We expect the CBT to end the tightening cycle and remain on hold this month with inflation peaking, relief in domestic political concerns and the conducive external backdrop. Equally, the bank is likely to refrain from early easing. This should be TRY supportive as the lira retains its very high risk adjusted carry. TURKGBs look attractive from a carry perspective, but one should not expect a YTD-like strong performance as the CBT is at no hurry to cut rates.

• The CBT is to keep the current tight liquidity stance for a while, until the recovery in the inflation outlook becomes apparent.
• Ongoing geopolitical issues (which could create pressure in market prices) as well as still elevated inflation levels will likely force the CBT to be cautious and refrain from early easing.
• We think any easing would be via gradual increase in TRY liquidity, while the policy rate, the upper/lower bounds of the interest corridor and late liquidity window rate will likely remain unchanged until the year end.

FX: In the current carry-friendly environment, TRY continues to stand out for numerous reasons: (a) the CBT regaining inflation-targeting credibility by keeping interest rates high despite CPI likely reaching its peak and the appreciating TRY; (b) TRY offers extremely attractive risk adjusted carry compared to its high yielding EM peers (Fig 5) due to the CBT’s tight liquidity stance and high average funding costs; (c) the still very attractive medium-term valuation, with USD/TRY currently being overvalued by c.24%. The expected CBT decision on Thursday to keep interest rates unchanged and leave the current liquidity stance tight (now and for a foreseeable future) should underpin the lira’s attractiveness. In the relative value space, TRY seems to be the most attractive among the CEEMEA higher yields as RUB decoupled from the oil price and seems too rich while ZAR’s highly unpredictable domestic politics warrants a larger risk premium and caution vs TRY. We expect USD/TRY to break through the 3.5000 level, though the bulk of future returns from long lira positions should come from the carry factor, rather than spot appreciation.

Domestic Debt and Rates: Following a c.150bp rally in long-end bond yields from the peak observed at the beginning of this year, we do not expect further strong performance. The 10-year TURKGB yield should not meaningfully break below the 10% level given the tight CBT policy stance and what we see as a low probability of rate cuts in coming months. Yet, given its high nominal yield and the likely increase in real yields once Turkish CPI starts moving lower more meaningfully (by the end of this year or the beginning of the next – Fig 6), TURKGBs look attractive from a carry perspective. Long dated bond yields should hover around current levels in coming weeks. For USD-TRY cross currency swap rates, we also expect limited room for a decline from here, given the tight CBT liquidity stance and expected only modest TRY spot appreciation.

In the June MPC meeting on 15 June, we expect the Central Bank of Turkey (CBT) to remain mute and keep all relevant rates unchanged. Since the beginning of this year, the CBT has increasingly used unorthodox policy tools and in the last two meetings, the bank was more hawkish than expected with more-than-expected hikes on the late liquidity window rate. The bank has pulled the effective cost of funding significantly up, by c.370bp since end-2016, to close to 12.0%. During the tightening process, the late liquidity window (LLW) rate, a facility to cover emergency needs of the banks, has been aggressively utilized, while the bank has also introduced a new tool by opening an FX-deposits-against-TRY-deposits market, a swap facility with 1-week maturity. Utilisation of the tool has reduced volatility in excess TRY liquidity in offshore markets and helped achieve stabilisation in the TRY. This month, we do not expect a further tightening move, given that inflation has already peaked in April.
Following significant deterioration in recent months with the lagged spillovers of TRY depreciation and volatility in food prices, inflation showed modest improvement in May from its high levels in April (the highest since the GFC). Core inflation (excluding all food & beverages, energy, alcoholic drinks & tobacco, gold) recorded a 1.33% change, below the average of May changes. This is another sign of weakening following a moderation in the strong upward pressure last month. As a result, annual inflation in this indicator inched down to 9.38% from 9.42% a month ago. However, core figures stay elevated, despite the fading FX pass-through. We thus think the bank has likely reached the end of the tightening cycle and won’t embark on further tightening unless the currently supportive global backdrop changes significantly. Recent TRY strength (due in part to the supportive global backdrop and improving political climate after the referendum) works to the CBT’s advantage, with increasing downside risks to the inflation outlook.
On the flipside, the bank should refrain from early easing and keep its current tight liquidity stance in place for a while, until the recovery in the inflation outlook becomes apparent. Economic activity continues to strengthen, thanks to fiscal easing, given stimulus measures such as VAT cuts in some consumer durables and social security premium cuts and significant lending acceleration. Credit growth (13-week MA, FXadjusted and annualised) has converged to 25% on the back of contributions from the Guarantee Fund. Recently released indicators hint at some further acceleration in 2Q17 economic activity, with higher PMI in tandem with rising CUR.

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.

Slower growth and weakening revenue have weighed on fiscal performance. The weak growth outlook also forced the government to increase nominal spending, with a consequent jump in the annual deficit to its highest since the beginning of 2010. The government measures are to expire by year-end, with likely improvement in budget metrics next year, though currently increasing the Treasury’s borrowing requirement.

According to the Ministry of Finance, the budget deficit will be c.TRY61.1bn at end- 2017 (translating into 2% of GDP, vs 1.9% already as of April, on a 12M rolling basis), implying that stimulus measures like VAT cuts on certain consumer durables, deferral of social security premiums for new hirings, etc, will not be extended. Given that most of these measures are temporary in nature, we are likely to see an improvement in fiscal performance next year, while early elections, ruled out by the government so far, remains a key risk. The debt-to-GDP ratio, on the other hand, is envisaged at c.30%, still comparing favourably with other emerging markets.

