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Risk Assets Rally as Major Tail Risks Ease

The biggest tail risks impacting markets this year have cleared up; risk assets are rallying, while safe haven assets are selling off

During the North American session, US November retail sales will be reported

Russia central bank cut rates 25 bp to 6.25%, as expected

Bank of Japan released a mixed Q4 Tankan report

The dollar is broadly lower against the majors as tail risk evaporates.  Nokkie and sterling are outperforming, while Aussie and yen are underperforming.  EM currencies are broadly firmer.  KRW and RUB are outperforming, while THB and INR are underperforming.  MSCI Asia Pacific was up 1.6% on the day, with the Nikkei rising 2.6%.  MSCI EM is up 1.6% so far today, with the Shanghai Composite rising 1.8%.  Euro Stoxx 600 is up 1.7% near midday, while US futures are pointing to a higher open.  10-year UST yields are flat at 1.90%, while the 3-month to 10-year spread has risen 1 bp to +36 bp.  Commodity prices are mostly higher, with Brent oil up 1.5%, copper up 0.5%, and gold up 0.1%.

In one fell swoop, the biggest tail risks impacting markets this year have cleared up.  The chances of a hard Brexit have fallen dramatically after the overwhelming Tory election victory (see below).  Elsewhere, reports suggest President Trump has signed off on a Phase One trade deal that cancels the December 15 tariffs.  Furthermore, reports suggest the US offered to cut some existing tariffs by up to 50%. In exchange, China will commit to boost agricultural purchases and take more action to enforce intellectual property rights.

Risk assets are rallying, while safe haven assets are selling off.  US equity futures are up 0.4% on top of yesterday’s 0.8% gains, set to make new record highs. The European equity indices up around 1.5%. In Asia, the Nikkei closed 2.6% higher, while Chines and Korean stocks were up around 1.5%. Another way to visualize the renewed optimism is looking at the declines in equity volatility indices. The VIX (US) and V2X (EU) are sharply lower, quickly approaching the low for the year. The US interest rate volatility index (MOVE) and FX volatility indices are also lower, but the moves were less dramatic.

The US 10-year yield traded today near 1.95%, the highest since November 12.  The recent high near 1.97% beckons.  After that is the late July high near 2.0% and the mid-July high near 2.15%.  The dollar is taking a near-term hit from the risk-on party under way, but higher US rates and stronger US data should eventually underpin the greenback.

AMERICAS

During the North American session, US November retail sales will be reported.  Headline sales are seen rising 0.5% m/m while ex-autos sales are seen rising 0.4%.  The so-called control group used for GDP calculations is seen rising 0.3% m/m.  Early indicators such as Black Friday and Cyber Monday activity and automobile sales suggest consumption remains strong.  October business inventories (0.2% m/m expected) and November import/export prices will also be reported.  With the FOMC behind us, the media embargo has been lifted.  Today, Williams speaks.

The US economy is doing better than anticipated in Q4.  The Atlanta Fed’s GDPNow model currently estimates Q4 GDP growth at 2.0% SAAR, up from 1.5% previously.  Elsewhere, the NY Fed’s Nowcast model now has Q4 growth at 0.58% SAAR, down from 0.77% previously.  It also cut its estimate for Q1 growth to 0.66% SAAR from 0.98% previously.  The Atlanta Fed is likely overstating growth a bit and the NY Fed understating it, and we suspect the truth is somewhere in between.  Both models will be updated today.  Either way, we are far from recession and the Fed is right to pause this week to assess the landscape.

The Fed announced a massive program of term repo operations totaling $365 bln.  This will (hopefully) head off any year-end volatility but we suspect the Fed stands ready to act even more aggressively if needed.  In related news, the New York Fed named Daleep Singh as head of its markets group.  Singh was long-rumored for this important post and it’s good to know he will be in place when the year-end turn hits.

EUROPE/MIDDLE EAST/AFRICA

The results of the UK general elections are in.  Please see our piece “Three UK Election Takeaways” for our initial thoughts.  The pound is up nearly 2.0% against the dollar and 1.5% against the euro. Sterling broke above $1.3455, the 62% retracement objective of the April 2018-September 2019 drop.  It has since fallen back below but a clean break would set up a test of the April 2018 high near $1.4375.  UK equities are rallying and it’s worth noting the sharp contrast in sectors, with small-caps outperforming large-gaps and exporters underperforming. Yields are up 3-8 bps across the curve over the last two sessions.

Russia central bank cut rates 25 bp to 6.25%, as expected.  It said it would consider more cuts in H1 2020 as inflation continues to fall.  CPI rose 3.5% y/y in November, the lowest since October 2018.  If inflation keeps falling below the 4% target, further easing is indeed likely in 2020.  Yesterday, Russia reported Q3 GDP growth remained steady at 1.7% y/y, as expected.

ASIA

Bank of Japan released a mixed Q4 Tankan report.  Large manufacturing index came in at 0 vs. 3 expected and 5 in Q3, while large non-manufacturing came in at 20 vs. 16 expected and 21 in Q3.  The outlooks for large manufacturing and non-manufacturing largely mirrored the headline readings.  Large industry Capex spending is expected to rise 6.8% vs. 6.0% consensus and 6.6% in Q3.  However, it’s worth stressing that the survey was taken in the second half o November, before the latest fiscal stimulus package was announced.  While we may some improvement in sentiment in Q1 as a result, it’s clear from the hard data that Q4 is shaping up to be a very weak quarter.

USD/JPY is trading more in line with US-China trade developments than with domestic fundamentals.  The pair is trading at the highest level since December 2 and is testing that day’s high near 109.75.  Break above would set up a test of the May 30 high near 110 and then the May 21 high near 110.65.  Looking further out, the April high near 112.40 looms as the next big target.

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About Win Thin
Win Thin
Win Thin is a senior currency strategist with over fifteen years of investment experience. He has a broad international background with a special interest in developing markets. Prior to joining BBH in June 2007, he founded Mandalay Advisors, an independent research firm that provided sovereign emerging market analysis to institutional investors. He received an MA from Georgetown University in 1985 and a B.A. from Brandeis University 1983. Feel free to contact the Zurich office of BBH
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