• 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.

It all started with Federal Reserve Chair Janet Yellen insisting that all meetings are “live”. Recent Fed rhetoric also accentuated the newfound hawkishness, even for some known doves. This week saw Brainard, Williams and Bullard essentially touting the case for serious consideration for a move in March, notwithstanding the fiscal policy uncertainties and as US president Trump’s Congressional speech failed to enlighten us on his exact execution of grand economic plans.

While markets are still waiting for Yellen, Fischer et al to speak this weekend, the futures market has already at this juncture priced in 90 percent probability of the first hike coming in March. No point fighting the FOMC given that both labor market conditions and inflation data have been very resilient. This is clearly a case of the Fed fearing to be labeled being behind the curve, OCBC Bank reported in its latest research publication.

With the SGD NEER trading above parity currently, there is room to be caught wrong-footed by the broad dollar if Yellen cements a green light for the March Federal Open Market Committee FOMC. That said, things will likely get more exciting going into the upcoming FOMC meeting and subsequently.

“As such, we shift forward the first FOMC rate hike scenario to March, with the second hike likely to follow in 2Q17. Assuming that US president Trump delivers on his phenomenal tax plan and the infrastructure investment plan, the Fed may feel compelled to get a third hike in 2H17 as well,” the report commented.

Retail sales across the eurozone fell for a third straight month in January missing market expectations of a rise. Data released by Eurostat on Friday showed retail sales in the 19 countries sharing the euro fell by 0.1 percent m/m in January. Data disappointed market expectations of a 0.4 percent increase on the month.

Year-on-year, the volume of retail sales grew 1.2 percent in January, also below the 1.6 percent rise forecasted. Data suggested lower consumer appetite for spending possibly caused by higher consumer prices.

A 0.2 percent drop in purchases of non-food products was seen as the main drag on monthly retail sales reading. Sales of food, drinks and tobacco were also down 0.1 percent. Car fuel sale was an exception which rose by 0.8 percent in the month.

The unexpected drop in retail sales was in contrast to broader signs that the eurozone economy has strengthened over recent months. A survey of purchasing managers at manufacturers and service providers also released Friday pointed to a pickup in private sector activity, with the composite Purchasing Managers Index hit its highest level in 70 months.

The known unknowns of Donald Trump to keep BoC cautious today The BoC meet to set interest rates today. Little is expected at this meeting, with expectations higher for the April 12th meeting, where a new Monetary Policy Report will be released. So far the BoC has been trying to soften any market expectations of tighter policy – and in fact market pricing is quite restrained currently, just 10bp of tightening priced in over the next 12 months. While Friday’s release of 4Q16 GDP data will also add to the picture, our view is that the CAD remains vulnerable to various threats from south of the border, such as i) NAFTA renegotiation ii) the introduction of a border tax and iii) early Fed tightening. 1.3310/20 looks an important resistance level for $/CAD (already broken) and a close above it will add confidence to our 3m forecast of 1.40.

Cable could see range break-out Stronger US rates and a stronger dollar have pushed Cable down to recent lows at 1.2350. Further dollar strength, plus Brexit news could push Cable to 1.2250. Here the UK’s upper House of Lords could tonight win an amendment on the rights of EU nationals, sending the Brexit bill back to the lower house for further debate. This could delay plans for Article 50 being triggered March 9th .

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


h2>GBPUSD and Scottish Referandum, Trump and the FED

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

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

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

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

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

Mexican Central Bank, Inflation and Outlook

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

 

Ruble strength, fiscal rule and CBR

The gov’t/CBR comments that RUB strength is a temporarily fuelled RUB correction. We do see RUB weaker going forward, but generally in a modest/orderly way. There were several officials’ comments about RUB and CBR policy on Friday, which clearly explain some RUB correction. Specifically, CBR deputy Ksenia Yudayeva commented to Bloomberg with the following points:

 · The RUB is not significantly overvalued, its deviations from fair-value estimates are “within the limits of the norms”, and the hot money inflows are not the only factor driving RUB stronger, so the CBR doesn’t see any threat for financial stability from this and, so, there is no need to react.

  • · Not only the level, but excessive RUB volatility adversely affects competitiveness, which requires removing the dependence from oil in the FX rate, which will likely be achieved through inflation targeting and the MinFin FX buying under the “budget rule”.
  • · The focus stays on CPI/anchoring inflation expectations at the 4% target, which may require higher rates for longer, so the current 4%+ real rate may persist.
  • · MinFin FX buying and the disinflationary impact from the transitory factors of RUB and good harvest leave risks to reaching the 4% target, so the CBR remains concerned that the disinflation trend may slow soon.
  • · The lower and shorter recession in 2015-16 than was initially expected justifies the CBR’s cautious stance.

After these, MinEco Maxim Oreshkin also commented saying that the recent RUB strength looks temporary, seasonal and not related to fundamentals, so the RUB may see some moderate weakening followed by a stabilisation. All in all, the CBR comments look like a rather hawkish message also making clear that the CBR doesn’t see any need to react from their side to RUB strength. At this point, the probability of rate cuts in Mar-17 is clearly below 50%, but we think it may still change if CPI slows down as in previous weeks, and the RUB stays resiliently strong. As for the RUB outlook, we do share the view that the recent strength looked excessive, so it would be natural to see some retracement back to 59-60/USD levels all else being equal.