Markets Enter Consolidative Mode Ahead of Weekend

Neither the terrorist attack in Paris nor the strong eurozone flash PMI has managed to shake investors.  Judging from the social media, many suspect that the terrorist attack plays into Le Pen's hands, but investors do not seem particularly concerned.  The French interest rate premium over Germany has narrowed, and gold is flat.   UK retail sales fell sharply, yet sterling is holding on to the bulk of this week's gains, which are the most here in 2017.   

The US 10-year yield is holding on to the lion's share of its gains as well.   It had bottomed on Tuesday near 2.16% and rose to 2.25% yesterday and is at 2.24% now.  Treasury Secretary Mnuchin's claim that tax reform will be passed by the end of the year seems to be more a statement of intent than a reliable forecast.   As President Trump's 100th day in office approaches, the legislative agenda still seems to be tied up between the different wings of the Republican Party.  Indeed, the attempt by the Republicans to forge a majority instead of reach across the aisle to some Democrats is proving more difficult and frustrating than many anticipated.  

Although it is too late to have much impact on the French election, the flash PMI reading for April was impressive as it pulls further ahead of Germany, if such comparisons are valid.  French manufacturing rose to 55.1 from 53.3, and the service reading rose to 57.7 from 57.3.  This lead to the composite is rising to 57.4 from 56.8.  All were above expectations. 

The German manufacturing edged to 58.2 from 58.3, and the service PMI fell to 54.7 from 55.6.  The latter was weaker than expected.  The composite stands at 56.3 from 57.1.  

The flash EMU composite of 56.7 represents a new six-year high.  The chief caveat is that survey data has been running ahead of real sector data.  The US and UK report Q1 GDP next week, but Europe's estimates are in the first week in May.  Next week's highlights will include the flash CPI readings, with a small uptick expected, and the ECB policy meeting.  There is room to adjust the securities lending program to relieve strain in the repo market.  

The most market friendly French election result would likely be a Macron-Fillon run-off in the second round, assuming that it is unrealistic than any candidate garners more than 50% of the vote.  Many suggest that the euro could rally on a Macron-Le Pen second round, given the tradition of forging a united front against the National Front.  Yet this would seem to be the least surprising result.  Nearly every poll suggests this is the most likely scenario.  And as we have noted, investors are relative calm.  

The relative calm in the face of geopolitical uncertainty is also evident in Korea.  The strongest currency in Asia this week, gaining 0.5%.  This snaps a two-week slide.  Korean stocks gain 0.75% today, which is about half of the weekly advance.  The Kospi and KOSDAQ are among the best-performing equity markets in Asia this week.  The MSCI Asia Pacific Index is up 0.7% on the day, which is enough to push the index higher in the week to break the four-week down leg.  Chinese shares posted their worst week of the year with the Shanghai Composite off 2.25%.  Regulators have tightened up their enforcement and also seem to be attempting to curb leverage.  

The UK provided the biggest surprise of the day with a poor retail sales report.  The BRC report had already warned that UK consumers pulled back, but the 1.5%  decline in retail sales (excluding petrol) was three times more than expected.  The small upward revision in the February series was not sufficient to ease the shock.   Sales were off broadly, including clothing, footwear, household goods and food.  The quarterly decline was the largest in seven years.  The main culprit appears to be rising prices, but the March decline may have been aggravated by the Easter holiday, which was earlier this month rather than in March as in 2016.  UK GDP expanded by 0.7% in Q4 16 and is expected to have slowed to 0.4% in Q1 17.  

Sterling was fairly resilient to the retail sales shock.  It eased on the news but remains within yesterday's ranges, which was within Wednesday's range.  After rallying strongly (we suspect mostly on short covering) in response to the surprise call for a snap election, sterling appears to be forming a continuation pattern (flag, pennant, or triangle).  Initial support is seen near $1.2770.  Many have their sights set on the $1.30 area.  

Sterling's gains are the FTSE 100's losses.  This index that tracks many UK multinationals has fallen over 3% this week, which is its worst performance since early last November.    More broadly, the Dow Jones Stoxx 600 is off about 0.2% today, and unless there is a strong recovery in the next few hours, it will post its second consecutive losing week and its largest weekly loss since late January.  

Comments by the Fed Governor Powell were in line with most other Fed officials; recognizing that full employment is at hand.  These comments, however, are noteworthy because they illustrate a point we have made about the Fed and the upcoming appointments by Trump.  Powell is the lone Republican nominee among the Governors.  His analysis does not differ much from the other governors.  The point is that a new member will see the same set of facts.  The Fed is close to its mandates.  A gradual removal of accommodation is not an ideological position, but a technocrat judgment about the prudent course.  

US data today includes the Markit flash PMI and existing home sales.  Barring a significant surprise, the former does not typically elicit much of a market reaction.  Existing home sales are expected to rebound from the 3.7% decline posted in February.  There may be some risk of a disappointment given the weather.    Canada's reports March CPI.  Although the month-over-month rate may tick up, the year-over-year rate may ease to 1.8% from 2.0%.  The new core rate is expected to be unchanged at 1.3%.   DBRS, the last of the key credit raters (from the ECB's point of view) to recognize Portugal as an investment credit is due to release its review today.  With growth appearing more solid, it would be a surprise to investors if it cut the rating.

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