TurkStat is due to release 1Q17 GDP data next week. We expect a continuation of the recovery that started in the last quarter of 2016. 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.
Following the significant deterioration in recent months, with the lagged spill-overs from TRY depreciation and volatility in food prices, inflation showed a modest improvement in May, from the peak realised in April. However, we think that May inflation will not make any significant impact on CBT behaviour. The central bank is likely to refrain from early easing and keep the current tight liquidity stance for a while, until recovery in the inflation outlook becomes apparent. Apart from the CBT’s liquidity tightness, the continued supportive global environment and a REER close to the lowest level realised since the 2001 financial crisis are likely to support TRY in the near term. Significant external financing needs are likely to remain a source of weakness in the longer term.

Elevated inflation and the CBT’s consequent policy tightening have kept the yield curve inverted in recent months, while an improving domestic climate after the referendum has accelerated debt inflows since mid-April, though foreign ownership of domestic debt remained low. Following a c.150bp rally in the long end from the peaks realised at the beginning of this year, we do not expect further strong performance.

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 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.

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

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

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

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

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

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

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

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

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

The 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).

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.

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.

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.

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.

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.

European Bonds and Credit

It was quite a rollercoaster ride in Eurozone government bonds yesterday, mainly in semi core EGBs, which was in part related to thinner-than-usual liquidty due to closed US markets. Although opening tighter, semi-core EGBs soon started to underperform Bunds, and after the news that Ms Le Pen had gained some ground on her main election rivals sparked strong selling in the 3-5yr OATs, 10yr OAT/Bund spreads suddenly leapt 4-5bp to exceed 82bp for the first time since August 2012. In this context, the 2yr Schatz yield plunged to a new all time low of -0.85%, helping to push Schatz ASW to 70bp. Meanwhile, the 10yr OAT/OLO spread – one of our favourite measures of the French politcal risk premium – even briefly touched the 30bp level. Later in the afternoon – when French Finance Minister Michel Sapin warned that betting against France would be costly – OAT/OLO spreads re-tightened, although the 3-5yr area struggled to reverse the heavy underperformance  Based on recent performance trends versus Austria and Finland, DSLs still hardly suffer from any political risk discount, even though they trade cheap versus Bunds by historical standards. Against this backdrop, we find 3-5yr BNG and NEDWBK trading at very attractive spreads versus KfW. 10s30s struggled to flatten yesterday, despite the broader risk-off mood, especially after the EFSF announced the intention to launch new 4yr and 39yr lines. When the ESM launched a new 40yr bond back in 2015, the extension in ASW from the existing 30yr line amounted to around 20bp. Applying this to where the EFSF 2047’s are currently trading we would arrive at around MS +68 for the new EFSF 2056 as an indicative pricing. Adding a NIP of abound 10bp (which is slightly more than the one seen in the recent ESM 11/46 deal) to the current 9bp curve extension from the ESM 45’s into the 55’s yields a roughly similar result. Elsewhere, ECB data revealed that PSPP purchases accelerated slightly last week, to €17.2bn from €16.9bn the week before. However, total APP purchases slipped to below €20bn due to slower covered bond purchases. Even so, the ECB remains well on track for another €85bn of asset purchases for this month.


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. 

Monthly Global EM Outlook, Trump Policies and Inflation

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

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

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

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

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

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

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

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


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

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

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

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

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

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.

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

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

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

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

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

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

USD Strength trying to recover, ECB committed to low real rates, Japan bond buying and AUD outlook

Conditions for the USD rally have improved with three events becoming topical. First, ECB’s Praet and the BoE have made it clear that Europe is not aiming for early rate hikes and are comfortable with seeing real rates dropping further from here. Secondly, Japan’s money market operations have underlined its commitment to control the JGB yield curve, which we view as a step towards Japan’s commercial banking sector regaining profitability and thus creating conditions for a faster money multiplier growth. Within an environment of DM reflation, the side effect of this policy is JPY weakness working via widening rate and yield differentials. Thirdly, China tightened its monetary policy by 10bps overnight, reported slower January manufacturing activity, but fixed the RMB weaker compared to market expectations. USDCNY came off a moderate 0.2% while USDCNH rallied this morning by 0.24%.

 The next hurdle for the USD to overcome is the Fed. Wednesday’s interest rate statement left the impression it may be operating behind the curve by acknowledging that inflation ‘will’ reach 2%, but refusing to send a signal to turn March into a ‘live meeting’. Today’s release of the US labour market report is only important in respect of impacting the FOMC’s mind set. Concretely, a strong labour market report helping the Fed by sending hawkish signals will be USD supportive. However, should the Fed stay dovish then a strong US labour market report may only steepen the US curve, but do little to support the USD. Fed chairwoman Janet Yellen’s testimony on 14 February will be a key risk event. In between, today the Fed’s voter Evans will speak on the economy and monetary policy.

The BoE has upped its growth forecast, has kept its inflation forecast little changed and has maintained its neutral policy bias leading to sharp GBP losses. The BoE left the impression of possibly underestimating inflation risks and by doing so it may be able to run accommodative monetary conditions for longer. While the National Institute of Economic Research sees inflation reaching 4% by the end of this year, the BoE has found additional labour market slack allowing it to project wage growth staying muted. The BoE sees inflation averaging 2.7% this year and 2.6% in 2018, little changed from its November projections. Its long-term economic projections are based on the assumption of rates rising early 2019, differing significantly from current market pricing, and suggesting rates going up by 25bp by August 2018.

ECB’s Praet as presented an equally dovish message suggesting that the recent upward trend in inflation was due to temporary factors including energy and food prices and the ECB would continue to “look through” factors contributing to the underlying trend.” With the Maastricht contract framework becoming less effective and EMU remaining fragmented in fiscal and regulatory terms (lack of fiscal and banking union) the ECB has to conduct policy according to the needs of its weakest link (see here for more). Italy seems to fall into this category. EMU’s equity markets and volatility curves have steepened recently. While some of this steepening may be related to upcoming general elections in Holland and France, the recent widening of EMU sovereign bonds spreads has added to concerns. EURUSD is a sell at current levels with a stop at 1.0840 and a target 0.9700. The risk to this trade is Italian data turning better, but given the continued weak credit creation by Italian banks we regard this risk as minor.

