It was relatively quiet start to the week with the US out on Monday and China celebrating Lunar New Year. This was until Wednesday where we had a number of key data prints from the UK and EU, and the FOMC minutes: which appeared to highlight the upside risks to US inflation. The yield on the 10-year UST endured a rollercoaster ride through the week, eventually closing marginally lower at 2.87%, and the dollar found its feet once again, gaining 0.88%.
In terms of the UST moves, we note that longer-dated Treasuries have outperformed shorter-dated in the last five tightening cycles - with the natural effect of higher rates (in due course) dampening both inflation and economic growth. And with the long-run dot plot implied Fed Funds Target Rate still at a modest 2.75% it seems unlikely there would be enough lasting shifts in forecasts to push the longer-end of the Treasury curve much beyond its recent highs. Global growth and inflation have of course picked up, and we continue to monitor these indicators closely along with our model forecasts, but we still see a number of factors that should limit further upside in both of these. Interestingly, Minneapolis Fed Governor Neel Kashkari, noted his concerns over the long-term shift towards greater inequality in the US, arguing that three-or-more hikes could, in fact, stifle consumption and growth; as millions of borrowers will have to deal with servicing higher debts costs, resulting in a contraction in consumption. This is something to watch, as despite the current ‘tight labour market’ a huge number of Americans are still unaccounted for in official job data.
Elsewhere, the renminbi was one of a few currencies to appreciate against the dollar, and the yen traded slightly weaker last week. So far this year the offshore Chinese renminbi has appreciated 3.30% in spot terms against the dollar (4.00% total return); despite sceptics’ calls for a ‘devaluation of the currency in order for the country’s exports to remain competitive’. Although the dollar has broadly remained on the back-foot this year, the RMB continues to trade stronger than its CFETS benchmark; which includes 24 currencies, expanded from 13 currencies in 2016. Aside from the weaker dollar, there are a couple of other factors holding the RMB at current strong (but still undervalued) levels, these include: China’s strong economic fundamentals, continued evolution of the capital flow regulation, tightly managed monetary policy, and the increased internationalisation of the currency. Comments from the PBoC adviser Fang Chang this morning - that policymakers are unlikely to intervene in the currency market if volatility remains stable and within range - will likely support the redback.
Some positive news came in late on Friday when Fitch affirmed its BBB- rating for Russia, with a stable outlook. However, more importantly, S&P upgraded the country’s long-term rating by one notch from junk status to BBB-, stable outlook. The country’s sovereign bonds, therefore, qualify for inclusion in most major bond indexes. Some yield-starved investors will be very pleased, as the 10-year USD and local benchmarks offer yields of 4.24% and 6.93%, respectively (at time of writing). We do not invest in Russian sovereign paper currently as we prefer hard currency quasi-sovereign bonds which are of strategic importance to the government, thus have been supported in the past if needed, and offer much wider spreads to similar sovereign issues.
This week’s main focus will be Fed Chair, Jerome Powell’s testimony before the House, where he will present his first semi-annual monetary policy report; we expect little deviation from Yellen’s preset gradual course, at this stage. Market focus will then shift to the Fed’s favoured PCE readings for January, on Thursday. The PCE Deflator reading is expected to remain unchanged at 1.7%yoy despite a pick-up in the mom reading; so still below the Fed’s 2% target.
Ahead of that, on Monday we will get the Chicago Fed National Activity Index reading for January; expected to remain within range. US New Home Sales could garner some attention with buyers rushing to lock in mortgage rates ahead of the further touted rate increases. On Tuesday, US retail inventories and durable good readings could be of interest; with market expectations for a fall in the latter, in January. A busy day on Wednesday kicks-off with a number of official China PMI readings, for February, expected to be softer due to the timing of the Lunar New Year. The second estimate of Q4’17 US GDP will grab market attention, especially as the consensus is for marginally softer annualised growth. German unemployment, France GDP, the Chicago PMI and Japan’s IP and retail sales will also be watched closely. The Caixin China Manufacturing PMI will be released in the early hours of Thursday. US personal spending and a series of ISM readings may be of interest, however, market focus will be on the aforementioned PCE readings and U.S. Transportation Secretary, Elaine Chao’s testimony to Senate on Trump’s infrastructure plan. A relatively quiet Friday will see a series of sentiment readings out of the US, ahead of that BoE Governor Mark Carney will speak at the Scottish Economic Conference. All the while, Brexit negotiations ensue.