The New Zealand bonds remained weak at the time of closing Friday, tracking softness in the U.S. counterparts amid a quiet trading session that witnessed data of little economic significance. Also, investors will remain focused on the GlobalDairyTrade (GDT) price auction, scheduled to be held on March 21.

The yield on the benchmark 10-year bond, which moves inversely to its price rose 1 basis point to 3.29 percent at the time of closing, the yield on 7-year note jumped nearly 1-1/2 basis points to 2.86 percent while the yield on short-term 2-year note also dived 1 basis point higher at 2.13 percent.

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

New Zealand’s Dairy prices fell 6.3 percent in the latest GDT price auction, following a 3.2 percent decline a fortnight ago. Within this, powder prices performed poorly, with whole milk powder prices falling 12.4 percent to USD2,794/MT, and skim milk powder prices falling 15.5 percent. Meanwhile, AMF continues to be well-supported at high levels, edging down only 0.8 percent.

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

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

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

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

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

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

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

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

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

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

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

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

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

Key factors at play in crude oil market –

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

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

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

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

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

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

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

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

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

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

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

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

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

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 Australian bonds rebounded on the first trading day of the week as investors remain glued to watch the February employment report, scheduled to be released on March 15. Further, the 10-year bond yields have formed a ‘bullish gravestone doji’ pattern after two consecutive sessions of selling activity in the last week.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, plunged 3-1/2 basis points to 2.95 percent, the yield on 15-year note also dived 3-1/2 basis points to 3.34 percent and the yield on short-term 2-year traded 1-1/2 basis points lower at 1.91 percent by 04:40 GMT.

Australia’s unemployment rate unexpectedly fell in January, despite a plunge in full-time jobs, underscoring the mixed picture of the country’s labor market. The unemployment rate held below 6 percent partly due to discouraged job-seekers giving up the hunt, underscoring spare capacity in the labor 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

The German 10-year government bund yields climbed to 5-week high on the last trading day of the week ahead of the Eurogroup Summit scheduled to be held later in the day. Also, a hawkish stance by the European Central Bank (ECB) in its monetary policy meeting held yesterday, drove prices lower.

The yield on the benchmark 10-year bond, which moves inversely to its price, jumped 2-1/2 basis points to 0.44 percent, the long-term 30-year bond yields surged 3 basis points to 1.26 percent and the yield on short-term 2-year bond traded 2 basis points higher at -0.84 percent by 08:10 GMT.

The ECB kept all policy measures unchanged at today’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 the trade balance, due late today for detailed direction in the debt market.

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.

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.

China’s new yuan loans fell sharply in February from near-record levels in the previous month but were still higher than expected. Chinese banks extended 1.17 trillion yuan (about 169.2 billion U.S. dollars) of new yuan loans in February, down from 2.03 trillion yuan in the previous month, central bank data showed Thursday.

The People’s Bank of China (PBOC) has adopted a modest tightening bias in a bid to cool explosive growth in debt, though it is treading cautiously to avoid hurting economic growth. Analysts polled by Reuters had predicted new February yuan loans of 0.920 trillion yuan.

China’s new yuan loans remained relatively strong in February, led by long-term household loans and corporate lending. Household and corporate long-term loans, in combination, accounted for CNY982.2bn or 84% of overall monthly new yuan loans.

The M2, a broad measure of the money supply that covers cash in circulation and all deposits, grew 11.1 percent from a year earlier to about 158.29 trillion yuan. The M1, a narrow measure of the money supply which covers cash in circulation plus demand deposits, rose 21.4 percent year on year to 47.65 trillion yuan.

“We see little chance for monetary policy to return to easing. In addition, the PBoC should continue to re-shape the interest rate curve in the money market, with higher 7-day reverse repo rates and Medium-term Lending Facility (MLF) rates,” said ANZ in a report.

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.