Some investors link bullish AUD strategy into a global reflation framework. Associating reflation with rising commodity prices may provide support to this idea. However, reflation and commodity prices are unlikely to stay linked for long should our view prove correct that part of DM is developing into a cost push inflation environment comparable to the 70s. The 70s did see precious metal strength while other raw materials stayed lacklustre. Opposite, the deflationary past 15 years were accompanied by periods of excessive raw material strength. So far, the CRB Rind has kept on rising, but with China tightening its policies while its manufacturing sector is weakening (Jan Caixin PMI eases to 51.0 from 51.9) it may not take too long from here to see commodity prices topping out.

FX Positioning for the week of January 23rd

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

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

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

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

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

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

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

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

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

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

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

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

South Africa news flow and changes to the CPI Index

First, the National Treasury will today at noon London time publish National Government budget data for December. We expect that the budget recorded a seasonal surplus in the month, of ZAR20bn. If this proves correct, then the annualized consolidated budget deficit would widen to an estimated 3.8% of GDP from 3.5% recorded in November, according to our estimates.

Second, the Reserve Bank will tomorrow at 6:00am London time publish monetary aggregate data for December. Domestic private sector credit growth likely stayed low, near a nominal 5% yoy, according to our estimates.

Third, the South African Revenue Service will tomorrow at noon London time publish external merchandise trade data for December. We expect that the trade account recorded a seasonal surplus in the month, of ZAR10bn. If this proves correct, then the annualized trade surplus would improve to an estimated 0.5% of GDP from 0.4% recorded in November, according to our estimates.

Fourth, the National Automobile Association (NAAMSA) of South Africa will on Wednesday (1 February) publish new vehicle unit sales data for January. In December 2015, sales (non-seasonally adjusted) were down 10% mom and down 15% yoy. For calendar 2016, unit sales were 11% lower than in 2015.

Fifth, the Bureau for Economic Research (BER) will on Wednesday at 9:00am London time publish its PMI for January. The index remained below 50 for five consecutive months to December 2016.

Sixth, Statistics South Africa will on Thursday (2 February) at 11:00am London time publish electricity production data for the month of December. In November production volumes (in seasonally adjusted terms) were down 0.4% mom, following growth of 1.5% in October. The sector looks likely to have been a positive contributor to GDP growth in the 4Q 2016, according to our estimates. On Friday (27 January) Statistics South Africa published new weights for the consumer price index. We think that there may be some good news for inflation in 2017 given the changes.

First, the ‘Food & NAB’ category increased to 17.24% from 15.41%. If we are correct in our expectation of a decline in domestic agricultural prices this year, then the deflation impact on headline CPI inflation could be more pronounced. Second, the ‘Transport’ category declined to 14.28% from 16.43%. Similarly, if our expectation of a weaker ZAR and higher oil prices proves correct, then the inflation impact on headline CPI could be less severe.

USD, Trump executive orders and NFP, GBP and Article 50, JPY Bond Buying 

USD: Trump’s executive orders a distraction from positive macro $ story The dollar is slightly softer in holiday-thinned Asia, with investors demanding a small concession for Trump’s seemingly erratic Executive Orders. The focus here is on the start of Trump’s extreme vetting of immigrants announced Friday, orders which have already been partially reversed by the US courts. That said, we would expect the focus to shift back to the US macro story this week, which looks a dollar positive. As outlined in our team’s FOMC Crib Sheet, we see the Fed potentially sounding less relaxed on inflation at Wednesday’s FOMC meeting. We think at 33% the probability of a March Fed rate hike is priced too low and that the dollar could rally 1-2% against the low yielders on a more hawkish statement. Additionally, the US labour market report (Fri) should show solid Jan average hourly earnings (2.6% YoY) and above consensus NFP (180k). Coupled with the solid US Q4 GDP last Fri (particularly in the context of the strong 3.5% YoY Q3 growth), we see this as being a positive week for the dollar. Favour DXY breaking above 101.00/101.30 resistance this week.

EUR: Higher CPI may cause a headache for the ECB this week The focus is on the January German CPI today which should give us a gentle preview for tomorrow’s flash EZ CPI. We are likely to see another spike higher (due to base effects), towards 2%. While this should add fuel to calls within Germany for ECB policy tightening, for now the effect on the near term ECB outlook should be limited (even if EZ CPI should move to 1.4% tomorrow). This is because the ECB policy stance for the remainder of the year is “fixed” (the commitment to €60bn monthly asset purchases). With inflation expectations rising but the ECB keeping policy rates on the floor, real interest rates should move more negative and be bearish for the EUR.

GBP: Article 50 to be debated this week It looks as though Article 50 will be debated Tuesday night in parliament with a preliminary vote on Wednesday – although a binding vote is not scheduled until Feb 8th it seems. This week will also see a Super Thursday at the BoE, where the MPC will decide on rates and release the February inflation report. The market is still quite short GBP, but we think a messy debate on Article 50 plus the strong dollar story can keep Cable capped near 1.2600 this week.

JPY: BOJ bond buying in focus. Tomorrow’s BoJ meeting has a little more focus than usual in that the BoJ is struggling to keep 10 year JGB yields near 0%. At 8GMT/CET tomorrow, the BoJ announces its bond buying schedule for February. Any increases/tweaks in the JGB buying scheme looks JPY negative. We see $/JPY to 116.80 this week.

Turkey MPC decision, money markets and inflation indexes

Following the MPC decision on Tuesday (24 January), the central bank provided all of its funding at the upper end of the interest rate corridor (9.25%), not at the late liquidity window (11.00%) yesterday. The central bank’s effective funding rate increased accordingly to 9.25% from 9.12% a day ago when the central bank had provided a mix of funding at the upper end of the corridor (8.50% then) and the late liquidity facility (10.00% then). The adverse market reaction to this development shows the significance of the marginal funding rate for the lira’s exchange rate, in our view – although the central bank’s effective funding rate increased yesterday compared to the previous day, its marginal funding rate declined to 9.25% from 10.00%, which did not support the lira. Meanwhile, the overnight FX swap rate declined to 8.00% yesterday from 9.39% a day ago.

