Fed meeting, markets are staying within tight ranges as tactical versus structural forces maintain balance. Tactically, investors fear the Fed emphasizing the gradual but continued tightening path projected by its dots, which, for a market that is heavily underpricing, the Fed could be a major headache. Structurally, excessive liquidity conditions will stay in place even if the Fed delivers according to its projections. The prospect of US financial sector deregulation has added a new source of capital availability, allowing capital costs to diverge significantly from nominal GDP expansion rates not only in the US, but also globally. Indeed, the testimony of Randy Quarles, who has been tapped by President Trump to serve as Vice Chair of Supervision, on Thursday is likely to support this effort and will have the means to do so. Spreads have stayed tight against warnings that credit spreads should widen when approaching a late cycle. The continued tight spread reading suggests either the market does not believe in the late cycle mantra or that investors, blessed with liquidity looking for yield pickups, are willing to ignore late cycle related credit risks. Regardless of driver, the message remains a risk positive one pushing financial conditions towards new highs.

The Fed may lean against a further valuation acceleration of risky assets. Given FX market positioning, there could be a significant short-term USD supportive impulse created by the outcome of the Fed meeting should its communication signal an earlier-than-expected balance sheet normalization or a faster-than-expected rate path. However, the USD is unlikely to return to its previous long-term bull trend. Indeed, the combination of US growth not accelerating meaningfully from its recent 2% path and financial sector deregulation has created a textbook environment for USD weakness. For the USD to rally lastingly, the US has to shift its growth potential closer towards 3%, which would require critical structural reforms. Fed policy changes may impact the USD tactically, but structurally it is the amount of USD made available for international use driving the USD.
Often we hear investors talking about China’s weakening credit impulse dampening demand for commodities via slowing Chinese economic growth. According to China News, the 25-member group of the Politburo stressed that the government would further regulate “financial chaos”, curb the increase of illegal debt raised by local governments, and stabilize the real estate market. The “barbaric” growth of the Public-Private Partnership projects will be controlled through better management of local government debt, the committee suggested. It seems China is heading towards a period of monetary tightness which does not bode well for the credit impulse. North Korea-related tensions have come back onto the agenda too, with the WSJ reporting that China is preparing for tensions with North Korea.

However, CNY swap rates and bond yields have eased since May. Interestingly, despite the PBoC ‘s tightness, China’s economic growth rate has accelerated over recent quarters. Here too the availability of capital plays in. When China faced strong capital outflows in 2015/16 it was its weakening asset base driving domestic monetary conditions tighter. The now-sealed capital account has stabilised domestic capital supply, allowing CNY spreads to tighten, bond yields to come down, and local equities to rally. This morning China’s Security Journal wrote that the liquidity situation is expected to improve further in the near term as the PBoC is showing a clear bias toward maintaining liquidity stability while positive changes in capital flows are providing additional support. All in, China’s liquidity and capital position is not overly tight.

Some DM central banks potentially undergoing a regime shift – trying to avoid mistakes of the previous cycle when funding costs undershooting nominal return expectations for too long led to a leveraged-funded boom and capital misallocation, eventually unleashing a substantial deflationary shock – stand in contrast to falling energy prices in terms of market implications. Fed minutes confirmed anticipated hawkishness, leaving it only a question of time before the Fed starts its balance sheet reducing operations. The ECB will release its minutes today. More important will be ECB’s Weidmann’s speech on the future of the EUR.
Simultaneously, markets have to digest oversupply issues mainly affecting energy markets. Here, two big issues seem to stand out. First, OPEC’s inability to stay compliant with previously agreed production cuts and second, the US turning into an energy exporter following its shale energy revolution. Our US economist estimates business investment into US oil and gas drilling structures will increase by 80% in Q2and 25% in Q3,not only supporting US economic growth via its implementation, but also adding to the supply of energy into global markets. The FT is running an article today suggesting that LNG supply could increase by about 50% from 2015 to 2020. The US will turn into a leading LNG supplier. Australia has also now built up infrastructure to become a big LNG exporter. Our stance of selling currencies of traditional oil suppliers such as NOK and COP remains unchanged.
Declining energy costs have helped dampen inflation expectations and yesterday’s pause of US yields breaking higher despite increasing prospects of the Fed adding to future net bond supply should be attributed to oil prices showing their biggest decline since 25th May. The 5% oil price decline on 25th May set the starting point for a four-week decline, seeing Brent losing around 17%.
The exhibit illustrates the crucial position in which markets are currently progressing. We compare the 10-year US real yield with 10-year US breakeven. For risk markets to flourish, a combination of falling real rates and rising inflation expectations bodes well, explaining the strong equity performance witnessed in 2012/13. The reverse picture emerged in 2015, pushing share markets into two significant downward corrections in August 2015 and January 2016. The problem is that real rates have diverged from falling inflation expectations as they did in 2015. In this sense, falling energy prices are not risk supportive if not compensated by other reflationary forces. Yesterday, we mentioned rallying soft commodity prices. Today, we like to put our emphasis on growth data where we hope the upcoming June ISM non-manufacturing PMI and NFP report may allow the gap between US real rates and inflation expectations to narrow somewhat.

