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Fundamental Analysis 22.01.2018 - Market Outlook

The US government shut down on Friday 19th January 2018. However, the impact of the shutdown faded quickly. While USD opened lower in Asian trading, it quickly recovered and at the European opening is trading higher against all G10 currencies except JPY, which is slightly (5 pips or so) higher than on Friday 19th January 2018 morning. The Senate will vote again today on a plan to fund the government through to 8th February 2018 while talks continue, but the Democrats have rejected this idea.

Why isn’t the shutdown hurting USD, especially since the big risk to EUR – the possible failure of the CDU/SPD coalition talks – has passed? It is perhaps that past shutdowns didn’t have that much impact on the US economy or markets. The graph below shows the performance of the S&P 500 index during the last three shutdowns. As you can see, in all three cases the stock market was higher at the end than at the beginning – substantially so in the case of the longest shutdown!

Investors may well be thinking that as long as the economy is healthy and the stock market is going up, the Federal Reserve is likely to raise rates in March 2018 as expected. 

How long will the government shutdown last? There’s no agreement at all on that. Previous shutdowns have ranged from one day to 17 days (median 4 days, average 7). 

The problem is that both sides seem to believe that the other side will be blamed for the shutdown and may think that they can win points with the voters by applying pressure and forcing the other side to capitulate. That makes negotiations unlikely, much less compromise.

Moreover, there are only two events that could force a resolution, and both are unlikely for some time. The first is a sharp fall in the stock market. Previous shutdowns had little effect on corporate earnings or overall economic growth and so should have little impact on stocks. 

The second is default on the US debt. The shutdown affects only discretionary spending, not mandatory payments. Failure to raise the debt ceiling would prevent repayment of US debt, and that won’t be a problem until sometime in March 2018. The big question is whether this stalemate is simply a preview of what we’re going to see when it comes time to raise the debt ceiling, which is a much more serious event for the markets.

The Treasury market has started to worry about this question as the yield of T-bills maturing after 1 March 2018 have started rising relative to ones maturing earlier. Note that the biggest movement was in the bill maturing in early March, indicating that again, the market thinks even if the government fails to raise the debt ceiling on time, the problem won’t last that long.

Elsewhere, CAD was the biggest loser over the last 24 hours as markets braced for the next round of The North American Free Trade Agreement (NAFTA) talks, which begin tomorrow in Montreal. 

Today’s market

Moving onto the events of the day, there are few indicators.  The big economic event on the schedule is the Bank of Japan (BoJ) meeting scheduled for Tuesday morning 23rd January 2018 Tokyo time and BoJ Governor Haruhiko Kuroda’s press conference afterwards.

As you can see from the graph, the market hasn’t changed its view much recently about the likelihood of a change in rates this year. Since October 2017, the odds that rates are unchanged at the end of this year has ranged between 49% and 77%, with an average of 68%. It currently stands near that average at 63%. So there's a likelihood of any change at this or indeed any of the next several meetings. 

The question the market has is whether the BoJ will change its target for the 10-year Japanese government bond (JGB), which it aims to keep around 0.0% as part of its “yield curve control” (YCC) program. Some possibilities are: 1) shifting the target to 5-year JGBs from 10yrs; 2) raising the target yield; or 3) shifting to a target range. 

However, with core inflation still well below target (0.3% yoy in Nov, vs the 2% target). On the contrary, I expect BoJ Governor Haruhiko Kuroda to use his press conference to try to stop any talk of change in the YCC program. Expectations that the yield curve might steepen could compromise the effectiveness of the YCC policy, cause the yen to appreciate, and thereby weaken the impetus for higher wages just ahead of the annual spring “wage offensive.”

Today’s indicators

Otherwise, very light schedule today. Canadian wholesale trade is in the schedule.

The Chicago Federal Reserve national activity index is a significant indicator for USD, even though like the leading index it’s really a summary of already-released indicators of national activity (85, in this case). It’s different than the other regional Federal Reserve indices, which evaluate economic activity in that particular region. The index is expected to rise slightly. Ordinarily that might be positive for the dollar.

The Fundamental Analysis is provided by Marshall Gittler an external service provider of an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.
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