The Statistics Office announced methodological revisions for the inflation statistics yesterday. There were adjustments in the weights of food prices (reduced by about 2pps), transport prices (increased by about 2pps) and housing and utilities prices (reduced by about 1pp). The Statistics Office also said that it will use a new methodology for the prices of seasonal products (which would be particularly relevant for unprocessed food items). The Office expects about 10% less volatility in the CPI index with the new methodology, but these changes will not impact the trend of inflation. The Statistics Office will also release new measures of core inflation, but will continue to release core indices H and I, which are widely used.

USD Strength, Employment Growth, Trump

US data continue coming in on the strong side, with yesterday’s NFIB small business optimism index reaching 105.8, well exceeding the 99.5 consensus expectations and accelerating sharply from the 98.4 November reading. Small business is inward looking and with this index rising to its highest level since 2004 it seems that animal spirits have come back to the US economy. Overcoming a balance sheet recession is fundamentally different from dealing with an inventory overhang-caused recession. Notably,a balance sheet recession sees capital expenditure staying weak for longer as corporates react to better demand indications by hiring into their work force instead of adding to their capital stocks. Most DM countries have experienced what we call a ‘monetisation’ of their capital stock,allowing the depreciation of the capital stock to exceed the replacement of investments. This capital stock monetisation allowed corporates to add to their cash flow and provide the foundation to engage in record equity buy-back programs.

At a certain point capital stocks reach a low point which is typically the case when the marginal costs of labour exceed the marginal risk adjusted cost of capital. The labour / capital ratio has increased since Lehman and with underinvestment and employment growth reaching an ever widening gap productivity declines. Surging small business optimism suggests that the US may now finally leave the post Lehman balance sheet consolidation recession behind,adding weight to our call suggesting the USD will rally. It is the US closing its output gap while others,especially AXJ, widening their output gap which suggest investment return differentials working increasingly in favour of the USD. All this happens when there are increasing signs of a international USD shortage as manifested by press reports suggesting Saudi Arabia tapping the USD market in February to cover for domestic fiscal deficits.

Some stumbling blocks for the USD to clear. While the big picture turns increasingly clearer helped by reports such as business optimism, there are still some stumbling blocks for the USD to clear before resuming its rally. The US consumer has sent out mixed signals with the December consumer climate indices as provided by the Conference Board and the University of Michigan showing pre-Lehman readings, but our in-house Alphawise Retail Tracker suggesting a retail dip in December. The US December retail sales report will be released on Friday and with the MS projection way below consensus we wait for the USD to dip before trading the USD aggressively from the long-side again.

Trump will b etalking. Today the focus will be on the content of President-elect Trump’s press conference (16.00 Ldn).From a currency perspective, markets will aim to get a clearer picture on trade, fiscal stimulus and the new administration’s relationship to the Fed. Recent press reports leave the impression that corporate tax reform in conjunction with a border tax adjustment may have a better chance of finding stronger support with the GOP and hence has a better chance of implementation. Should Trump hint at something in this direction the USD is likely to move immediately higher. The USD would rally against commodity currencies as the border adjustment tax may not bode well for global trade.

Trump supporting measures allowing the US to export more energy combined with a border adjustment tax may provide a substantial boost to US energy exploration and production. Consequently, the US, which is currently the globe’s third largest oil producer, could add to global supply. International oil prices would fall. China will listen. China’s Security Times suggested China may seek retaliation should the US erect a trade barrier. Concretely, the paper threatened to “cancel orders from Boeing, disrupt Apple’s supply chain or even impose higher tariffs on imported agricultural products from the U.S.” Hence,any talk about serious trade restriction plans will not bode well for global risk appetite. The USD rally would move from turning a low-yielding currency event towards a high-yielding currency event. Commodity FX should fall most should the designated US President focus on trade. A different market reaction should occur should fiscal policy expansion make the headlines. In this case,a rising USDJPY would be the best game in town.

Eurozone: Political clouds, Yields and Rates

While the economic momentum is clearly accelerating, the European political outlook continues to be highly uncertain in 2017. A new terrorist attack in December, this time in Berlin, is likely to play into the hands of populist parties, potentially jeopardizing free movement within the European Union. Likewise, it seems realistic to expect that the rise of populism in Europe will push traditional political parties to play a more nationalistic card to secure victory in the upcoming elections. That implies that 2017 is unlikely to see much political and economic coordination on a European level. Besides, Brussels will be completely absorbed by the difficult Brexit negotiations, which is likely to put all other pan-European initiatives on the backburner. For the time being financial markets seem to be taking it in their stride, but that cannot be taken for granted in 2017.

The outcome of the Italian referendum could have been a bombshell, but there wasn’t much of an impact on financial market sentiment. That said, the uncertainty has not disappeared, as once the electoral reform is approved, elections are likely to be called by June. As for the banking troubles, a solution seems to be in the offing, with parliament approving a €20bn fund to prop up banks. A precautionary recapitalization of Monte di Paschi is now all but sure, although it could take until April to put in place a scheme on the back of EC approval. At the same time retail junior bond holders will be compensated after a bail-in, to avoid populist parties capitalizing on the ill-fated small savers. Meanwhile in Greece, the European problem child, the involvement of the IMF in the third bail-out plan remains quite uncertain, while tensions between the Greek government and its creditors flared up in December. Short-term debt relief measures, which had been decided in early December, were withdrawn after a unilateral decision of the Greek government to hand out a pre-Christmas bonus to retirees. We believe that debt relief will be granted after all, but that it will remain a very difficult process.