This analysis suggests that the risk outlook has turned more data sensitive. The Fed’s potential change of its reaction function – now increasingly emphasising buoyant financial conditions – and its readiness to look through current weak inflation data have created this new data sensitivity. The Q2 earnings reporting season starting tomorrow should help tip the balance in favour of risk appetite for now. We stay USDJPY bullish and use a near term setback to last Friday’s bullish 112.00 break point as a buying opportunity. The 10y JGB yield trading up to the unofficial 10bp upper ceiling due to a weak open market operation should not strengthen the JPY. There is no appetite within the BoJ for moving the signposts of its yield curve management policy yet. The MoF weekly security flow data showed foreign investors shying away from JPY money market investment, suggesting the USDJPY cross-currency basis should stop tightening, thus no longer reducing Japan-based investors’ hedging costs. Japanese investors reducing their FX hedge ratio should strengthen USDJPY.

GBP has corrected some of its recent gains in light of weak UK postelection PMI readings. Remember, post-Brexit UK soft indicators crashed for a couple of months before turning back up again. Anyhow, our GBP optimism finds its foundation in what we call ‘Brexit economics’ and the BoE reconsidering GBP weakness and its impact on the economy. So far, GBP weakness has been unable to lift net exports, but ithas undermined real disposable income via rising import prices. In short, GBP weakness has undermined living standards and with inflation above the BoE’s 2% target and its own staff projections, GBP stabilisation should now be on the BoE’s agenda. Talking up rate expectations is a sufficient tool to reach this target. With regard to the GBP outlook, we should not underestimate the growing influence of Chancellor Hammond within the Cabinet. There is a new openness to listen to businesses to reduce Brexit-related supply and market access restrictions, which should work in favour of the market which is still GBP short positioned. We hold our GBPUSD 1.32target.


GDP expanded by 5.0% YoY in 1Q17, much higher than the market consensus at 3.5%. The rebound was driven by private consumption while net trade had a significantly positive contribution with improving export performance. The data show continuation of the recovery that started in 4Q16 at a strong pace. Economic activity was higher than expected in 1Q with 5.0% YoY growth while market expectations, according to a Bloomberg Survey were at c.3.5% with a range between 0.8% and +4.8% vs our call at 3.6%. Accordingly, following a contraction in 3Q16 for the first time since the global crisis, growth has maintained an improving trend, pulling annual GDP growth to 3.0% in 1Q17 from 2.9% in 2016. In seasonal and calendar adjusted terms (SA), GDP expanded 1.4% QoQ, down from 3.4% QoQ a quarter ago, though showing that the recovery has remained in place. 12-month cumulative adjusted GDP growth accelerated to 1.1% from 0.9% on a sequential basis.

Looking at the expenditure breakdown, we see that private consumption was again the main contributor to growth at 5.1% YoY in the first quarter of the year. This shows the improvement in consumer sentiment in recent months with stabilisation in the currency and the impact of stimulus measures such as VAT cuts in some consumer durables and social security premium cuts as well as easing macro-prudential measures, ie, extending the maximum maturity of consumer loans, arrangements in credit card installments, etc. Fixed investment gained further strength despite the political uncertainty ahead of the referendum and recent CBT tightening with 2.2% YoY growth. This is attributable to significant lending acceleration as credit growth (13-week MA, FX-adjusted and annualised) has converged to 25% on the back of contributions from the Guarantee Fund. Public consumption was up by 9.4% YoY with the introduction of stimulus packages and with increased public spending, providing a stronger contribution to growth vs 4Q. We think this will likely reverse in the second half of the year. Also, exports were up by 10.6% due to the strong economic growth in the EU and recovery in trade with Russia while imports recorded a mere 0.8% increase with the result that net trade provided the first positive contribution to the headline since 2015. Finally, inventory depletion shaved a significant 2.3ppt from GDP growth, supporting the view that production should improve in the coming period. All in all, the improvement was relatively broad-based in 1Q17 showing a further rebound after the robust performance in 4Q16 following a significantly weak 3Q16 with implications of the failed coup attempt in July on household and corporate sector behaviour.

Among the sectors, manufacturing stood out with a 1.1ppt contribution with a second strong reading after the drop in 3Q16, while construction was another driver with a 1.6ppt (including real estate activities) addition to the headline. Overall, after economic growth rose back into positive territory in the last quarter of 2016 following political tensions and a shock to the tourism sector, we saw across-the-board strength with further recovery in private consumption and net exports. For 2017, risks seem to be on the upside given the acceleration in activity in 2Q17 and low base effect of 3Q16. Recently released indicators hint at some further acceleration in 2Q17 economic activity, with higher PMI in tandem with rising CUR. Improvement in sectoral and consumer confidence after the referendum should also contribute to the recovery.

