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Fundamental Analysis 18.05.2018 – Market Outlook

Market Recap

Rising Treasury yields exerted their influence on the FX market and the dollar rose.

The US data was good – following the better-than-expected Empire State manufacturing index earlier in the week, the Philadelphia (Philly) Federal Reserve System (Fed) index unexpectedly rose 11.2 points (a 2.2-point decline was expected) to the highest level in a year. New orders surged, which implies that manufacturing will remain strong in coming months, and the prices received index rose to the highest level since 1989, implying upwards pressure on inflation. The Conference Board’s leading index rose for the seventh consecutive month and the four-week average of initial jobless claims edged down a new low. While higher yields weighed on the S&P 500, which closed slightly lower, the Russell 2000 index of small-cap stocks hit a record high.

Nonetheless, looking at the timing of the Treasury market moves, they don’t seem to have been so directly influenced by the data – rather, it appears that yields started to drift higher around 2 PM New York time. We’ve seen similar action many times in the last few week.

Given the rise in Treasury yields and USD/JPY’s sensitivity to US interest rates, it’s no surprise that JPY was the biggest loser on the day. The yen weakened steadily throughout the day, helped this morning by the announcement of a larger-than-expected slowdown in Japan’s inflation rate. JPY is expected to continue to weaken as US yields over 3% prove attractive to Japanese investors. US 5-year nominal yields are now higher than the 10-year yields of any other G10 currency.

CAD was lower as the US administration failed to meet yesterday’s Thursday 17th of May 2018 deadline to notify Congress about a North American Free Trade Agreement (NAFTA) agreement. Now any agreement will have to be approved by the new Congress that’s seated in January 2019, if indeed they can reach agreement at all. With a Mexican presidential election coming up on the 1st of July 2018, it  will be increasingly difficult to reach an agreement. US Trade Representative Robert Nighthizer said the countries are “nowhere near close to a deal.” With the Consumer Price Index (CPI) expected to remain steady today (see below), we could see further weakness in CAD.

The Italy situation seems to be clearing up a bit. Reports surfaced yesterday that the final agreement between the League and 5 Star Movement wouldn’t include asking the European Central Bank (ECB) for debt relief to Italy nor would it call for Italy to leave the euro. But a larger fiscal deficit and greater bond issuance does seem likely. The League’s leader said Monday 21st of May 2018  would be the “make or break” day for the discussions between the two parties. Italian spreads over Bunds fell by 4 bps, but this hardly makes a dent in the 20 bp jump on Wednesday 16th of May 2018, implying that the market isn’t totally reassured yet.

Today’s market

The day starts with a speech by Cleveland Fed President Loretta Mester on macroprudential and monetary policy at an European Central Bank (ECB) conference on the topic. She’s a voting member of the Federal Open Market Committeee (FOMC) and one of the more hawkish members. She just spoke a few days ago and said that a) inflation hadn’t yet reached the 2% target on a sustained basis (even though it has actually reached the target), and b) it might be necessary for rates ultimately to rise higher than she had previously anticipated.

After that, it’s pretty much Canada Day. These are the last major Canadian indicators before the Bank of Canada meeting on the 30th of May 2018 and so will be closely scrutinized.

Canadian retail sales are forecast to grow more slowly than in the previous month, but still at a pace above the recent trend. The figures are expected to be taken as encouraging and could therefore be modestly positive for CAD. 


However, there’s little doubt that the Canadian CPI, which is released at the same time, will be the more important indicator. Canada has a bewildering number of ways of measuring inflation, but almost all of them are expected to show the rate of inflation staying the same (except for the “CPI core – trim yoy%”, which is forecast to accelerate to 2.1% yoy from 2.0%). In theory no change in inflation should mean no change in currency expectations either, but what we saw last week with the US CPI was that an unchanged CPI can lead to a fall in the currency which could be negative for CAD.

The Fundamental Analysis is provided by Marshall Gittler who is an external service provider of Claws and Horns (Cyprus) Limited, 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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