The US dollar remains on the defensive. One would never know looking at the price action in the capital markets the earlier this week, new Fed Chair Yellen made it clear that the tapering course that Bernanke put the Fed on at the end of last year will continue barring a significant deviation from its expectations or that a week ago the German Constitutional Court opined that the OMT was likely violating EU Treaty, though referred it to the European Court of Justice. Or that Italy's weak center-left led government collapsed, not because of the rise of some anti-EU force, like the 5-Star Movement, or a resurrection of Berlusconi, but rather because of the center-left's own internal divisiveness.
The US Dollar Index is just above the year's lows seen at the very start of the year. Sterling is at new highs for the year, extending this week's gains to 1.8% to lead the major currencies, all of which have gained against the dollar this week. The yen has gained almost 0.5% against the US dollar this week, even though equity markets rallied (even though today's 1.5% decline in the Nikkei cut the weekly advance in half) and the US 10-year premium over Japan increased by 6.5 bp this week. The dollar bounced off the JPY101.50 support we had identified, but has failed to resurface above the JPY102 area, warning perhaps this week's decline may not be over.
The euro has gained above 0.4% against the US dollar this week and managed to trade today above $1.3700 for the first time in almost three weeks. It is has straddled this area through the European morning. The next immediate target is the January 24 high near $1.3740, which also corresponds with a retracement target of the decline from the $1.3900 level approached on December 27.
Euro area countries did report somewhat better Q4 GDP figures today, including Italy, Spain, Portugal and France. Growth for the region was estimated at 0.3% quarter-over-quarter pace, lifting the year-over-year pace to 0.5%, which is the first positive reading since Q4 11. While the preliminary data is good, it is unlikely to change Draghi's assessment of the recovery as weak, fragile and uneven.
As we noted yesterday, Italian markets have not be disrupted by the likely swap of Renzi for Letta. Italy's 10-year bond yield is off a basis point, in line with Spain and narrowing the spread over Germany. The 2-year yield is off 2 bp, also in line with Spain and reducing the premium over Germany. The FTSE-MIB is up 1%, leading the major European bourses higher and reaching new 3-year highs.
Talk suggests that Renzi had grown fearful that the electoral reform, which changes the voting system to favor large parties (coalitions) and changes the function of the Senate to internal regional issues, would get stuck in the political paralysis felt compelled to push Letta out. Yet, arguably the fact that Renzi struck a deal with Berlusconi on electoral reforms, which will deal a significant blow to the Letta's junior coalition partners, added to the policy paralysis, as did his constant criticism of the Letta government. Now Renzi is likely to have to deal with those same coalition partners.
Once again the trials and tribulations on the center-left create more space for Berlusconi, who can pull his support for those very electoral reforms. Polls suggest that the center--right could win the election if it were held now, which seems impossible without electoral reform since the judicial ruling said the current system, adopted by Berlusconi, is not legitimate. Renzi would not only be the third consecutive prime minister that has not been elected, but since 1992, only two of the Italy's nine Prime Ministers have been elected, Berlusconi and Prodi.
Moody's could make a statement on Italy today. No statement would be understood as affirming its current ratings and outlook. The political climate cannot be considered a net positive, but yields are low and falling. This week, Italy auctioned 1- and 3-year paper at record low yields. The debt servicing burden has fallen. This is a net positive.
The main economic data from Asia was China's inflation figures. CPI was unchanged at 2.5%. Many had expected a 2.4% pace. Food inflation to 3.7% from 4.1%. Non-food inflation ticked up to 1.9% from 1.7%. The main take away is that inflation is not a significant issue for Chinese officials. Credit and debt appear to have replaced inflation as the main issue. Deflation in producer prices continues with a 1.6% decline after a 1.4% decline in December. Weaker commodity prices and excess capacity appear to be the main drivers.
Japan's weekly MOF flow data show an extension of the recent patterns. Japanese investors sold foreign bonds for the sixth consecutive week (through February 7). Foreign investors have sold Japanese shares for the third consecutive week and four of the past five weeks. This is the most persistent selling since before the election that brought Abe back to power was announced in October-November 2012. There are at least three flows then that have helped fuel the yen's rise. Japanese selling foreign bonds, foreigners unwinding short yen hedges on equity purchases, and speculators (drawing from CME currency futures data) reducing shorts.
The US reports import prices and industrial production. Import prices are expected to remain soft. The year-over-year decline is expected to have fallen to -1.8% from -1.3%. Often we have suggested that a surprise on import prices could warn of a surprise on producer prices. This is not the case now. Officials will announce significant revisions to the PPI time series that will present a break. The announcement of the revisions is likely today ahead of next week's January report. The risk on industrial production seems to be slightly on the upside, as economists may have under-estimated utility output. Manufacturing itself is likely to cool after a very strong Q4 and inventory accumulation.
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