The Eurozone economy is starting 2017 on a strong footing. December saw an acceleration in manufacturing activity, with the composite purchasing managers index (PMI) hitting its highest level since April 2011. With new orders picking up rapidly (foreign demand has been boosted by a more competitive euro exchange rate), activity is unlikely to slow in the short run. The message is equally positive when one looks at the household sector. As unemployment continues to fall and wages are now slowly picking up, consumer confidence ended the year on a high note, which augurs well for consumption in the first quarter. The pace of the recovery is speeding up, with the €-coin indicator, a monthly estimate of the underlying GDP growth pace, rising to 0.57% in December. Without the potential political uncertainty, GDP growth could hover close to 2% in 2017.

However, in our forecast we incorporate some political turmoil (given the heavy electoral calendar and the rise of populism). In addition 2017 will see fewer working days than 2016, which might also be a small drag on growth. We therefore now have a 1.5% growth projection for 2017, followed by 1.7% in 2018. In December headline inflation increased from 0.6% to 1.1%, while core inflation increased moderately to 0.9% after months of stagnation at 0.8%. We have already suggested that for a few months businesses have been feeling confident enough to increase output prices. However, it will take some time before this translates into higher consumer prices.

On top of that, we don’t believe that the oil price rally has much further to run, meaning that the initial inflation effect will peter out in the course of 2017. Inflation is clearly trending higher, but this is likely to be a very slow process, as witnessed by the painfully slow bottoming out of core inflation. After the decision to lengthen its QE programme until December 2017, the ECB seems to be done easing. But we still believe that there will be a new lengthening of the programme into 2018 to allow for some tapering. Although by mid-2018 the ECB should have stopped adding to its bond holdings, the upward bond yield pressure from a strengthening economy and slowly rising inflation will, to some extent, be capped by the continuing bond purchases.


Theme of the Week: Fed speakers may spur hawkish excitement

A constructive US labour market report is likely to sustain the positive USD sentiment going into next week; the combination of modest job gains (+156k) and strong wage growth (+2.9% YoY) was enough to drive both short- and long-term US rates modestly higher, while equity markets remained unthwarted. Still, this jobs report was more a reconfirmation of expectations for two 2017 rate hikes, with the next moves currently expected in June and December.

Markets remain unconvinced over the prospects of an earlier March rate hike (ING’s base case) and we attribute this to a number of factors: (i) prior Fed cautiousness; (ii) Trump fiscal policy uncertainty and (iii) sub 2% headline US inflation. But all three headwinds could fade, and quite soon. We wouldn’t be surprised to see some hawkish Fed talk this week, with the intention of preparing markets for the prospects of a 1Q17 rate hike. Strong US inflation and growth data over the next month will likely see the reflationary uptick in US yields continue and this means a USD buy-on-dips strategy remains attractive.

USD and China, EM currencies, UK Data

China preemptively dealing with capital outflow risks and Mexico interveninghave allowed the USD to correct gains witnessed since November. However, USD corrective activity should be limited. Notably, we believe the current situation has too few similarities to January 2016 when a USD rally was followed by a 6.5% downward correction. Importantly, China preventing capital outflows will help to keep the current global reflationary theme alive for longer and seeing the USD rallying against low-yielding currencies is part of the global reflation trade.

EM currencies offering a solid domestic story have fared well, keeping their access to the global funding pool intact, thereby showing a substantial difference to last year when EM funding conditions tightened by the day driven by weaker currencies. The current USD rally has predominately materialized against low-yielding currencies. There is a reason risky assets tend to rise when there is EUR and JPY weakness, as weakness in these currencies improves global liquidity conditions – as opposed to EM currency weakness, which tends to weaken global liquidity conditions. We add long USD trades vs the EUR and NOK to our already short KRW position.

Continued strong UK data releases have not been sufficient to keep GBP supported. Worries about the British government finally triggering Article 50 and investment spending reacting to increasing planning insecurity should put GBP under renewed selling pressure. We expect GBPUSD easing moderately to 1.17 with the global reflation theme preventing a bigger setback. However, it would still make sense to trade GBP short against a global reflation winning currency. The SEK falls into this category, suggesting GBPSEK shorts offer value.

Additionally, we sell into the current EURUSD rally. Continued ECB dovishness suggests rising inflation rates pushing EUR real rates and yields lower. Over the next few weeks, we see better EUR downside potential compared to the JPY, which took most of the weakening effort from November into this year. EURJPY may correct moderately lower.

G10 FX, USD Strength, EURUSD and Oil Currencies

USD: Higher longer dated UST yields benefiting USD against EM FX The focus of the week is on the Dec FOMC meeting (Wed) which should be neutral / modestly positive for USD. The 25bp rate hike is all but priced in, hence the price action will be largely driven by the new set of FOMC forecasts and Chair Yellen’s press conference. Should the Fed convey the message that it is willing to run the economy hot (with higher growth and inflation projections, yet largely unchanged interest rate forecast), this would likely add to upward pressure on longer dated UST yields and benefit USD particularly against higher yielding currencies, as well as JPY where the BoJ yield curve control allows for a clear policy divergence. US Nov CPI (Fri) should also help the USD as prices are expected to increase to 1.8% YoY. As for today, higher oil price translating into higher UST long-end yields should be USD positive against most of EM FX.

EUR: Consolidation after last week’s large decline We expect EUR to consolidate today following the large decline after the ECB December meeting last week. The news that the Italian Foreign minister Paolo Gentiloni was asked to form a government is modestly EUR positive to the extent to which it shows a commitment to resolve the current political uncertainty without a delay. Yet, the focus still remains on the Italian banking sector particularly after the ECB reportedly rejected Bank Monte Paschi’s request for more time to raise capital. This in turn should prevent any EUR rally at this point.

Oil currencies: Non-OPEC and Saudi production cuts benefiting oil FX The spike in the oil price following (a) the agreement of non-OPEC countries to join OPEC and cut output next year; (b) Saudi Arabia commitment to a larger cut than previously agreed have benefited oil exporting currencies such as NOK, RUB or MXN. For NOK, the another leg in oil price higher all but rules out any easing from NB this week. 