UK consumer price inflation is getting closer to 3%, but slower growth and political uncertainty mean there is little chance of an interest rate rise. The pound’s collapse since last June’s EU referendum has seen import prices rise across the board, but it has been most felt in food and fuel costs. This has seen headline CPI rise to 2.7% YoY and we look for it to push higher again today. This is primarily due to higher utility bills (gas and electricity) with providers having announced significant price hikes in response to wholesale price moves. There are also tens of thousands of households impacted by fixed term deals coming to an end this month. These people will find themselves put automatically on higher price tariffs.

However, there is going to be some offset from a temporary drop in motor fuel prices (they have risen again in early June), but with an increasing number of retailers facing higher import costs as their currency hedges come to an end we suspect headline inflation will rise to 2.8% before hitting 3% in 4Q17. Tomorrow’s labour report is likely to show wages remain little changed so the squeeze on spending power looks set to intensify. Already, there are worrying signs for consumer spending with this week’s retail sales report likely to post a heavy decline after a bizarrely strong outcome last month. Indeed, Visa, the payment card provider, reported that according to its own internal data consumer spending is now falling when adjusted for inflation. The pain is likely to get worse before it gets better.

The outcome of the election is not helpful for the growth story either. The uncertainty that this generates is prompting a steep fall in business confidence. The Institute of Directors found that 57% of their members were either “quite” or “very” pessimistic about the UK economy over the coming year versus just 20% who described themselves as optimistic. Given the lack of positive news flow on the domestic economy and the political uncertainty the UK faces it is not surprising that financial markets are pricing in a less than 10% chance on an interest rate rise this year, with the probability of a rate rise by the end of 2018 put at just 33%. Given the lack of domestic price pressures (as highlighted by subdued wage growth) we don’t expect an interest rate hike before the official deadline for Brexit talks to conclude in 2019.

USD: Role of Fed hikes reduced to providing a buffer for the $, not a driver When the FOMC meet this week (Wed), there’s no doubt that the case for a rate hike will be less compelling than it was back in March. Economic data, especially short-term inflation dynamics, have been unnervingly soft and one could argue that this should keep a data-dependent Fed sidelined until things pick-up. Most FOMC members, however, have been quick out of the blocks to dismiss this soft patch as nothing more than a transitory phase. Still to us, this week’s move looks like an opportunistic rate hike if anything, making use of the fairly benign market conditions to take another step away from the zero-lower bound. Not everyone in the FOMC may agree, so watch out for dissenters (Kashkari, possibly Brainard). As for the economic projections, well there’s an outside chance that the growth and inflation profile could be tinkered lower – the extent to which will be telling of just how transitory some members see the current slowdown. We see downside risks to the Fed’s dot projections as well, although it’s more likely that we’ll see a more positive skew rather than any wholesale changes to the median dots. We think the Fed have been somewhat clever in constructing a dot plot that serves to fit in either a world of Trump ‘reflation’ or the status quo of secular ‘lowflation’. A hike this week means that we’ll move one step closer towards the start of the Fed’s balance sheet reduction. We’re likely to see the normalisation principles updated, though overall we don’t expect to see any surprises that could lift the $.

EUR: Quiet EZ week allows focus to shift to central bank events elsewhere In the EZ, we expect a relatively calm week following the June ECB meeting; the German ZEW index (Tue) should pick up. EUR/$ neutral around 1.12 this week.

GBP: Short-term political woes could see GBP/USD decline towards 1.25 The dust is beginning to settle following another UK election rollercoaster. Still, there remain many domestic political – as well as Brexit policy – unknowns that will continue to hangover the pound over the coming weeks: Domestic political risk premium: Theresa May has unequivocally stated her intention to stay on as Prime Minister and while there may be some underlying unrest within the Conservative Party, it seems that a leadership contest at this stage remains highly unlikely – especially as it would see another election that could risk handing the keys to Downing Street over to Jeremy Corbyn. On that note, the Labour leader hasn’t given up on forming a minority government and putting forward an alternative Queen’s speech – but again this seems unlikely. Still, we note that any confidence and supply arrangement between the Tories and DUP would be a less stable form of government than the 2010 coalition. It would risk slowing down the legislative process on key policy areas – not least the Budget and Brexit. Political uncertainty remains a headwind for GBP. ‘Hard’ Brexit risk premium: Brexit negotiations are set to begin shortly and the UK’s position remains up in the air. Calls for a ‘softer’ Brexit seem pre-mature, especially as Labour have signalled their intent to leave the single market. What we do see, however, is an economically rational Brexit – with the dial shifting towards obtaining a deal that is in best interests of the UK’s long-run economic prospects. This would be a net positive for a undervalued GBP.


Global FX, DXY strength, China and AUD
The DXY is expected to gain further from here, with the overnight FOMC statement helping to restore USD optimism. Our probability of the Fed hiking rates on 14th June has risen to 80%+ after the Fed called the slowing in growth during the first quarter as ‘likely to be transitory’ and that the fundamentals for consumer spending ‘remained solid.’
Today will see US releases on trade, initial jobless claims and factory orders. Initial jobless claims may have been distorted by the Easter holidays; hence we will not pay too much attention to a potential rise in claims. Weak productivity data is a reflection of the past and the natural consequence of the rising labour/capital ratio witnessed in the US over the past years. Factory orders have improved substantially over recent months, seeing orders ex transportation now gaining 7.5%Y, representing its best expansion for more than 5 years. March trade data should be looked at in terms of activity, with rising imports and exports pushing the USD higher. US trade is now in a better position compared to previous occasions when the US was aiming for higher growth rates. Previously, better US demand acted as a magnet for imports, driving the trade deficit swiftly higher. Nowadays, the increasing output of the US energy sector reduces energy imports and likewise increases energy exports, helping to keep the trade deficit stable for longer.

