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March: Going Out like A Lamb after Wrestling with a Lion

March:  Going Out like A Lamb after Wrestling with a Lion

Overview: The banking stress that roiled the markets this month has eased. However, the emergency lending by the Federal Reserve, vias the discount window and new Bank Term Funding Program hardly slowed in the past week ($152.6 bln vs. $163.9 bln). Money markets took in more funds. Almost $305 bln has flowed to them over the past three weeks. The US KBW bank index is up 3.75% this week coming into day (after pulling back 1.2% yesterday). Europe's Stoxx 600 bank index is snapping a four-day advance today but is up nearly 6.2% this week. The Topix bank index in Japan rose 2% this week.

Asia Pacific and European equities are finishing the month on a firm note, and US futures are slightly positive. Bond market are mostly little changed today. The 10-year US Treasury yield is near 3.56%, up a few basis points this week, while European yields are up 14-18 bp on the week. Two-year yields are up around 25 bp in Europe this week and about 16 bp in the US. The dollar is paring this week's losses today and is up again nearly all the G10 currencies. The Dollar Index is firmer but is poised to finish the week lower, and this would be the third consecutive weekly decline. Emerging market currencies are mostly higher against the dollar today, with the notable exception of eastern and central Europe. Gold is hovering near its best level for the week, reached today near $1985, before slipping toward $1973 as the US dollar recovered from its early weakness. May WTI is little changed around $74.25, which is near a two-week high and the (61.8%) retracement of the loss since the month's high (~$81) was recorded on March 7.

Asia Pacific

Tokyo's headline and core (excludes fresh food) inflation slipped a bit in March, though in line with expectations. It is a good approximation of the national figures, which are not released until April 20. The headline rate stands at 3.3% and the core at 3.2%. However, the challenge immediate challenge is coming from processed foods, while the government subsidies are masking energy inflation. Excluding fresh food and energy, Tokyo's CPI ticked up to 3.4% from 3.1% (revised from 3.2%). It is a new cyclical high. Separately, Japan reported February retail sales by jumped 1.4% after the January's gain of 0.8% (previously revised from 1.9%, oops). The median forecast in Bloomberg's survey anticipated a 0.3% increase, which was last year's average. Japan's industrialized production jumped back after crashing by 5.3% in January. It rose by 4.5%, easily surpassing expecting expectations of a 2.7% gain. The Lunar New Year skews not only Chinese economic readings but also many of its trade partners. Stronger Japanese exports in February (1.5% vs. -5.3% in January) point to a recovery in industrial output. Despite stronger than expected industrial production and retail sales, Japan's labor market disappointed. Japan reported its unemployment rate unexpectedly rose to 2.6% in February (from 2.4%) while the job-to-applicant ratio slipped to 1.34 (from 1.35). The ratio was in the averaged 1.61 in the 2018-2019 pre-Covid period and inflation was lower.

China's PMI is showing an economy in recovery. The manufacturing PMI eased to 51.9 from 52.6, and the non-manufacturing PMI rose to 58.2 from 56.3. Construction, as in infrastructure efforts, is included in the non-manufacturing PMI. The new orders sub-index for non-manufacturing rose to 57.3, the highest since 2007. The new orders for manufacturing eased to 53.6 from February's five-month high of 54.1.  New export orders slowed to 50.4 from 52.4. The composite rose to 57.0 from 56.4.  Last March, the composite stood at 48.8.   

Politics rivals economics for attention by the market and the focus may shift back to politics, given that the economic reports next week include only the Caixin PMI and likely March reserve figures. Given the dollar's decline this month and the rally in bonds suggests on a purely valuation calculation, the dollar value of Chinese reserves likely recouped the $51.3 bln decline in February plus a bit more. China has threatened to respond to the Taiwanese president's meeting with the US Speaker of the House in California. Taiwanese President Tsai-Ing-wen had proposed meeting the House Speaker in California rather than Taipei to minimize antagonizing Beijing. 

Separately, and likely to annoy Beijing, the Biden administration is considering an agreement that would end the double taxation, as the US has with many other countries. The problem is that the agreement typically takes the form of a treaty, despite the mental and verbal gymnastics, the US does not recognize Taiwan as a sovereign nation. An agreement with Taiwan that is reserved for sovereigns, even if not a treaty, would likely antagonize Beijing. Taiwan officials argue that the effective tax rate its companies' profits in the US is 51%, some 10 percentage points higher than South Korean and Australian firms for example, after accounting for withholding taxes on dividends that are setback to headquarters.

The dollar rose to almost JPY133.60 against the Japanese yen today. It is the best level since in two weeks. The JPY133.80 area corresponds to the (61.8%) retracement of the dollar's losses from the month's high near JPY138. The 20-day moving average, which the greenback has not closed above since March 9, is found around JPY137.35. A possible head and shoulders bottom (neckline is about JPY133) projects toward JPY136.50. The Australian dollar was bid to six-day highs near $0.6740 before stalling and being pushed back to reach $0.6670 in early Europe. Like last week, it was greeted by sellers as the 200-day moving average was approached (~$0.6750). A close below the $0.6660 area would weaken the technical tone. The greenback gapped lower against the Chinese yuan, mostly reflected its weakness in the North American afternoon yesterday. It fell to CNY6.8445, a new low for the week, before rebounding to nearly CNY6.8740. The PBOC again set the dollar's reference tight to expectations (CNY6.8717 vs. CNY6.8721). 