Commodity markets are taking centrestageas oil had its largest one day fall (- 4.5%) in 13 months. Oil net long positions from the CFTC have been overextended since the start of the year, but it was the combination of technicals and ever more inventory builds in the US that gave investors the signal to take profit. Within G10, CAD has been, and should continue to be, more sensitive than NOK because leveraged market positioning is still very long CAD. CADJPY is sitting on its 100DMA, with a move below 84.20 marking a technical break. AUDUSD is about to break below its 100DMA at 0.75,helped by iron ore prices falling 9% from their peak, keeping us bearish on this pair. AUDUSD has bounced off the top end of a trend channel, bringing the bottom end of the channel at 0.7080 into focus. Even with expectations of a neutral Norges Bank next week (or essentially less dovish than last time), we stick with our tactical long USDNOK trade of the week.

Oil inventory data from the EIA showed a rise of 8.2mb to 528.4m, which is the highest in the data series going back to 1982. US producers appear to be ramping up production quickly, helped by stronger margins from high oil prices and relatively low funding costs. According to Reuters, producers in the red-hot Permian Basin in Texas are expected to increase production soon. An observation from our oil desk highlights the extent of the extreme technicals. They say that there hasn’t been a time in the last 30 years when the weekly front end Brent contract has been in such a tight range, trading sideways for three months. The longer that went on for, the more positioning stresses built up, explaining the sharp drop yesterday. The next formal OPEC meeting isn’tuntil May 25.

The DXY is still under performingtherisein positive US data surprises: Yesterday’s bumper ADP jobs estimate of growth of 298k in February beat market consensus of 187k. Our US economist has revised up his NFP expectation from 200k to 250k. Jobless claims hitting a series of record lows all year, combined with one of the warmest Februarys on record, has helped outdoor industries like construction do well. The market now prices a 100% probability of a hike in rates by the Fed next week, and so any USD strength needs to be driven by expectations of a faster pace of rate hikes in 2018.

JPY: Investors sensitive to US yields: Weekly security flow data for last week showed Japanese net selling of 1.13trn of foreign bonds. There will likely be some volatile data in the run-up to fiscal year-end (March 31) but we think there should be more focus put onto country reallocations for Japanese investors, with a potential to shift into higher-yielding assets. Yesterday the Nikkei reported that the Japanese Financial Services Agency will start to audit regional banks who have large exposures in foreign debt. In particular, concerns have been raised about losses made on US Treasuries. The benefits of USD rising versus JPY as US Treasuries sell off are not there if the bank is holding the foreign asset with an FX hedge. This story needs to be watched to see if changing governance may push Japanese banking sector investments locally instead of abroad. Thinking about that flow, it may actually still be bearish for JPY if it puts downward pressure on JGB yields or increases local lending. If the BoJ’s central bank liquidity turns into ‘high-powered liquidity’ as the banks lend more to businesses, this would help local inflation and thus weaken JPY. Selling EURGBP over the ECB: Today’s market focus will be on the ECB press conference and specifically how much more confident Draghi is about the recovery in inflation. Should the market, against our economist’s expectations, perceive today to be a hawkish outcome, then we think that EUR will trade in two stages. Initially EUR should rally as bond yields rise (with our limit being at 1.08). However, the bond yield rise may be disproportionate across the region, causing spreads to widen. The spread widening is not a good sign for the monetary union as it will highlight further the divergence in economic data performance. EUR should fall as markets realise this and EUR becomes inversely correlated with peripheral spreads. On the UK side, Nicola Sturgeon has suggested to the BBC that a second independence referendum in autumn 2018 would make sense but still stresses thatno final decision has been made. This story adds to our bullish GBP view since it may bring Theresa May’s approach to the Brexit negotiations away from the ‘hard Brexit’ and towards the middle to accommodate Scottish views. We think that Brexit risks are largely in the price and still like selling EURGBP, with a stop at 0.88.