USDJPY has reached 112.89 overnight and will now need to overcome the 112.90/113.10 resistance to open upside potential to 116.50. Our bearish JPY call requires markets to stay confident on the global reflation outlook. The Fed expressed this confidence yesterday, but commodity prices have come off sharply over recent days, suggesting USDJPY may see some corrective activity before overcoming the 113.10 resistance. Over the next few days, AUD may be the better short instead. China related commodities have come under selling pressure with iron ore and coal futures now approaching their mid-April lows. China’s PMI releases including today’s services sector PMI have disappointed. Its equity markethas underperformed while its bond yields have risen, indicating that China’s financial conditions have tightened. The mini tightening cycle designed to reduce the pace of leverage build-up seems to now be impacting China’s economy. The PBoC has injected RMB 140bn (USD 20.3bn) on Wednesday, representing the largest single-day addition since 19th January, but their refraining from rolling over maturing medium-term lending facility loans caused the seven-day repo rate to rise 80bp to 4.5%. Back-end RMB yields have continued to rise, representing bad news for the AUD.

Rising RMB yields may undermine the AUD from various sides, especially if the yield increase is not covered by better Chinese economic data. First, the discrepancy between the evolution of China’s economic growth rate and yield does not only signal tighter financial conditions, it also highlights the risk of the economy deleveraging, suggesting it will lose further growth momentum. Secondly, globally rising bond yields increase the funding costs of Australia’s wholesale dependent banking sector.


Since Monday, April 10, positioning has shifted. Within G10, the largest shorts are still in USD and GBP; the largest long is now in EUR. EUR positioning moves further into long territory: All components except IMM showed an increase in EUR positioning. Global macro funds and Japanese retail accounts were big buyers, moving from neutral to long. Japanese retail accounts are now small net long EURJPY for the first time since November. Sentiment also turned less bearish, helped by a fall in USD bullish sentiment after Trump’s comments that the USD was getting too strong.

Non-commercial IMM accounts were the only ones who sold EUR, but their net short EUR positioning remains near the smallest since May 2014. The French election this Sunday will be the main driver for EUR; see our expectations for EURUSD under different scenarios here. JPY positioning remains neutral: Investors’ JPY positioning was mixed. Among Japanese investors, retail accounts were JPY sellers but Toshin accounts were buyers. Among global investors, global macro funds were sellers, but non-commercial IMM accounts were large buyers, and sentiment turned bullish, with the percentage of bullish JPY traders rising by nearly 20% on the week. We remain bullish on USDJPY strategically.

GBP short positioning unchanged: GBP was the second most sold currency among non-commercial IMM accounts, bringing these accounts’ short GBP positioning back near the historical high. Global macro funds were also large sellers. On the other hand, Japanese retail accounts doubled their long GBP positions last week, and sentiment became less bearish. This short positioning is likely to contribute to GBP strength on any positive news, as shown by the GBP rally today after the announcement of early elections. We still like EURGBP shorts on positioning differentials and the potential for GBP to develop a safe haven status should markets get worried about Eurozone political risks.

The independent centrist candidate Emmanuel Macron is still the favorite candidate to become the next French President. Odds of his presidency still hovers above 50 percent, far higher than any of his rivals, however, the odds have declined from 67 percent just three weeks ago to 52 percent as of now. While nobody can predict with certainty on who might win on May 7th, one thing is certain that the French are looking for changes and they are looking for it so hard that for the first time main political parties are not at all expected to make it to the round two of the election that will be on May 7th. The incumbent President is so unpopular in France that his approval rating at one point declined to just 4 percent and that legacy would continue to hurt his socialist party for years to come. That is probably is the main reason for his not running for re-election.

Shadow of his disastrous legacy is one of the reasons why the odds are declining for Macron. Many lawmakers of the socialist party are openly supporting Emmanuel Macron against his closest opponent Marine Le Pen. President Hollande has openly declared that it his duty to make sure that Le Pen doesn’t’ win the Presidency. The former Prime Minister under Hollande government of the Socialist Party Manuel Valls has openly declared his support for Mr. Macron instead of his own party’s candidate Benoît Hamon.

Mr. Macron is increasingly being seen as an extension of the establishment and the current socialist government and that is not a good portrayal on an anti-establishment year.