Although the aggregate CPI reading for the eurozone slowed to 6.9% in March from 8.5% in February, ECB officials cannot be pleased. The 0.9% month-over-month increase means that prices rose at an annualized rate of a little more than 6.0% in Q1. Moreover, the core rate (excludes food, energy, alcohol, and tobacco) rose to a new cyclical high of 5.7% (from 5.6%). If there is a kernel of good news in eurozone inflation, it is that Germany's is running especially hot. It means that Germany is not exporting deflationary forces, and other countries are gaining competitiveness. German CPI rose an annualized rate of more than 10% in Q1. French inflation rose slightly less than 10% at an annualized clip. The comparable pace in Spain was about 4.4% and Italy's harmonized CPI fell at an annualized rate of almost 2.5% in Q1.

The market is feeling more comfortable with an ECB hike at the May 4 meeting. The swap market shows that during the heightened financial stress the odds had been reduced to almost a 50% chance but is now near 90%. The market sees the ECB's terminal rate near 3.5% in late Q3 or early Q4. We suspect expectations may continue to recover toward 3.75%. Prior to the banking stress, the swaps market had discounted a peak rate of 4%. In the holiday-shortened week for most European centers, the highlight is the final March PMI readings. The preliminary estimate usually is sufficient close to the final report as to steal its thunder.

After running up to about $1.0925 yesterday, its best level for the week, but just shy of last week's $1.0930 high, the euro has steadied. It is consolidating above $1.0870. The intraday momentum indicator has turned back up in the European morning, but we suspect the upside is limited now ahead of the weekend. Still, the euro settled at $1.0760 last week and this week's ~1.2% gain is more than cumulative gain of the past three weeks. It is the fifth consecutive weekly rally. Sterling has been sold after poking above $1.24 for the first time in nearly two months. It was pushed back to almost $1.2350 before finding bids. Sterling settled near $1.2235 last week, and barring a stunning reversal in North America today, it would be the third consecutive weekly gain and the fourth in five weeks. This month, the low for the year was recorded near $1.18 (March 8) before recovering to the two-month high. The momentum indicators are stretched and the $1.2450 high from December and January offer formidable resistance. 


Today's highlight is supposed to be February's PCE deflator but don't be surprised by a non-plus market reaction. First, in this cycle, the CPI is more important even though the Fed targets the headline deflator. It is taken for granted that the headline rate eased, while the core rate is proving sticky. There seems to be a consensus expecting lower housing cost to begin showing up around the middle of the year, and that this will moderate measured inflation. Second, the Fed will see another CPI and PCE report before it meets again in early May. By the time it meets then today's data is less relevant. Third, in terms of the Fed's reaction function price pressures clearly remain elevated and, all things being equal, there still seems to be a majority thinking that additional rate hike are desired. The problem is the key to the extent of the Fed's work that lies ahead is now seen as a function of the extent and duration of the tightening of lending. And that will not be learned today. 

Canada's January GDP is too old to elicit much of a market reaction. It does underscore, though, the Bank of Canada's acknowledgement that the economy is doing better early this year than it expected. The 0.4% expansion of the median forecast in Bloomberg's survey would be the best since last March and would roughly match the growth of the last third of 2022. The Bank of Canada estimates that the economy will grow by 1.0% this year. The IMF is more optimistic and puts Canadian GDP at 1.5%. this year. The market (median forecast in Bloomberg's survey) is more pessimistic at 0.8% (up from 0.6% last month). 

As expected, Mexico's central bank lifted the overnight target rate by 25 bp to 11.25%. After falling to MXN18.05 in the European morning yesterday, the dollar recovered to new session highs (~MXN18.1625) early in North American morning before sliding back toward the lows before the decision was announced. The dollar bounced a little through MXN18.12 and stabilized in the MXN18.08-10 area. After last month's surprise 50 bp hike, the central bank signaled a smaller move. This time it changed its forward guidance to greater dependency on incoming inflation developments, which it characterized was on a "stable trajectory."  Its updated forecast sees this year's CPI at 4.8% at the end of year, down from 4.9% in February's forecast. The core rate forecast was unchanged at 5.0%. The central bank does not meet again until May 18. The swaps market thinks it’s done. Still, as we suspect the risk of another Fed hike is greater than the market has discounted, by extension, the same may be true of Banxico. That said, March CPI will be reported next week (April 5). It has already been reported that CPI in the first half of the March ticked down (7.12% vs. 7.48%). As widely expected, Colombia's central bank also delivered a quarter- [point hike (to 13%). Its inflation was at nearly 13.3% in February. Like Banxico, the Colombian central bank conditioned policy on the performance of inflation. The swaps market thinks it is done.

The Canadian dollar is the strongest G10 currency this week. With today's slippage it is still up nearly 1.5% on the week. Initially, in Asia Pacific, the Canadian dollar extended the week's gains before reversing lower. The US dollar held support near CAD1.3500 and recovered to around CAD1.3565. Yesterday's high was by CAD1.3580, where this week's average is found, and a move above there, and especially a close, would sour the near-term tone. Some momentum indicators are stretched, warning of the risk of some retracement. Meanwhile, the greenback has returned to yesterday's lows against the Mexican peso near MXN18.05. The dollar snapped a five-day decline yesterday and eked out a negligible gain (~0.02%). Even if central bank is done tightening, which may not be the case, the carry is very attractive. The momentum indicators show scope for additional peso gains. That said, while volatility (another important element of carry strategies) has pulled back from the spike above 15% earlier this month, remains elevated near 12.7%. Before the financial stress struck, the benchmark three-month implied volatility was closer to 11.0%-11.5%.

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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