As a harbinger of what may be in store in Friday’s US jobs report, surprisingly strong ADP data pushed bond yields higher yesterday. The 10yr UST yield topped 2.56% as markets assess the Fed’s potential hiking pace for the year. The discounted odds for a hike at the March meeting have risen to 90%. By the end of the year the effective fed funds rate is now seen some 65bp above the current average, which can be interpreted as a c. 60% probability for a third hike this year being discounted.
10yr Bund yields were dragged higher alongside to 0.37% with Bund ASWs largely reversing Tuesday’s widening. EGB spreads versus Bunds saw only moderate widening pressure with 10yr OAT/Bund widening just 1bp yesterday, while only slightly underperforming OLOs. With a new Harris poll showing Macron overtaking Le Pen in the first round, OATS may receive some tailwind today.
ECB meeting. Today’s focus will be squarely on the ECB, but we do not expect any changes to policy or communication against the backdrop of increased political risks. Rather we believe that the ECB will want to reinsure markets with more dovish tones. Nonetheless, the money market curve re-steepened yesterday, dragged higher with the overall rates market. The June 2018 ECB dated EONIA forward is up at -0.24bp again, some 11bp above current average EONIA fixing. We doubt whether the ECB will alter its forward guidance already at today’s meeting, although a risk remains that larger revisions of the staff forecasts might outweigh an unchanged guidance. Our economists believe smaller upticks to the headline inflation projection on the basis of adjusted underlying assumptions regarding oil prices and/or the exchange rate might be possible. However the core inflation profile should be more important, and here the ECB is more likely to reiterate that there is little evidence of self-sustainable inflation yet. Accordingly, we do not expect any discussion regarding a tapering to have occurred at this point.
EGB supply. Only Ireland will be active today reopening the IRISHs 5/26 and 2/45 for a combined €1-1.25bn. Italy announced a new 7yr BTP 5/24 (€3-3.5bn) for auction on 13 March. Alongside the Tesoro will also reopen the BTP 10/19 (€2.25-2.75bn) as well as the BTPs 9/33 and 9/46 (combined €2-2.75bn).

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

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

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

Prime Minister Theresa May’s Brexit bill suffered a second defeat at the House of Lords after the lawmakers rejected last week an amendment with regard to the rights of the people of the European Union who are staying in the United Kingdom. Yesterday, by an overwhelming majority, 366 to 268, the lawmakers voted in favor of an amendment which gives the parliamentarians in the United Kingdom, the final say over the Brexit deal, which is expected to be reached over next two years after the Article 50 is triggered before March 31st this year.

The amendment was introduced by the Labor Party of the UK but the government had argued that it would be a threat to national interest. However, that didn’t prevent the amendment from securing a bipartisan victory. While Ms. May had verbally promised a vote to the parliament in her Brexit speech, the amendment binds her to make good on that promise.

The Brexit bill will now return to the House of Commons with the amendment forcing May to have a vote on her Brexit deal and another guaranteeing the rights of EU citizens. The government is working hard to pass the bill and trigger the Article 50 divorce clause by March 31st or the exit would become more difficult after that date. From April 1st, a country looking to exit the EU would need the support of 14 members of the 27 members group.

The Japanese government bonds skid Thursday on the back of falling U.S. Treasuries, after comments by the Federal Reserve Chair Janet Yellen raised chances of an interest rate hike at the monetary policy meeting scheduled to be held on March 14-15. Also, weak investor demand at the 5-year auction held Wednesday weighed on bond prices, pushing the yields to multi-month highs.

The benchmark 10-year bond yield, which moves inversely to its price, rose 1-1/2 basis points to 0.09 percent, while the long-term 30-year bond yields hovered around 0.86 percent while the yield on the short-term 2-year note jumped 2-1/2 basis points to -0.26 percent by 06:30 GMT.

Recent comments from the Federal Reserve Chair Janet Yellen, specifying that a March rate hike is definitely on the cards, if the economy holds momentum, added to the rise in market expectations and investors have quite already priced in for a rate hike this month. This further, led to a surge in bond yields, pushing prices to record lows.

The auction attracted weak investor demand as the five-year bonds remained expensive. Further, the bid-to-cover ratio, a gauge of demand, at Thursday’s JPY2.4 trillion (USD20.97 billion) 5-year auction slipped to 2.86 from 4.26 at the previous sale in February.