The following are some of the highlights from last week’s release of the central bank’s monetary policy minutes from the 30 March meeting. The majority of the board members noted that the “preventive” monetary policy adjustments since late 2015 have generated an “appropriate stance” to face the shocks that the central bank has been facing. One board member said that possible interest rate increases abroad would not necessarily have to be matched with a greater monetary restriction in Mexico, in the absence of additional adverse shocks that could affect inflation in Mexico. Two board members, however, countered this. One of them said that “it is probable that new increases in Mexico’s overnight rate may be needed in coming months” to ensure the convergence of inflation to the target. Another board member said that there cannot be much flexibility for the central bank of Mexico to deviate from monetary policy decisions taken by the US Federal Reserve and, therefore, the central bank of Mexico should at least keep the current short-term interest rate differential with the US. The majority of the board members agreed that the balance of risks to inflation did not worsen further, but noted that risks to inflation are still to the upside (higher inflation), mainly due to the number of inflation shocks in recent months. The majority of the board members also noted that conditions in the labor market have been tightening “in an important way.” Some of them think that the output gap is at zero and one of them said that there are indicators that reflect risks of possible generalized pressures on prices. Another board member noted that he is not too concerned about wage-related pressures on prices given that the economy is slowing down and that recent pressures on wages have not been excessive. The majority of the board members acknowledged the risk of an abrupt reversal in investor sentiment, due to economic policies in the US, geopolitical problems and/or the strengthening of nationalist policies particularly in Europe.

Does payrolls matter for the USD today? The FOMC minutes gave the market a lot of information on how the Fed is thinking about reducing monetary accommodation. In 2018 the focus will be on balance sheet reduction. The market took this as a signal that the focus in 2017 will be to use the pure interest rate tool to tighten. The market prices 38bp of hikes by the end of this year and a cumulative 70bp by the end of 2018. The strong ADP print on Wednesday has already pushed expectations higher for today’s headline NFP (MS: 195k), therefore it is the wage data that matters for the USD. Average hourly earnings above the 2.7% market expectations would drive the USD higher on the day, particularly vs the JPY. The US 10y breakeven rate has come down from the Jan high of 2.07% to 1.95% today.

Short EURGBP. The best way to play for a dovish ECB in the next 3 months is to sell EURGBP. The pair is developing strong bearish technical signals, which continue to hold as long as EURGBP stays below the 0.8610 level. Draghi and other ECB members yesterday tried to send a message that there has been a recovery in the economy, monetary policy is working but inflation needs to be sustainably close to 2% for us to consider changing policy. Emphasis was also on the sequencing of the removal of accommodative policy, should they reach their targets. We don’t think the ECB will raise rates before starting to taper asset purchases. The ECB minutes said they discussed removing the phrase “rates will remain at present or lower levels”, but that has stayed, possibly to give the ECB as much flexibility as possible, should political events cause market volatility. On the GBP side, a survey released overnight highlights some labour market tightness appearing. The Recruitment and Employment Confederation showed that companies are finding it difficult to fill jobs in London and the South, particularly in the temporary sector where staff availability fell at the fastest rate since January 2016.

SNB still intervening. After the Czech National Bank removed their EURCZK currency floor yesterday, focus will naturally turn to the Swiss. Without having a formal floor any more, we don’t think the SNB are near stopping their currency interventions since they currently have the flexibility to intervene if and whenever they like. Inflation data have been improving, with the latest headline print now at 0.6%Y, the highest since 2010. The latest core inflation print is now above zero (0.1%) but has not yet recovered to levels seen in late 2015 (0.4%). The domestic economy is still dealing with the impact of a strong currency and, more importantly, the slowdown in Chinese demand for luxury goods. For now we think the SNB will continue to intervene in the largest volumes around major risk events, with the next ones being the first and second round of the French election. Recently the SNB have been more explicit than ever before about their management of the FX reserves portfolio. Interestingly they are justifying holding a large equity position (20% of portfolio) by saying they need to do this because of the strong exchange rate. We expect EURCHF to stay stable for now.

Energy • US crude oil inventories: Yesterday’s EIA report showed that US crude oil inventories increased by 867Mbbls over the last week, below the 2MMbbls stock build that the market was expecting. The lower-than-expected build was due to higher refinery throughput, which increased from 15.8MMbbls/d to 16.23MMbbls/d over the week. A higher refinery throughput rate and a decline in refined product inventories suggest strong demand currently. • Russia oil output cuts: According to reports, the Russian Energy Minister has said that the country has cut oil output by 200Mbbls/d so far, versus their agreed cut of 300Mbbls/d. However, the country expects to reach this target by the end of April. With regard to extending production cuts, Russia has said that it is too early to decide on whether an extension is needed.
Metals • Grasberg copper mine: Reports suggest that the Indonesian government and Freeport have finally completed discussions on converting the company’s current mining license to a new one. With Freeport apparently now agreeing to this new license, we should see Grasberg resume copper exports, while the mine is likely to ramp up operations once again. • Australian cyclone aftermath: Following the cyclone that hit Queensland, a number of coal mines in the state that were forced to shut are now looking to restart mining operations. However, currently, ports and rail lines remain shut. The scale of damage to infrastructure is still unknown.
Agriculture • Ivory coast cocoa export tax: There are reports that the Ivorian government is considering cutting the export duty on cocoa, from the current 22%. This comes at a time when Ivory Coast has seen a rebound in domestic production, evident through higher port arrival data. A lower duty does potentially mean increased exports from the country. • Brazilian robusta coffee imports: It appears that the government is close to deciding to allow the importation of up to 1m bags of robusta for re-export. Imports were initially approved, but this led to protests from coffee growers, which prompted the president to quickly reverse the decision.