Turkey Update, Explosions and GDP
Two deadly explosions near a football stadium in Istanbul late on Saturday (10 December) killed 38 and injured 166 people.

Also on Saturday, the ruling AKP submitted to parliament a draft proposal on constitutional amendments for executive presidency. The proposal allows the president to directly appoint the cabinet and give the president the power to rule by decree. The draft proposal also increases the number of parliamentary seats to 600 from 550, calls for two-term limit for the president, and sets the first presidential elections under the new set of rules for November 2019. The draft proposal was finalized after the AKP reached an agreement with the nationalist opposition party MHP. The draft needs to get at least 330 votes in the 550- seat parliament before it can go to a referendum, and a referendum must take place within 60 days of the parliamentary vote. The AKP needs the support of the MHP for the parliamentary approval, as it has 316 parliamentary seats (except the parliament’s AKPaffiliated speaker) and the MHP has 39.

Because of secret-balloting, defections from both the AKP and the MHP are possible at the time of the vote, although our baseline scenario is that the draft proposal will be approved by the parliament. The parliament will likely vote on the proposed amendments sometime in 1Q 2017 and a referendum will likely take place “at the start of summer”, according to previous comments by Prime Minister Yildirim.

Gross domestic product shrank an annual 1.8 percent in the three months starting in July, Turkey’s statistics bureau reported Monday. The median estimate in a Bloomberg survey called for an annual expansion of 0.3 percent.

Domestic consumption, which makes up nearly two-thirds of the economy, fell 3.2 percent from a year earlier, adding to evidence that the takeover attempt on July 15 damaged business activity. Government spending on wages, goods and services rose 23.8 percent, limiting the impact from a slump in investments, which fell 0.6 percent from the same period in 2015.

AUD GDP Miss, CAD Divergence and OPEC, JPY correction, Interest Rate Drivers of FX
The focus is all on AUD today which weakened,at its most 0.7% overnight,as 3Q GDP contracted by more than the market was expecting (- 0.5%Q, market -0.1%Q). The story is clear – the prior quarter saw an upside surprise as public spending picked up by 4.8%. This couldn’t be repeated again at that pace of spending as the government is worried about losing its AAA credit rating. The result was 3Q public spending contracting by 2.4%Q,nothelping the overall GDP print. Usually the idea of government consumption is to boost business investment too, but as the mining industry is still dealing with a terms of trade shock and restaurants and retail consumption isn’t sufficient to compensate, the ‘fiscal boost’ of 2Q was short-lived. Even after today’s downside surprise, the market is still not setup for the RBA to cut rates next year, which we are forecasting. We believe that AUD remains a sell from current levels, especially on the crosses, with AUD/NZD helped by yesterday’s strong dairy auction.

2014 saw massive monetary policy divergence within the G4 space,allowing USD to rally over 15%. Now we look at the policy divergence in the commodity currency space and see renewed opportunities that are not yet priced in. From the USD side, the market is already expecting 1.7 x 25bp of hikes in 2017,and it is for this reason that we expect a short-term USD pause.From the AUD side,however, the markethas only priced 7bp of cuts by the middle of the year, while our economists expect 25bp. It may now take the RBA to shift its tone from yesterday’s note on downside surprises to growth to explicitly saying that it is worried and could act to make the rates markets reprice cut expectations. The RBA minutes, released on December 20, will now be in focus together with 3Q house price data on December 13. Of course, today’s strong iron ore trading during Asian hours again supports the terms of trade but we don’t think it is sufficient to keep AUD supported. The Canadian rates market is more fairly priced for BoC expectations, we believe. Today’s BoC meeting should help our short AUD/CAD position to break through the August lows.

USD/CAD has started to diverge from the 2y rate differential, but it should still be the monetary policy outlook driving the currency today. In general, our constructive outlook on CAD is based on the idea that the BoC is to keep rates on hold for now and the US economic growth expected in 2017 should spill over to Canada too. Yesterday’s Canadian trade balance was strong on the headline number -1.13b (-1.7b exp.) but was mainly driven by a contraction in imports. Non-commodity export volumes fell by 1.5% and, while this is not great for an economy that is trying to deal with a terms of trade shock and like Norway is also seeing a bit of a fiscal support, the data aren’t sufficiently bad to make the BoC take action to cut rates. This is why we see CAD outperforming on the crosses, with potential for EUR/CAD to cross below its December 2015 low around 1.40. Today we think the BoC could note that there are downside risks to growth, but we think that this isn’t sufficient to make it want to look to cut rates next year. Oil prices need to be on their way back to the US$30s for that to occur. Oil prices remaining fairly well supported after the OPEC deal should also help CAD on the margin. This environment of a tactical pause in USD could see MXN recover too, towards the 20 level. Mexico’s deep water oil auctions went well, with eight out of ten blocks awarded, while very strong bids for bonds issued by state oil company Pemex highlight strong demand for Mexico paper.
We outlined yesterday that we expect a short-term pause in USD’s appreciation, meaning even USDJPY could see a setback towards the 112level. However, we are not participating in the setback and would only use it to add to short JPY positions. This morning the BoJ’s Iwata reiterated the bank’s stance to buy as many JGBs as required to keep the 10y close to 0%, in particular he thinks the bank will need a large scale of JGB purchases to control rates. The expansion of the BoJ’s balance sheet and the interest rate differential with the world should continue to weaken JPY over the medium term. What is now becoming a driver of the story is the development of local risk appetite. Favourable tax policies and an outperforming local equity market should push more investment into riskier assets. Those riskier assets may be outside the country, which would weaken JPY if done on an FX-unhedged basis.