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

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

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

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

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

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

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

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

This may seem a little surreal. US treasury secretary under the Trump administration, Wilber Ross is talking of steps to stabilize the US dollar/ Mexican peso exchange rate. Speaking on CNBC today, Mr. Ross suggested that the US administration would think of ways to work with their Mexican counterparts to stabilize the exchange rate. The dollar/peso exchange rate has been very volatile since the Republican candidate Donald Trump got elected as the president of the United States. Mr. Trump had been severely critical of Mexico during his election campaign and the US border with its neighbor. Mr. Trump has vowed to renegotiate the North Atlantic Free Trade Agreement (NAFTA), calling it a disaster for the United States. Mr. Trump has vowed that he will make Mexico pay for his proposed border wall.

While Mr. Ross said that the administration needs to think of mechanisms for a stable exchange rate, the Mexican central bank governor said that the country is not considering a swap line from the US Federal Reserve.

Peso is enjoying the biggest single-day gain since January as the news surfaced. The Mexican peso is currently trading at 19.56 per dollar, up 2.4 percent so far today.

Speaking with the BBC, before her speech to the Scottish conservative conference, the UK Prime Minister Theresa May has blasted the Scottish National Party (SNP) for their singular vision of independence. In recent days, the Scottish first minister Nicola Sturgeon has added pressure on the UK government to adopt some of her party’s recommendation in the upcoming Brexit negotiations, which includes access to the European Union single market for Scotland. She has threatened to call for another independence referendum. Last time in 2014, Scottish people rejected separation from the United Kingdom with 55-45 margin. Ms. Sturgeon has argued that then the Scottish people, who overwhelmingly voted in favor of staying in the European Union, were promised single market access.

The Prime Minister said that she is looking very closely to the proposals presented by the Scottish National Party (SNP) though Ms. Sturgeon has accused Ms. May’s government hasn’t paid the attention required. She said to the SNP and Ms. Sturgeon that politics is not a game and keeping Scotland in the UK is a personal priority for her. However, she felt short of saying whether she would grant another referendum or not.

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 Australian bonds gained modestly at the start of the trading week Monday ahead of the Reserve Bank of Australia’s (RBA) monetary policy decision, scheduled to be held on March 7. However, investors have largely shrugged off the upbeat reading of the country’s retail sales during the month of January.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, slipped nearly 1 basis point to 2.81 percent, the yield on 15-year note also fell nearly 1-1/2 basis points to 3.23 percent while the yield on short-term 2-year traded nearly 1/2 basis point lower at 1.84 percent by 03:50 GMT.

Australia’s nominal retail sales rose by 0.4 percent m/m in January, in line with market expectations and a recovery from soft results in November and December. In annual terms, retail sales were up 3.1 percent y/y in January.

However, in trend terms, retail sales slowed to 0.2 percent m/m in January (from 0.3 percent m/m in both November and December) but remained steady at 3.2 percent y/y.

“There is little sign of this dynamic changing anytime soon, in our view. Thus, while we think the RBA is most likely on hold we see the prospects of a rate cut in the next 12 months as much greater than those of a rate hike,” ANZ Research commented in its latest research report.

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 .

The bearish flattening seen in the US yield curve and the move in two year USD swap rates to new highs has pushed US-Germany two year spreads towards levels not seen since the late 1990s. It is surprising that EUR/USD is not a lot lower. Severe under-valuation is probably playing a role here, as is the fact that Trump has Germany’s large trade surplus in his sights. For today, we’ll see German Feb CPI, seen rising to 2.1% YoY from 1.9% – providing clues on EZ CPI tomorrow. On balance, Trump’s plans, yield spreads & EZ politics suggests EUR/USD stays pressured and 1.0500/0520 comes under heavy pressure again.

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.