In an interview with CNBC yesterday, the vice-chair of the US Federal Reserve said that the Fed’s March projections that forecast two more hikes in 2017, is about right. He stressed that it’s is his forecast as well. In the December 2016 meeting, the Fed projected three rate hikes for 2017 and in March they delivered one while projecting two more for the year. He expects the economy to continue to perform and the inflation to reach the 2 percent goal gradually.

With regard to the fiscal policy promises of the new administration, Mr. Fischer said that last week’s failure of the congress to pass the healthcare bill may have changed his internal calculus but not the overall outlook. He said that the central bank is closely monitoring the fiscal negotiations without prejudging the outcome. He partially blamed lower productivity for hindrance to growth but added that the reasons limiting the productivity growth aren’t fully understood. He expressed his concern with protectionism as he feels that greater global integration since World War II has benefited the US and other nations as well.

Our previous dashboard focusing on the March meeting correctly predicted the outcome including Kashkari dissent, now, our new dashboard will be focusing on the June meeting and it looks like below,

Doves: Neel Kashkari
Hawks: Charles Evans, Patrick Harker, Stanley Fisher and Robert Kaplan.
Unknown: Janet Yellen, William Dudley, and Lael Brainard
Pls. note that Daniel Tarrullo has resigned and the position is yet to be filled. He voted at the March meeting.

The British Prime Minister Theresa May has signed the Brexit letter to invoke the Article 50 of the Lisbon Treaty last evening and the letter is on its way to Brussels to the President of the European Council Donald Tusk. The official Article 50 exit process is due to begin on Wednesday after 1:30 pm Brussels time (11:30 am GMT), when the Britain’s Ambassador to the EU, Tim Borrow is expected to hand over the letter to the Council President Donald Tusk.

While both sides have agreed to cooperate with each other, Prime Minister May has cleared that she is ready to walk out without a deal if an agreeable one can’t be reached. The EU, on the other hand, has said that it doesn’t want to punish the UK over Brexit but a new deal would be an inferior one compared to the full membership. Mrs. May has also indicated that she plans to take back the immigration control from Brussels as well as jurisdiction away from the European Court of Justice. However, reports are coming out that the UK government might soften its rigid stance on the matter.

The talk is likely to start in troubled waters as the European Union is planning to hand over Britain an exit bill amounting to as much as €60 billion. According to the Article 50, the current relation between the UK government and the EU would cease to exist after two years from the date of the triggering if the timeline is not extended by a unanimous voting by the member countries.

The pace of credit growth to households and businesses in the Eurozone edged lower in February, data from the European Central Bank showed Monday. The broad money measure, M3, rose 4.7 percent year-over-year in February, slower than the 4.8 percent climb in January, missing expectations for a 4.9 percent rise. The Eurozone money supply growth eased for the second straight month in February.

Within M3, the annual growth rate of deposits placed by households stood at 5.4 percent in February, down from 5.5 percent in January. While, deposits placed by non-monetary financial corporations registered a decline of 2.0 percent.

The ECB has maintained an ultra-loose monetary policy with low interest rates and stimulus measures which have helped bolster credit growth in the Eurozone over the last two years. The narrower aggregate M1, which includes currency in circulation and overnight deposits, remained unchanged at 8.4 percent in February.

Details of the report showed that the annual growth rate of total credit to euro area residents decreased to 4.3 percent in February from 4.6 percent in the previous month. The yearly growth rate of credit to general government moderated to 9.8 from 10.5 percent.

Rotation from high yield into emerging markets is in evidence, on HY outflows versus EM inflows. Investment grade space sees a different rotation from government funds into corporate funds, with in particular large chunks of cash going into front end corporate funds of late. At the same time, long end government funds have seen resumed inflows, which should help to cover some duration shorts, leaving aggregate positioning more balanced (bearish).
Seven things learnt from latest flows data
1) There is evidence of rotation out of high yield space into emerging markets, as the latter continue to see steady cash inflows. No evidence of EM re-think as of yet.
2) Emerging markets hard currency funds have been the largest recipient of new money, and local currency funds have seen significantly more inflows than blend funds.
3) Some centres that had seen reduced investor allocations are now seeing a re-build in allocation, with for example Turkey and Mexico now seeing increased allocations
4) High yield inflows in the past couple of months have correlated with the risk-on theme seen in equity markets, and the recent pull back in equities is consistent with the maintenance of that generic correlation.
5) Valuation effects rationalise the recent rotation from high yield into emerging markets, whereas prior W Europe high yield outflows were more reflective of evidence of deceleration of issuance volumes.
6) Rotation from peripheral Eurozone government paper into corporates continues as evidenced from flows. The biggest of the corporate inflows have been into front end funds, which acts as something akin to “a front end haven with a spread”. 7) Government funds continue to see outflows, but there have been some reverse inflows to long end government funds in the past quarter. We read this as evidence of short covering, which should see positioning becoming more balanced ahead.