EU Rates higher on oil, caught by the referendum

The OPEC decision to cut oil output for the first time in eight years has sent oil prices higher and with it government bond yields. In the US, where additionally the ADP report hinted at a strong US labour market report tomorrow, 10yr UST yields rose almost 10bp and briefly revisited the recent highs at 2.40%. This has pushed the 10yr UST Bund spread to new long term highs of 213bp. Earlier in the day the Eurozone inflation flash estimate had been less inspiring. Headline inflation rose to 0.6% in November, but core inflation held steady at 0.8%. The EUR 5y5y inflation forward did increase on the day, but it hasn’t topped the range around 1.60% that has prevailed since the start of last week. While sentiment has remained constructive, political risk factors in the Eurozone and a potential prolonging of €QE still capped the 10yr Bund yield at 0.28%. EGB spreads vs. Bunds tightened slightly, a show of confidence especially for BTPs after already tightening 13bp the day before. The focus today will be on the bond taps out of France and Spain, also as a further gauge of sentiment ahead of the Italian constitutional referendum this weekend. EGB Supply: Spain will reopen the 5yr SPGB 7/21, 10yr SPGB 10/26 and off-the-run SPGB 7/41 for a total of €2-3bn as well as the linker SPGBei 11/19 for €0.25-0.75bn. The US election outcome and Italian spill-overs had pushed the 10yr spread over Bunds some 30bp wider, but levels have stabilized since mid-November suggesting much has been priced in already in terms of risks. This counts for BTPs especially against which SPGBs still look rich despite some recent cheapening. France will reopen the 15yr benchmark FRTR 5/31 and FRTR 4/41 for a total of €2.5- 3.5bn. Both bonds trade special in repo, in particular the off-the-run bond. The 4/41 was last reopened in July this year and has cheapened slightly into the auction against surrounding bonds. The sell-off in bond markets has taken the z-spreads to the widest level since end-Q1, but the starkest cheapening was seen versus Bunds and OLOs. The FRTR 5/31 trades at 10bp vs. the BGB 6/31, up from close to flat in mid-November.


Commodities: OPEC and Oil, Metals, Agriculture
• Iraq & OPEC: The Iraqis now say that they will be willing to cut output as part of the larger OPEC deal. The Prime Minister wants to see OPEC cut output by 900,000 bbls/d, from the current 33.6MMbbls/d. Previously Iraq was insisting to be exempt from any cuts, and their apparent change in attitude does increase the likelihood of an OPEC agreement. • US inventory data: There was little in the way of surprises from EIA inventory data released yesterday. US crude oil inventories declined by 1.25MMbbls (similar to the API numbers), while US gasoline stocks increased by 2.3MMbbls.
Metals • US Midwest aluminium strength: Premiums for US Midwest aluminium have moved higher this week, with tightness in the spot market. Regional producers are apparently sold out for the month of December. As a result the premium over the week has strengthened to 7.70-8.25c/lb from 7.50-7.75c/lb, the strongest levels seen since May this year. • Silver weakness: ETF holdings of silver have declined to their lowest level since August 2016, with total known holdings standing at 661.28m oz, down from a record high of 676.15m oz back at the end of October. A further reduction in holdings will put further pressure on silver, which is already down over 12% since early November.
Agriculture • Sugar deficit narrows: Green Pool Commodity Specialists have revised their 2016/17 global sugar deficit estimate from 5.8m tonnes to 5.3m tonnes. The driver behind this change has been weaker demand, and this has been a result of the stronger prices that we have seen in the sugar market this year. • Indonesian palm oil: The Chairman of the Indonesian Palm Oil Association expects palm oil output in the country this year to decline by 10% to 30.9m tonnes, the fall is a result of the impacts from El Nino. However moving into 2017, expectations are that there will be a recovery in production.


Emerging Markets, Mexico, Turkey and South Africa

Long USD positioning remains relatively muted, as our positioning tracker indicates. As such we expect pullbacks in the USD to be reasonably shallow. Nonetheless, we believe that high yield EM currencies will post decent total returns in the near term as real yields in the US are starting to stabilize and commodity prices continue to rally. Typically EM currencies do fine during periods when real UST yields are stable, even as nominal yields move up. BRL is our top high yield pick.  

We maintain our bullish stance on Brazilian assets despite the latest negative headlines on Brazil. Focus has turned to concerns over the 2017 growth picture.  Tomorrow’s IPCA release could also support the trade if it continues to decline, opening the way for an aggressive cutting cycle. We are also watching headlines regarding uncertainty surrounding Temer’s cabinet, as domestic politics remain the greatest risk to our otherwise constructive view on the country, and in particular our long BRL/COP position. Today’s current account data will provide information on the external health of the economy.

The Turkish PM has stated that he believes the CBT will take measures on the TRY’s volatility, which has raised expectations of a 25bp hike at this Thursday’s central bank meeting. The impact of declining TRY deposit rates will mitigate the impact, and with the authorities doing little to change the dominant view in the market that they would prefer to have lower TRY interest rates over the medium term, we doubt the impact of a small rate hike on TRY will be meaningful. Latest data on FX deposit trends suggest that even as the currency depreciates, there is a reluctance of local deposit holders to shift back into TRY, from foreign currency. So far in November, the value of deposits in foreign currency has stayed broadly flat in USD terms.

South Africa continues to take measures that reduce the likelihood of a ratings downgrade and support market sentiment. Following labour market reform measures yesterday, the government has announced plans to delay building nuclear power plants, which will lower the market’s concern about potential contingent liability risks that the projects entailed. This should support ZAR in the near term, though we believe that the base case for the market is already that South Africa will avoid a ratings downgrade. Moody’s announces its ratings decision on November 25th,and S&P is on December 2nd.


USD Index, US Rate Differential, EURUSD, USDJPY and NOK

The Fed’s broad USD Index surpassed its January high on Friday and is now setup for further gains, marking the next leg of the USD supercycle. USDJPY is leading the way this morning, which we expect to continue as the pair has broken through the July high around 107.50, seeing little resistance until beyond 110. We believe that the DXY should underperform the broad USD index as its largest constituent, EUR, is being supported by real rates, leaving the USD rally to be concentrated on Asian currencies. The US-world nominal rate differential continues to head higher, with focus now on real rates and their potential impact on risk appetite. This week market focus will remain on debating the potential policies from the newly elected US president and on Fed Chair Yellen’s testimony to the economic committee on Thursday.