With January meeting gone, there are eight more Fed meetings scheduled ahead for this year and according to the December projection, the Fed is expected to hike rates by 25 basis points in three of them. Let’s look at the market pricing of the hikes,

March 15th meeting: Market is attaching 73 percent probability that rates will remain at 0.5-0.75 percent, and 27 percent probability that rates will be at 0.75-1.00 percent
May 3rd meeting: Market is attaching 48 percent probability that rates will remain at 0.5-0.75 percent, 43 percent probability that rates will be at 0.75-1.00 percent, and 9 percent probability that rates will be at 1.00-1.25 percent.
June 14th Meeting: Market is attaching 30 percent probability that rates will remain at 0.50-0.75 percent, 45 percent probability that rates will be at 0.75-1.00 percent, 22 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 25 percent probability that rates will remain at 0.50-0.75 percent, 42 percent probability that rates will be at 0.75-1.00 percent, 25 percent probability that rates will be at 1.00-1.25 percent, 7 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 17 percent probability that rates will remain at 0.50-0.75 percent, 37 percent probability that rates will be at 0.75-1.00 percent, 31 percent probability that rates will be at 1.00-1.25 percent, 12 percent probability that rates will be at 1.25-1.50 percent, 2.5 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 15 percent probability that rates will remain at 0.50-0.75 percent, 34 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, 15 percent probability that rates will be at 1.25-1.50 percent, 3.5 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.
December 13th meeting: Market is attaching 6 percent probability that rates will remain at 0.50-0.75 percent, 23 percent probability that rates will be at 0.75-1.00 percent, 33 percent probability that rates will be at 1.00-1.25 percent, 24 percent probability that rates will be at 1.25-1.50 percent, 10 percent probability that rates will be at 1.50-1.75 percent, 3 percent probability that rates will be at 1.75-2.00 percent, and 1 percent probability that rates will be at 2.00-2.25 percent.

Most notable hawk in the European Central Bank’s (ECB) governing council and the chief of German central bank Jens Weidmann maintained his sharp criticism of the ECB’s monetary policy as usual; however, he was ready to provide the assurance that the central bank would not end the quantitative easing program all of a sudden. In December last year, the European Central Bank (ECB) unveiled a fresh new package of stimulus which includes buying of debt below the ECB deposit rate which is currently at -0.4 percent, and additional bond purchases of €540 billion until December this year.

However, the recent sharp rise in both actual inflation and inflation expectations has led to the speculation that the ECB might end its stimulus by rolling back on its December commitments. Many in the market feared that such a move could disrupt the bond markets in the Eurozone and could lead to sharp rise in the interest rates. While Mr. Weidmann’s comments would ease some of those concerns, it is quite clear that the ECB is unlikely to dive further into easing and the very next action would be in the opposite but the question that remains is – how fast?

The FED and USD, European Bonds

Whether markets were on an “unmotivated sugar high” (as Larry Summers put it) or were in some fiscal honeymoon period, there is no doubt that reflation trades are now crying out “Show me the money!” And just like in the iconic scene from Jerry Maguire, investors will need more than just a faint whisper from President Trump at his speech to Congress this week (Tue 9pm ET) to be convinced that fiscal promises (and the money) will be delivered. The best case scenario is that a detailed tax plan is unveiled, although we’re not holding our breath – especially after Treasury Secretary Mnuchin said that the President will only be “touching” on tax policy in his Congress Speech. This is unlikely to inspire much $ upside.

On the flip side, we’ve got what could be a hawkish Fed story unfolding; all eyes will be on the PCE inflation data (Wed), which should show the Fed’s preferred inflation measure at the 2% target. This will undoubtedly get Fed hawks excited over the prospects of a March rate hike and with Chair Yellen speaking (Fri), we think there are upside risks to short-term US rates. The $ faces a balancing act between a vague Trump and hawkish Fed, though we remain modestly upbeat.

It’s clear that investors are becoming more unnerved by the upcoming European elections season, with signs of risk aversion creeping into EZ bond markets and greater EUR downside protection being bought in FX markets. But what should we be on the lookout for? Well, the French presidential race is grabbing most of headlines given the less than trivial risks of a ‘shock’ Le Pen win; the next major event here won’t however be until the first televised debate on 20 Mar. Ahead of this, we’ll have the Dutch elections (15 Mar) – which is incidentally also the same day as the March FOMC meeting. This could prove to be a tricky period for EUR, with political risk compounding any widening of US-EZ rates at the short-end of the curve. We look for a combination these factors to drive EUR/$ down to 1.02.