After the new healthcare bill that was supposed to replace the current bill, which is popularly known as the ‘Obama-care’ failed to pass through the congress last week, the relation between the US President Donald Trump and the House majority leader Paul Ryan has probably taken a turn for the worse. The new bill was expected to be put to voting on the House on last Thursday, a day marked by the seventh anniversary of the old bill. But the voting was initially postponed to Friday and then it was again canceled on Friday. As the opposition and the media targets ‘dealmaker’ Donald Trump for this failure, President Trump has allegedly showered his anger and frustrations towards Paul Ryan.

On March 25th, President Trump tweeted, “Watch @JudgeJeanine on @FoxNews tonight at 9:00 P.M.” He usually endorses shows via his tweeter account whenever he is either due to appear or appeared already in a show but in this one he wasn’t there. Instead, it was all about criticism against the Republican Party for failing to pass the new health care bill. In that show, Judge Jeanine Pirro called for the resignation of Paul Ryan from his post as the House leader.

A rift between Paul Ryan and Donald Trump is not a new phenomenon. There were clashes many a time during the campaign but after the election, they were getting along well and a rift between the White House and congress will be in nobody’s interest. Trump has also taken a jab towards congressional freedom caucus which remains allegedly behind the failure.

The EUR/PLN currency pair is expected to gradually edge higher towards a level of 4.35 in the coming quarter, following the National Bank of Poland’s relaxed monetary policy stance. The zloty appreciated in recent months, even outperforming peers such as the Hungarian forint, despite notable adverse political developments, Commerzbank reported.

Among recent developments, there was the awkward situation recently surrounding the PiS government’s opposition to the re-nomination of Donald Tusk for European Council President, and deterioration of EU relations as a result, when even allies, Hungary and the UK, voted against Poland.

Secondly, the Constitutional Tribunal probe is ongoing and could re-escalate at any time; this week, European Commission Vice-President Frans Timmermans remarked that the Polish government’s response to EC recommendations has been unacceptable — it could easily have triggered the use of the so-called Article 7 sanctions (which could strip Poland of its EU vote).

But, despite calls on him to activate this clause, Timmermans is resisting because of other political re-occupations in EU. Finally, the PO opposition has called for a vote of no confidence in the PiS cabinet and PM Beata Szydlo which will be held around April 5-7. Ruling PiS will be able to win the vote in the Parliament, no problem, but this is not to gloss over the fact that PiS’ approval ratings are no longer rising.

In fact, polls express greater public confidence in PO’s ability for foreign policy. All said, the zloty has remained unaffected, which probably reflects some kind of market ‘fatigue’ after constant debate and discussions of Polish political risks over the previous year, which ultimately led to nothing significant, the report added.

Centrists at the ECB are continuing to downplay the prospects of early tightening, although markets continue to price a hike in Sep 18. Understandably the ECB is concerned that markets will overshoot on any early hint of early tightening. Look out for Eurozone PMIs today. These have been running strong and suggest Eurozone growth may be running at 2%. We’re still clinging to the view that the 1.0850 area is the top of the EUR/USD range, but that could be severely tested if the US healthcare bill fails in the House today.

German bunds trade higher ahead of ECB member lautenschlaeger’s speech, March manufacturing PMI
The German bunds trade higher Thursday as investors wait to watch the European Central Bank member Lautenschlaeger’s speech, scheduled for later in the day. Also, market participants remain keen to read the March manufacturing PMI, due on March 24, which will remain crucial in determining the future direction of the bond market.

The yield on the benchmark 10-year bond, which moves inversely to its price, slumped 1-1/2 basis points to 0.39 percent, the long-term 30-year bond yields also plunged 1-1/2 basis points to 1.12 percent and the yield on short-term 1-year bond also traded 3-1/2 basis points lower at -0.80 percent by 09:00 GMT.

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.

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 Japanese government bonds traded narrowly mixed Tuesday 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 steady at -0.25 percent by 06:00 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 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.

UK industrial output slows less than expected in January, but manufacturing and construction activity both shrank more than expected. Data released by the Office for National Statistics showed Friday UK industrial production decreased 0.4 percent in January compared to a 0.9 percent rise in December.

This was the first decrease since October 2016 and was less than expected fall of 0.5 percent. On a yearly basis, growth in industrial output eased to 3.2 percent in January, in line with expectations, and compared to 4.3 percent in December.

Both manufacturing and construction activities shrank more than expected in January. Factory output was down 0.9 percent in the opening month of 2017 against expectations of a 0.4 percent decline, while construction sector output dropped 0.4 percent compared to forecasts of a 0.2 percent fall, according to the Office for National Statistics.

The figures follow a strong end to 2016, and markets were anticipating a pullback. However, there is little evidence of a dramatic slowdown as Brexit talks loom, with the falling pound continuing to underpin exports.

