Bank of Canada may say pause, but the market hears finished

Overview: Amid sharp losses in the US equity futures, the US dollar is mostly firmer against the G10 currencies. The notable exception is the Australian dollar, where high-than-expected inflation boosts the risk of a more aggressive central bank. The Aussie reached its best level since last August (~$0.7125). With a light US economic diary and Fed officials in the quiet period ahead of next week's FOMC meeting, the main focus in North America is on the Bank of Canada meeting. A quarter-point hike, after last month's 50 bp move is expected to end the cycle, but the central bank will want to keep its options open.

Asia Pacific equities mostly advanced, and the return of South Korea saw the Kospi jump 1.3%. Singapore markets also re-opened, and the Strait Times rose 1.8%. European equities are heavy, and the US futures are pointing to a sharply lower opening. Benchmark 10-year yields are mostly 2-6 bp lower in the Europe. The 10-year US Treasury yield is slightly lower near 3.43% after snapping a three-day increase yesterday that had taken the yield back above 3.50%. After API reported 3.3 mln barrel build on top of 7.6 mln barrels the previous week, March WTI is trading softer. If the losses are sustained, it would be the third consecutive decline and the longest such streak in more than a month. Meanwhile, gasoline prices have continued to drift higher.

Asia Pacific

A quickening of Australian inflation boosted lifted rate expectations and sent the Australian dollar sharply higher. CPI rose 1.9% in Q4, which lifted the year-over-year rate to 7.8% from 7.3%. The median forecast in Bloomberg's survey was for a 1.6% quarterly rise and 7.6% annual increase. The underlying measures were also stronger, and adding inflationary picture was the acceleration in the new monthly metric to 8.4% in December from 7.3%. Australia's 2-year yield jumped 10 bp to almost 3.08%. In the futures market, participants had been flirting with a 15 bp hike to bring the target rate back to quarter-point increments, but now sees the greatest chance of a 25 bp move in over a month. Separately, New Zealand's reported higher-than-expected Q4 CPI as well (7.2% vs. 7.1%), but rather than accelerate, it plateaued. The year-over-year rate has been at 7.2% in H2 after 7.3% in Q2. New Zealand's two-year yield fell seven basis points and the New Zealand dollar is trading heavier. The swaps market had already discounted at least a 50 bp hike from the RBNZ (February 22) and sees about a 1-in-3 chance for a 75 bp move.

Japan's Ministry of Finance reports weekly portfolio flows tomorrow (for the week ending January 20). Recall that in the previous, which featured the BOJ standing pat, saw Japanese investors pour into foreign bonds. Specifically, the MOF reported that Japanese investors bought JPY1.23 trillion (~$95 bln) of foreign bonds, the most since November 2021. For their part, foreign investors dumped nearly JPY3.9 trillion of Japanese bonds, one of the largest weekly liquidations though slightly less than after the December surprise (JPY4.86 trillion, a record).  What could prove to be an end of the bear market for G10 bonds and what appears to be a gradually improving current account balance could see Japanese investors continue to return to global bonds after selling last year.  

The dollar is in narrow range against the yen today, roughly JPY129.80-JPY130.60.  That is inside yesterday's range. Implied overnight volatility, which surged above 50% ahead of last week's BOJ meeting is below 15% and back within well-worn range. We anticipate the dollar can rechallenge the session highs in North America but will likely stop short of yesterday's brief push above JPY131.00 Its surge today above $0.7100, the Australian dollar has met the (50%) retracement of the decline from the February 2021 high slightly above $0.8000.  The next retracement target (61.8%) is near $0.7300. Recall that last week's low was near $0.6870. The combination of the China re-opening story and reassessment of the RBA's trajectory has lifted the Aussie by nearly 4% this year to lead the G10 currencies. The upper Bollinger Band is near $0.7100 today. It has pulled back to around $0.7080 in the European morning and initial support may be found around $0.7060. With the mainland closed, the offshore yuan continues to be traded quietly. The greenback remains between CNH6.7650 and CNH6.7950. Lastly, as widely expected Thailand's central bank delivered a 25 bp hike that brings the target rate to 1.50%. 

