Another Brick In The Wall

 | Jan 29, 2017 01:54AM ET

The dollar ended the week firmer today, across most currencies, despite Friday’s weaker than expected Q4 GDP as capital goods was positive, tempering headline disappointment. The markets are less focused on backwards looking data, as President Trump has been in office for little more than a week and has yet to cement key policies involving Trade, Tax and Fiscal expenditures. Moreover, depending on the scale of the infrastructure projects, (Fiscal) U.S. GDP could push well beyond 3% this year.

The BOJ played a significant role in USD/JPY fortunes by increasing 5-10 year bond purchases to ¥450 bln from ¥410 bln on Friday. It was a big surprise to traders, as the BOJ had skipped 1-5 y purchase on Wednesday, which likely exacerbated Friday’s outsized topside move more than would otherwise have been expected. However, with the BoJ policy meeting next week, I think the Central Bank is sending a clear signal to the markets that they will be resolute in keeping the JGB 10 year yields near 0% for the foreseeable future.

The Mexican peso will remain in the limelight, and the current proceedings are being viewed cautiously around the world. U.S. trade policies directed at Mexico could be a precursor to the events to unfold in Asia. However, when trading in a market driven by the political headline, more so in a highly crowded trade, while competing with algorithms for reading “market-moving’ headlines, it is a dangerous game distinguishing chaff from reality.

Moreover, while relations between Trump and President Nieto are clearly a work in progress, it is clear the past Obama administration diplomacy is out the window in favour of boxing gloves in the ring. On a positive note, the discussions will likely continue.

Not to be outdone on the headlines, USD/TRY had a wild ride in very thinly traded markets, when comments from Turkish President Erdogan hit the news ticker.

Raising interest rate would impact both the currency and inflation in a negative direction. I especially defend removal of the top-bottom issue and maintain just the policy rate.

More or less "greenlighted" the TRY bears as the prospects of additional intervention on the interest rate front is now unlikely.

While the confluence of Credit Rating Agency warnings and downgrades added some fuel to the fire, we have come to accept these moves have little legs, but given the sheer amount of negativity in the TRY trade, it certainly didn’t help matters.

h3 Monday Morning Regional G-10 Market Roundup/h3 h3 Australian Dollar/h3

Currently trapped in the .75-76 range trade, as the confluences of Carry, China and Commodities (3 C equation) continue to shape Aussie sentiment.

The carry trade was dealt a significant blow after the miss hit on last week’s CPI. In my view, Carry is the most important factor in the 3 C equation, as the prospect of narrowing interest rate differential has hiked substantially this week. Yearly CPI has trenched in the 1.5-1.6 % region domestically, despite the uptick in global inflation. Now there is growing concern amongst investors that there is some risk of not hitting the midpoint of the RBA’s CPI forecast and will force the RBA to lower rates.

While the market is pricing a high probability of a U.S. hike in May, sentiment has shifted from a possible RBA rate hike bias to a greater chance of an interest rate cut. If a slowdown in Australian housing market unfolds as some expect, an RBA rate cut will be on the table in 2017 and as this likelihood becomes a reality look for the Aussie to move towards .7000.

I have been fairly consistent in my view of China the past few months regarding the possible adverse implications for Australia if the China-U.S. trade war escalates. However, without clarity on President Trump's Trade policy directed at China, we need to be extremely guarded on this view.The globalist in me hopes for a working agreement, but the pessimist in me is preparing for the worst.

Last week China's MLF(Medium-term Lending Facility) hike was a real game changer for Mainland interest rates. Even though the hike was minor, it nonetheless indicates the Pboc are clamping down on leverage and the ultra-accommodative monetary policy gauge is getting dialled down. Moreover, while it’s the SLF (short term lending facility) that sets interbank rates, there may be some feedback loop nonetheless. The onshore rate hikes will likely have negative implications for Chinese growth and demand, which could bubble over into the commodity markets, in particular, iron ore.

Keep in mind, surging iron ore prices and the prospects of rising domestic inflation have kept the Aussie dollar bears at bay since the U.S. election.