After several days of losses, stock markets recovered somewhat Monday and the fear level subsided. The S&P 500 opened higher and stayed in positive territory all day long, ending up 1.7%. This morning, most stock markets in Asia are higher as well. The S&P 500 has now regained 42% of the ground that it lost during the recent plunge. With the recovery, the VIX index – the so-called “fear gauge” – has receded from its recent peak of 50.30 back to 25.61 – which is still a high level well above the 14-15 average for the last five years.
With a lower level of fear came a lower level of “flight to safety” into the dollar and USD retreated somewhat. There was also some disappointment in Trump’s infrastructure plan, which seems unlikely to ignite the kind of spending that had previously been expected. That weighed on Treasury yields and thereby pressured the dollar.
The curious part of today’s market is the good performance of both AUD and JPY. Ordinarily, a risk-on environment could be expected to push AUD higher but JPY lower. The rise in iron ore prices also helps to explain the continued recovery in AUD. The question then is why JPY also firmed despite media reports that PM Abe was likely to reappoint Bank of Japan Gov. Kuroda to another term – Kuroda being the architect of the BoJ’s massive stimulus program, which has been weakening the yen. The move may have reflected the fall in Tokyo stocks, although comments on the stock market suggested that stocks were following the currency market, not the other way around. Finally, both moves may be due just to the weaker dollar, although it’s notable that CHF, which is also a risk barometer, fell.
GBP was the big loser of the day despite the view of both the Bank of England speakers yesterday that interest rates are likely to rise more rapidly than they had previously expected. It’s no surprise that Brexit fears are dominating economic expectations, since Brexit snafus have the potential to alter economic policy.
We get the first of this week’s inflation data this morning as the UK releases its various inflation measures. Headline inflation and producer price inflation are both expected to slow, but core inflation is forecast to accelerate slightly. Which is the most important? My research shows that the subsequent market movement is most closely correlated to the core CPI measure, the green line in the graph below, which makes sense as that’s the one that the Bank of England targets. In this case, it suggests that even though the headline figure might show slower inflation, the data is likely to be positive for the pound.
The UK house price index, issued by the UK Land Registry, gives the change in the average price for all houses. It’s not the most closely watched of the UK’s many house price indices, but it is one of the more official. It’s expected to show a continued deceleration in the rate of growth of house prices, but of course this masks a great variety in the performance of the various regions. As we all know, there are three things that determine the price of real estate: location, location and location. In any event, a slower appreciation in house prices means a reduced wealth effect for those who own their houses already, and so is likely to be negative for the pound.
The US National Federation of Independent Businesses (NFIB) small business survey is expected to show a slight improvement in sentiment. Moreover the hiring component of the survey, which is released before the overall survey results, already showed hiring intentions stabilizing at just slightly off the record high recorded in November. That’s an amazing statistic, seeing as a) most people in the US work at small companies, and b) we’ve had 88 consecutive months of increases in the nonfarm payrolls already. Improved sentiment among smaller businesses would usually be positive for the dollar, but if it suggests faster inflation and therefore faster rate hikes, the implications could be difficult to forecast. I would say that even now, if the number pushed stock prices down, that would cause risk aversion which as we saw last week can also be positive for the dollar.
Cleveland Fed President Loretta Mester will discuss monetary policy and the economic outlook at the Dayton Area Chamber of Commerce. This is not the Economics Club of New York so don’t expect any new revelations on the mechanics of linear quadratic Gaussian rational inattention tracking problems (the title of a Fed paper last year). Mester is one of the more hawkish people on the FOMC and is also a voting member, so her views are significant. When she last spoke (around 19 January) she said she preferred “three to four” rate hikes both this year and next – at the top end of the FOMC’s range.
Overnight, the first estimate of Japan’s Q4 GDP will be released. It’s expected to show a notable slowdown in growth. Nonetheless, it would be the eight consecutive quarter of positive growth, which for a country like Japan, with a shrinking workforce, is pretty good. Remember that growth = change in the number of people working X increase in their productivity. So even if everyone is working more productively, overall output can shrink if the number of people working shrinks. Moreover, the figures are expected to show an increase in the contribution to growth from domestic demand, which is a more significant indicator of the health of the economy than external demand, which they can’t do much about. I would think the figure will be positive for the yen even if it does show a slowdown in growth.
Then early Wednesday as the European day gets started, Germany announces its first estimate of 4Q GDP. The qoq growth rate is expected to slow slightly, while the yoy rate is forecast to return to the Q1 & Q2 rate. In short, the figure probably will not show as strong growth as in Q3 but nonetheless will demonstrate that growth in Germany remains at a healthy level, supported by both domestic and overseas demand. This should give the ECB more confidence about raising interest rates – particularly with a new Finance Minister taking office in Germany who may not be so worried about fiscal rectitude. EUR-positive.
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