Europe

Dutch PM Rutte is throwing a wrench into a common European response to the US green subsidies. EU President von der Leyen, France, and Germany seemed to favor a joint response. To be sure, Rutte favors a response, but it does not think it needs to issue more debt. He noted that there are still funds available from the 800 bln euro NextGeneration recovery fund, which requires a bit more than a third of each country's spending to be committed to the transition to more sustainable energy. This is, of course, the type of response one could anticipate from the more fiscally conservative governments. The same is true of his opposition to relaxing, at least temporarily state aid rules, as some have suggested including von der Leyen. It also is part of the jockeying for position ahead of the EU Summit on February 9-10 that will take up the issue. The risk of more national strategies is that it could lead to a further fragmentation of the eurozone. Recall, last year's German decision to commit 200 bln euros to protect businesses and households from a rise in energy bills raised the ire of more fiscally strapped countries. The Financial Times coverage of the issue, two days after what turned out to be the euro's bottom (~$0.9535 on September 28), it said that Germany's plan was spurring "animosity" within the EU.  

While economists have turned more optimistic toward the eurozone, and Germany in particular, the IFO survey was a not so impressive. The current assessment for January slipped to 94.1 from 94.4.  The market had looked for some improvement. The expectations component rose to 86.4 from 83.2.  It is the fourth consecutive gain and is the most optimistic since last May. The overall business climate measure rose to 90.2 from 88.6 but missed expectations slightly. Lastly, the dispute over sending tanks to Ukraine has been resolved, and Germany was broadly criticized, in the end it appeared to get what it sought with the US sending its tanks as well. Moreover, Germany reportedly has lobbied Switzerland to lift its ban on re-exporting Swiss-made armaments to Ukraine too.

The euro pushed through $1.09 in Asia but seemed to have triggered some profit-taking that has taken it to nearly $1.0860, session lows, in the European morning. With the intrasession momentum indicators getting oversold, yesterday's low near $1.0840 may hold. Recall that the $1.0940 area corresponds to the (50%) retracement of the euro's decline from the January 6, 2021, high near $1.2350. The risk-off mood, reflected in the sharp losses in the US equity futures and what may be the first back-to-back loss of the Stoxx 600 since the middle of last month, may be sapping the euro's strength. That said, pullbacks have been generally shallow over the last few months and nearly everyone seems bullish. Sterling recorded a four-day low yesterday near $1.2265 before settling back around $1.2335. It is consolidating within yesterday's range today but has spent little time higher that yesterday's close. Near-term risk may extend toward $1.2215-20, but the push to session lows in the European morning (~$1.2285) are stretching the intraday momentum indicators. 

America

The Bank of Canada meeting is the key event today. A quarter-point hike is widely expected by economists, but it is not fully discounted in the swaps market. Recall that at last month's meeting, the market was split between 25 bp and 50 bp. We recognized it was a close call but favored the half-point move that was delivered. The challenge of today's meeting is how to deliver the quarter-point hike and signaling a pause without encouraging market expectations that it is finished with the overnight lending rate at 4.50%. Moreover, the swaps market sees the policy rate back near 4.00% by the end of the year. The Bank of Canada forecasts the economy to expand by slightly less than 1% this year (year-over-year) CPI to from around 6.8% at the end of last year to 4.1% at the end of 2023. The IMF projects that the Canadian economy will grow 1.5% here in 2023 with CPI moderating to 4.2%. Meanwhile, the Canadian dollar was the best performing currency in H1 22, losing only 1.8% against the US dollar. However, in H2 22, it was the worst performer, losing 5%. Here in January, it has risen by about 1.4%, worst among the dollar-bloc (Australian dollar is up about 3.3%, while the New Zealand dollar has risen by 2.4%). Among the G10, only the yen, Swiss franc, and Norwegian krone has had under-performed the Canadian dollar.

The US has a light economic schedule today but tomorrow it picks up with the first estimate of Q4 GDP. The Atlanta Fed's GDPNow points to 3.5%, while the median forecast in Bloomberg's survey has slipped to 2.6%. The Fed's Summary of Economic Projections from last month see the long-term trend, which is understood to be the non-inflationary pace of growth to be about 1.8%. Tomorrow December's merchandise trade balance and inventories (wholesale and retail) are also on tap. The weekly jobless claims may also draw more attention than usual a week ahead of the nonfarm payroll report after the unexpected drop below 200k was reported for the week ending January 14. There seems to an unusually large drop in claims from New York. Tomorrow, durable goods orders, and new home sales are also due.

Ahead of the Bank of Canada meeting, the US dollar is remains confined to Monday's range against the Canadian dollar (~CAD1.3340-CAD1.3420). Weakness in US equity futures may have helped lift the greenback to session highs in Europe and is stretching the momentum indicators. That said, a move above CAD1.3420 could see a quick move toward CAD1.3450 -70. After peaking near MXN19.11 on January 19, the US dollar has gradually pulled back and reached about MXN18.7670 today. This is roughly the (61.8%) retracement of last week's surge. The risk-off mood may suggest that consolidation is likely near-term. Potential may extend toward yesterday's high, a little above MXN18.88.