Commodities, Oil Rig Count, Copper Mine Strike

WTI speculative positioning: It has been another week where speculators have increased their net long in WTI. Over the reporting week, speculators increased their position by 23,299 lots, to leave them with a net long of 413,637 lots. This is yet another fresh record net long held by speculators. This large net long continues to see positioning risk grow.

US oil rig count: Over the week, the US oil rig count passed 600 for the first time since early October 2015. The rig count has increased by 77 since the start of 2017 and by an impressive 286 since the lows of late May 2016. At current prices, we would expect the rig count to continue trending higher.

Escondida copper mine strike: According to Bloomberg, striking workers at the Escondida copper mine will be able to hold out for more than two months. The main trade union for mine workers says that they have a contingency fund to cover strike costs, while they have also secured further funding from a credit union if needed.

Brazilian aluminium import quota: The Brazilian government has lowered the quota for duty-free primary aluminium imports. The government has reduced the quota from 240,000 tonnes to 173,000 tonnes. Reports suggest the quota was reduced as a result of poor domestic demand.

Wheat spec positioning: Over the last reporting week, specs reduced their net short in CBOT wheat by 12,662 lots, to leave them with a net short of 27,385 lots. This is the smallest net short position that specs have held since November 2015. 

EU sugar exports: The European Commission is set to vote this week on whether the second tranche of out-of-quota sugar exports is to be approved. Given a tight EU balance, the EC has held off from allowing these exports. Export licences are usually awarded in January.


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.

 

Commodities, US Oil rig count, Copper strikes

US rig count: Baker Hughes data shows that the US oil rig count increased by 6 over the week, taking the total number of active rigs to 597. Since the start of the year, the number of rigs has increased by 72, while from the lows in May 2016 the number has increased by 281. 

WTI speculative position: Over the last reporting week, speculators increased their net long position in WTI by 30,951 lots to leave them with a record net long of 390,338 lots. This sizeable position does continue to pose a risk to the market, although with the right catalyst. 

Escondida strike: Having failed to meet last week, BHP and unions at Escondida copper mine are scheduled to meet today, in the hope of moving closer towards an agreement. Workers at the copper mine have been on strike since the 9th February, which has continued to offer support to the copper market. 

Philippine mine closures: There is still plenty of uncertainty around the closure and suspension of mines in the Philippines. The president will now be reviewing the environmental secretary’s decision, while miners continue to fight the order. The Philippines in the largest nickel supplier in the world. 

Indian sugar production: Cumulative sugar production in India since the beginning of the season to mid-February totalled 14.7m tonnes according to Indian Sugar Mills Association. This is a 15% decrease YoY, and with a number of mills already shut for the season, production will be significantly lower YoY. We continue to believe that India will need to import around 2m tonnes of sugar for domestic needs this year. 

Corn spec position: Speculators continue to build their long position in the corn market, with their net long increasing by 56,527 lots to leave them with a net long of 85,360 lots. This is the longest speculators have been since July 2016, and expectations of reduced US acreage next season has been positive for sentiment. However this is some distance off still, and with good crops expected from South America this season, we would expect the upside in corn to be limited. 

Italy: Risk of imminent snap elections reduced

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

FX Update- European Politics and the UK

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

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

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

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

Monthly Global EM Outlook, Trump Policies and Inflation

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

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

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

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

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

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

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

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

 

Daily FX Outlook, USD, EUR, GBP and HUF

USD: Yellen testimony provides asymmetric risks into USD favour The key event of the day is Chair Yellen’s semi-annual testimony to the Senate. With the market pricing rather a benign probability of March rate hike (30-35%), risks are asymmetric into USD favour. If the status quo is retained and no hints at higher probability of March rate hike are presented, USD downside should limited. On the other hand, if Yellen chooses to look to nudge expectations up to 50:50 to keep the option of a March hike on the table, the upside to USD should be more pronounced due in part to the less overcrowded USD positioning. See Will Yellen keep March alive? DXY 100.08 support (100-day MA) to hold, while the break of the 101.44 resistance (50-day MA) at risk.

