Risk Appetites Return - For The Moment

The US 10-year yield backed off from the test on the 2% threshold and was around four basis points lower near 1.92%. European benchmark yields were 3-5 bp lower. The dollar softened by as much as 0.25%, led by the Scandis and the Antipodeans. Emerging market currencies were also mostly firmer, with the JP Morgan EM FX index rising for the third session.

Gold was pushing higher for the fourth consecutive session to test $1830. After falling about 3.25% in the past two sessions, March WTI was stabilizing above yesterday's low near $88.50. After steadying yesterday, US natural gas prices were near two-week lows, while Europe's benchmark was firm after falling 7.5% over the last two sessions. Iron ore was snapping a six-day advance, while copper was under pressure for the third consecutive session.

The Bank of Japan's absence continued to be notable. Many expected the central bank to step in to buy bonds to defend the upper end of the 10-year yield bond at 0.25%. However, they have been patient, and may even allow the yield to rise above the cap, if it thought it would be for a short time. The BOJ has its next scheduled purchases for Feb. 16. Officials seemed confident that it had the tools to enforce the cap if needed, including fixed rate operations. 

Chinese officials warned against false price disclosure in the iron ore market, which may have triggered today's sell-off from five-month highs. Ideas were that strong infrastructure efforts and easier monetary policy helped drive the metal higher. Officials warned against speculation and fraudulent price information last month. Iron ore had extended its rally when Chinese officials postponed the deadline for "peak-emissions" in the steel sector by five years to 2030. 

The dollar reached the high from late January just shy of JPY115.70 before coming off. The lower yields were offsetting the risk-on impulses from equities. The $780 mln option that expires today at JPY115.80 looked "safe." There was another option for $725 at JPY115.00 that may be more at risk today, but we saw support ahead of it, near JPY115.20.

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The Australian dollar was testing last week's high near $0.7170, where a A$605 mln option expires today. A move above $0.7180 targeted the $0.7230 area initially but could lift technical tone and spur a retest of the year's high around $0.7315.

The Chinese yuan strengthened a little today, recouping yesterday's minor slippage. The PBOC set the dollar's reference rate slightly lower than expected, CNY3653 vs. CNY6.3659. The dollar appeared to be in a CNY6.35-CNY6.37 near-term range.

The ECB has used about 1.65 trillion euros of its 1.85 trillion "envelop" for the Pandemic Emergency Purchase Program that was set to end next month. Several countries have sold long-term bonds this week, including 30-year bonds from Spain, the EU's Next Generation fund, and Germany (today). The UK sold 50-year bonds.

One of the focuses at next month's ECB meeting will be on the updated forward guidance about its pre-existing bond purchases program, APP. Under APP around 20 bln euros a month were being bought and this was going to double to smooth the transition from the end of PEPP. Meanwhile, France's Villeroy joined ECB President Lagarde in trying to temper the response the ECB's "hawkish pivot."

Press reports suggested the crisis in eastern Europe may be entering a new phase. Pressure may be mounting on Ukraine to implement that Minsk agreement that required the reintegration of the Russia-controlled separatist regions. It has been terribly unpopular in Ukraine and could trigger a collapse in the government. Russia had tended to keep the US central to the talks, but Europe has been pushing ahead and tomorrow's meeting in Berlin (Germany, France, Ukraine, and Russia) could potentially be important.

Separately, Russia reports January CPI later today. It is expected to accelerate and spur a 100 bp rate hike when the central bank meets at the end of the week. It has raised rates at its last seven meetings. The rate target has doubled from 4.25% to 8.50%. The central bank was expected to deliver another 100 bp hike (as it did last December and July). With this hike the market was expecting the tightening cycle to be over or nearly so. A resolution of the crisis could see foreign investors buy Russian bonds.

The euro continued to consolidate after last week's surge. Yesterday's dip below $1.14 did not spur follow-through selling and the euro was trading quietly in yesterday's range (~$1.1395-$1.1450). It was hard to get enthusiastic about the price action. Large options at $1.15 expire over the next two sessions.

Sterling was firm near $1.3585. This brought last week's highs (~$1.3615-$1.3630) into view. However, the intraday momentum indicators were getting stretched, suggesting limited scope for gains in early North America turnover. Tomorrow, the UK reports its first estimate of Q4 GDP (~1.1% quarter-over-quarter expected, the same as Q3.) That said, the economy appeared to have lost some momentum at the end of the year, and this should be reflected in the December details. 

The Fed's Bowman and Mester speak today ahead of tomorrow's CPI report. The odds of a 50 bp hike next month was off its peak above 40% and was slightly below 30%. No Fed official had explicitly endorsed such a move, and several have argued against. Today's mortgage applications and wholesale inventories would not be what moves the capital markets.

The EIA boosted its estimate for US oil production this year and next. Next year, it anticipated that the 2019 record of 12.3 mln barrels a day would be surpassed. It now projected output of 12.6 mln bpd. While large shale producers were stepping up their investment plans, it was still modest by 2019 standards. Several were returning more to shareholders via buybacks and dividend increases.

Oil prices were still vulnerable to a change in tensions in Eastern Europe and progress in negotiations with Iran. Meanwhile, OPEC continued to struggle to meet its output goal, and reports indicated that Russia missed its quota last month. API saw a 2 mln barrel drop in US inventories, while the EIA was expected to report a 1.2 mln barrel build. Note that Canada has been the largest oil supplier to the US and its inventories were also running low. India, the Netherland, and Canada were the three biggest destinations for US oil exports.

Mexico and Brazil report January inflation figures today. Mexico's CPI may slip for the second consecutive month, but it was expected to remain above 7%. The central bank meets tomorrow. Economists were expecting a 50 bp hike by Banxico as the new governor takes the helm. The swaps market had a little more than 100 bp tightening priced in for the next three months and 200 bp over the next 12 months.

After easing in December, Brazil's IPCA inflation measure likely ticked up last month. While it may stay off its 2021 peak of 10.74% in November, it likely remained above 10% for the fifth consecutive month. The swaps market had another 200 bp of tightening discounted for the next six months but anticipated a cut by the end of the year.

Brazil also reports December retail sales figures. This is the other side of the economy. The real economy is weak. It contracted in Q2 and Q3 21. It may have stagnated in Q4. Retail sales were expected to have fallen by 0.6% in December. Separately, note that a drought is stressing Brazil's soy harvest and driving up US prices as the other major source of supply. US soy export orders were strong.

The US dollar built a base in the CAD1.2650-CAD1.2660 area. Note that Friday, options for more than $2.7 bln expire at CAD1.2650. A break may find support around CAD1.2600. On the upside, initial resistance was seen in the CAD1.2720-CAD1.2730 area which held about $735 mln in expiring options.

The greenback was offered against the Mexican peso. It was testing the lower end of its recent range near MXN20.50. The next area of support was around MXN20.43. Meanwhile, the dollar may break out lower against the Brazilian real, where it closed yesterday near BRL5.26. Below there, support was by BRL5.20.

Written By: Marc Chandler