“The data suggest the Bank of England will adopt an increasingly dovish view in coming months, with rhetoric highlighting the downside risks to the economy posed by rising inflation and heightened political uncertainty,” said Chris Williamson, Chief Business Economist, IHS Markit

US real yieldsare breaking higher, driven largely by nominal yields and pushing USDJPY through the 115 level. US 10y real yields (59bp)have now retraced 70% of the decline seen in the past 3 months (falling from 71bp to 30bp). Within the G10 the JPY is generally the most sensitive as real yields rise, but recently also the NOK has come up on the scale. The NOK generally moves in line with oil prices, suggesting the recent rise in nominal yields, while inflation expectations stay flat as oil prices have fallen, should keep USDNOK on an upward trend for now. USDJPY is approaching a technical level, where a move through 115.62 should mark a break of the current trading range, with little resistance before 118.60.

USD and Payrolls. Market expectations are for a strongFebruary employment print today following ADP on Wednesday. Using submission to Bloomberg, sent after the ADP, we calculate median expectations to be at 230k. Average hourly earnings will be more important for the USD relative to the headline NFP as this would suggesthigher domestic inflationary pressures. The US saw import prices from China, the source of over 20% of U.S. imports, rise 0.1% in February. According to our economists, that may not seem like much, but it was the first increase in three years. Global and local inflationary pressures could soon make markets reprice Fed rate hike expectations going into 2018 and beyond, which we think would be bullish for the USD.

ECB lookingat EUR REER. Markets perceived the ECB to have been hawkish yesterday,yet we couldn’t find much difference in the commentary relative to December. The sell-off in bunds drove EURUSD higher but we are considering it as an opportunity to sell. Inflation forecasts were pushed higher (as markets expected) with marginal tweaks to growth forecasts. Most importantly for investors looking for signals to the end of the current QE programme, Draghi reiterated several times that their current forecasts are conditional on finishing the current programme and thatunderlying inflation pressures remained subdued. We need to wait for more domestic core inflation prints.For our FX analysis, the most interesting comments were in response to a question about the US administration (Peter Navarro) saying that the EUR is too weak for Germany. After repeating what the US treasury (not classifying Germany as a currency manipulator) and Weidmann (ECB sets monetary policy for Germany) have said before, Draghi went to say, (in a comment that appeared to be offscript,) “By the way, if we look at where the [real] effective exchange rate stands today with respect to historical average, we don’t see especially that the euro is off the historical average. But the [real] effective exchange rate of the dollar is off the historical average. So it means that it’s not the euro which is the culprit for this situation.”

EUR: watching equity flows. EURUSD is currently tracking the 5y yield differential between Germany and the US.Front end rates (such as in the 2y part of the curve) point to a lower EURUSD due to the repo related distortions in the German 2y. We showed earlier this week that looking at forward rate differentials, EURUSD should be trading massively lower and could be experiencing something that we last observed in 2013. Back then it was foreign equity and bond inflows helping the currency. Today, the bond market valuations are much less attractive for a foreigner. Data from the IIFsuggests that global equity allocations to the euro area are low relative to a year ago (partly a result of political worries). We will therefore be watching for the next balance of payments release (22 Mar) to see if equity flows are limiting the downside for the EUR.

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.

Speaking with the BBC, Scottish first minister Nicola Sturgeon said that she has not decided whether to push for another independence referendum but insisted that she is not bluffing with her demands to the UK government for special concessions for Scotland. Previously she had said that she has cast iron mandate as her party was overwhelming elected in the regional election and because in the last referendum it was publicized that only by remaining in the UK, Scotland would have access to the EU single market. Her government brought a litigation saying that the parliament in Scotland should have voting power over Article 50, which was denied by the highest court. She has repeatedly accused Prime Minister Theresa May’s government of overlooking her demands.

While she kept her Scoxit referendum date thinly veiled she seemed to be agreeing on the time suggested by her predecessor Alex Salmond, who resigned after losing the first referendum. The time suggested by him is autumn 2018. According to Ms. Sturgeon, the time suggested makes sense as the major outline of the Brexit deal would be clear by then.

The UK gilts remained flat Tuesday in mild trading session and after Britons overwhelmingly oppose Theresa May’s plan to quit the EU with no deal in place if Parliament dares to reject the terms she agrees with Brussels, an exclusive poll by The Independent has revealed.

The yield on the benchmark 10-year gilts, which moves inversely to its price, rose 1/2 basis point to 1.21 percent, the super-long 30-year bond yields hovered around 1.82 percent and the yield on the short-term 2-year remained flat at 0.11 percent by 09:00 GMT.

The survey also showed the public are bracing themselves for a Brexit hit on the economy over the next two years as painstaking negotiations over future relations play out. This comes ahead of a major stand-off between May’s Government and the House of Lords, which is demanding Parliament be guaranteed in law the final say on approving her Brexit deal and given the power to send her back to the negotiating table if it is rejected.

A greater proportion, 27 per cent, said May should try to renegotiate a deal, 14 percent said we should stay in the EU on new terms that May should try to negotiate and 15 percent said we should stay in on existing terms, a total of 56 percent who favoured options at odds with the Prime Minister’s plan to quit and trade on World Trade Organization (WTO) rules.

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.