EUR: Limited impact of EZ data on EUR; Yellen a bigger driver Our economists expect Eurozone industrial production to have come down substantially in December, given weak German numbers (due to the cold Christmas weather related issues). While not EUR positive, its effect on the currency should be rather marginal. EUR/USD to be largely driven by the Yellen testimony, which poses downside risks to the cross (towards the 1.0500 level).

GBP: Sterling gains from higher UK CPI to be short-lived UK Jan Inflation looks set to hit 2%YoY today (vs 1.9% consensus) as the effect of sterling’s post-Brexit collapse continues to feed through to prices. This is particularly evident in food and fuel prices, which are being lifted by surging input price inflation. While this may provide short-term support to GBP today (to the extent to which it translates into market expectations of higher probability of BoE rate hike – following the change in the BoE bias from dovish to neutral and the introduction of the two-way risk to policy rates), we would fade any move in EUR/GBP lower / GBP/USD higher as the UK activity data later this week (softer employment report and retail sales) should weigh on GBP.

HUF: High Hungarian CPI to create false hopes for tighter monetary policy Our economists look for a meaningfully above consensus Jan CPI (2.5% YoY vs 2.1%). Not only will base effects from higher oil prices kick in significantly, but the market is likely overestimating the degree to which the recent VAT tax cuts weigh on prices (as pass through is unlikely to be 100% and usually takes three months to feed in). We expect the higher CPI to be HUF positive due to false market hopes that high inflation will cause the NBH to move closer to policy normalisation/tightening. As per yesterday’s NBH’s FX swap tender (ie, an example of an ongoing unconventional easing), we don’t think this will be the case and the NBH will retain a dovish bias in coming months. EUR/HUF to break below 308.00 level today and PLN/HUF to converge towards the 71.00 level.

Global FX Stories, USD, EUR, JPY and PLN

USD: Focus turns back to the domestic drivers The lack of focus on the currency manipulation rhetoric’s during the Trump-Abe meeting on Friday (note JPY was one of the currencies mentioned recently by the US administration as being unfairly kept weak) should allow USD to re-focus back on its domestic drivers. Bar the expectations of the details about the ‘phenomenal’ Trump tax plan, markets will be closely watching Chair Yellen’s testimony to the House (Tue) and Jan CPI and Jan retail sales (both Wed). With market pricing rather benign 30% probability of Fed March rate hike and much cleaner long speculative USD positioning, the bar is not very high for USD to record more gains this week, particularity vs low yielders such as EUR and JPY.

EUR: EUR/USD to move towards the 1.0500 level Very calm week on the EZ data front suggests that EUR crosses will be driven (a) news/data from elsewhere (b) potential additional increase EZ political risk. On the latter, EZ political risk premium pricing in EUR remains still very benign, allowing for more downside to EUR. We look for EUR/USD to move towards the 1.0500 level this week.

JPY: Scope for USD/JPY to resume its upside Japan Q4 GDP modestly disappointed the consensus expectations (0.2%QoQ vs 0.3% expected). Yet with the little scope for material shift in the BoJ policy stance in coming months, the driver of USD/JPY remains the USD side of the equation. Following the non-negligible adjustment in USD/JPY lower since the beginning of the year, the potential for higher UST yields and cleaner USD/JPY speculative positioning (ie, the speculative community is currently net short USD/JPY) point to USD/JPY re-testing the 115.00 level this week.

PLN: Boost from Jan CPI to provide a good entry point to short PLN Our economist look for an above censuses Polish Jan CPI (1.8%yoY vs 1.7%). While this may provide a boost to PLN, the zloty gains are likely to be short lived given the already stretched EUR/PLN levels. Equally, we don’t expect the Friday’s PiS leader Kaczynski’s confirmation on a dilution of CHF bill (see Snap) to lead to persistent PLN gains due to: (a) with PLN no longer pricing a domestic political risk premium (on short term basis), the Friday’s good news should not lead to material re-pricing of PLN risk premium; (b) the EZ politics and negative spill over into CEE FX should kick in as we approach Dutch and French elections. We retain negative PLN view and stay long EUR/PLN.