 Trump continues to make senior appointments to his cabinet. Last night Reince Priebus was named as chief of staff and Stephen Bannon as a chief strategist and senior counsellor. The press is reporting that these appointments suggest that Trump is trying to take views from all sides of the Republican party. Equity investors may now try to put probabilities on each detail of the suggested policies made during the campaign, such as which parts of the Affordable Care act and the Dodd-Frank act could remain. For FX investors, however, it will be about the expected growth and inflationary boost from these policies and whether they will spur the Fed to raise rates faster next year.

Crossing through a previous high at 107.49, we foresee an initial target of 112. We have often said that higher inflation expectations or steeper yield curves would have been required for USDJPY to turn around. However, the reason for steepening didn’t need to come from the Japanese side. The correlation between global bond markets is high, meaning the US 2s10s curve hitting the highest level this year has spilled over into the Japanese curve steepening too. Steepness has been focused on the shorter end of the curve.

As the market prices in a faster pace of Fed hikes due to expectations of higher growth and inflation, there could also be debates forming about whether the ECB will need to extend its QE programme beyond next year. The US 5y5y inflation swap has hit the highest level this year at 2.47%, allowing the eurozone’s equivalent measure to also rise to 1.55%. We expect EURUSD to find support around 1.07, with the January low of 107.11 being key.

 Tomorrow will see the release of Norway’s 3Q GDP, which we expect to be relatively weak as industrial production data have not picked up recently despite the global rise in manufacturing PMIs and commodity prices. Our economists see headline GDP at 0.1%Q and mainland GDP at 0.4%Q. We will be focused on what proportion of growth has been generated by fiscal spending, as government spending is expected to decline next year, presenting a downside risk for NOK. We will also be looking for any signs of Brexit-related weakness. We see upside for USDNOK, which is still loosely correlated with oil and is now breaking through upper resistance at 8.40. We still think the market is long NOKSEK, which failed to break through 1.10, so position adjustment may also put downward pressure on NOK.



Turkey: S&P upgrades Turkey’s outlook to “stable”

S&P changes Turkey’s outlook to “stable” from “negative”, while rating the Turkish economy at “BB.” S&P revised Turkey’s outlook up to “stable” from “negative” in its last regular assessment for this year, while keeping “unsolicited” foreign and local currency credit ratings unchanged at ‘BB’ and ‘BB+’, respectively. According to the agency, the upgrade reflects the Turkish economy’s resilience against regional and domestic risks, while it believes policymakers will continue to implement reforms for economic stability. The country’s internal environment was also considered in the decision to revise the rating, while the state of emergency following the coup attempt in July 2016 is predicted to remain in place until at least January 2017. The announcement came after markets closed following a busy day with a sharp increase in USD/TRY to all-time highs on the back of local political developments.


Turkey Trade Balance and TRY

The trade balance came in at USD4.4bn in September, while the 12M rolling deficit stood at USD56.2bn, a slight increase over the previous month from the lowest level since mid-2010. The foreign trade deficit, at USD4.4bn in September, raised the 12M rolling deficit to USD56.2bn, from the lowest in six years at USD55.7 a month ago. This is likely a reversal in the long-term trend since end-2013 given the gradual decline in the supportive effects of commodity prices and ongoing risks due to geopolitical tensions. Following strong YoY growth rates recorded in August, both exports and imports contracted by 5.6% and 0.7%, respectively, translating into a 14% widening of the merchandise trade deficit in September over the same month of the previous year. As a result, coverage of imports by exports dropped to 71.5%, showing the impact of expansion in core trade deficit (excluding gold and energy), which, on a 12M rolling basis, also widened slightly.


Cross Currency Basis Swap Levels in Developed and Emerging Markets


Selected Developed Markets

• Negative basis circumstances remain in place versus USD for most key developed market currencies.

• The most extreme versions are in JPY, CHF and DKK followed by EUR. SEK basis circumstances are less extreme and close to zero for long tenors.

• CAD pushes into positive territory for longer tenors, while AUD is the outlier with positive basis circumstances right along the curve.

• Large negative basis currencies can be played by overlaying issuance in USD or bond holdings in the FX in question (with CCS), while for AUD, long CAD and long SEK the opposite holds.

Selected Emerging Markets

• Negative basis circumstances remain thematic in Emerging markets space, with the most extreme version of this to be found on the front end of the CZK curve.

• The back end of the RUB curve has seen basis widening too (deeper negative), while long end MXN has seen some tightening (lower negative).

• TRY basis circumstances remain wide and negative. And negative basis circumstances obtain for the likes of PLN, HUF and KRW too. The outlier remains ZAR, which continues to show positive basis circumstances.

• Negative basis circumstances imply a premium being attached to USD, and so makes local currency issuance swapped into USD through CCS relatively expensive (to varying degrees).

*** Turkey – Guidance ***

– Guidance set at 4.8% +/-5bps WPIR
– Books subject at 14.30 London / 9.30NY
4.5 bio

Issuer: Republic of Turkey
Ratings: Ba1 / – /BBB- (Moody’s/S&P/Fitch)
Format: SEC Registered Global Offering
Current Size: US$1.5bn
Tap Size: US$ Benchmark
Maturity: 9 October 2026
Coupon: 4.875%, S/A 30/360
Price Guidance: 4.900% area
Listing: Luxembourg Stock Exchange’s regulated market
Denoms: US$200k + US$1k
Docs: Issuer’s US Shelf Programme
ISIN: US900123CK49
Bookrunners: Citi, HSBC, JP Morgan(B&D)
Timing: Books open, pricing today