Collective Sigh of Relief Ahead of the Weekend

Like a car ignition that finally catches after several attempts, the global markets are building on the recovery seen in North America yesterday.   Asian stocks rallied, with the Nikkei leading the way with a 5.9% rally.  More modest 1.25% gains in Shanghai Composite allowed Chinese stocks to finish the week with small gains.  Australian, Korean, and Thai shares have also finished higher on the week.  European bourses are higher, and the Dow Jones Stoxx 600 is up 2.5%.  Not only is it poised to post a weekly advance but so are most of the major markets, except Italy, which had been a star performer last year.

Core bond yields are highs, including a three bp rise in both 10-year Treasuries and Bunds.  Peripheral European bond yields are off 4-9 bp.   Oil prices are extending yesterday's gains.  Brent is flirting with $31 after finishing last week below $29.  The spread between Brent and WTI is a few cents.  On Wednesday, the March light sweet crude contract reached a low near $27.55.

There are two main drivers.  First there is a widespread sense that the moves in the market had taken a life on of their, unhinged from fundamentals.  However, given money management considerations, few buyers wanted to step into the fray.  Reports suggest there are high levels of cash to be deployed, and the sharp sell-off since the start of the year has created opportunities for The value investors.

Second, to the extent that there was a fundamental consideration, it may have been that many participants thought the central banks were done.  What was seen as timid action by the ECB last month, and apparently operational tweaks by the BOJ, with the Fed hiking, may have given the impression that officials no longer had the ability and/or willingness to do more to support asset markets (which also means compressing volatility).

However, in recent days, three things have happened.  First, the Fed funds futures market had discounted not the four hikes the Fed has suggested, or even the 2-3 hikes that we thought likely, but a single hike this year.  Second, there have been some reports, albeit conflicting, suggesting that the Abe government may encourage the BOJ to ease policy further.  Yesterday Draghi was clear.  The ECB has the desire and ability to achieve its mandate and unequivocally signaled that the March meeting was live in the sense that its policy options would be reassessed.

The US dollar is mixed.  The Canadian and Australian dollars are building on yesterday's gains.  They are 2.5% and 2.3% higher on the week at pixel time.  The recovery in oil prices has helped the Norwegian krone recover too.  It is up 1.2% on the week against the dollar, and nearly 2% higher against the euro. Most of the emerging market currencies are higher on the day, thought here is a pocket of weakness in central Europe (Bulgaria, Romania, Czech, Turkey), though not Poland or Hungary.

On the other side are the funding currencies, like the euro, yen and Swiss franc.  They have a clearly weaker bias today.  After briefly slipping through $1.08 in response to Draghi, the euro recovered yesterday to $1.09.  It was pushed lower in Asia and has largely been confined to a $1.0815-$1.0865 range since the Asian morning.   At $1.0840, the euro is off 0.7% on the week.

The dollar dipped ever so slightly below JPY116 in the middle of the week.  A note of concern from the Japanese government coupled with the rise in US yields and equities has seen the greenback bounce to the upper end of the range seen in the past two weeks near JPY118.30.

We suspect money management is trumping the fundamentals today.  This is most evident with the disappointing UK retail sales.  The 1.0% decline at the headline level was more than three times larger than the consensus forecast, and the November series was revised to 1.3% from 1.7%.  The year-over-year rate fell to 2.6% from a revised 4.5% in November (initially 5%).  This is the slowest pace since September 2014.

Excluding auto fuel does not really change the picture.  The decline in December was three times greater than the market expected and the 2.1% year-over-year rate is the lowest since November 2013.  Still, sterling is building on yesterday's potential key reversal (made new lows for the move and then closed above Wednesday's high).   UK yields are also higher across the curve in a bear flattening move.

The market also appears to have taken the disappointing eurozone flash PMI in stride. The manufacturing PMI fell to 52.3 from 53.2.  The market had expected a smaller decline.  The service PMI slipped to 53.6 from 54.2.  The Bloomberg consensus called for an unchanged reading.  Combined the composite fell to 53.5 from 54.3, which is the lowest since last February. 

The North American session features both US and Canadian data.  In the US, the main interest will be in the existing home sales report.  A snap back after the 10.5% decline in November is anticipated.  Leading Economic Indicators for December may have fallen for the first time since August.