Appetite for risk returns as Russia brings (some) troops back to bases

Overview: Russia's decision to return some troops to their bases following the completion of some military exercises has stoked a relief rally in equities, while weighing on the dollar, gold, and oil. The announcement was made too late for most Asia Pacific bourses, but those open late, like India, are benefitting. A boost in China's policy loans help lift the local shares. Europe's Stoxx 600 is recouping around half of yesterday's 1.8% loss, while the US S&P and NASDAQ futures are 1.0%-2.0% higher. The US 10-year yield is probing the highs near 2.03%, while European yields are a little firmer with the peripheral premium narrowing, except for Greece. The greenback is heavier against most currencies, while the other "safe-havens" (Japanese yen and Swiss franc) are slightly softer. Among emerging market currencies, central European currencies are leading the relief rally. The JP Morgan Emerging Market Currency Index is up about 0.2% for the second day. Gold is reversing lower after reaching an eight-month high near $1880, around $100 higher than late January. Initial support is seen in the $1840-$1850 area. After poking above $95 a barrel briefly yesterday, March WTI is giving back all of yesterday's gains. Nearby support is seen near $92. US natural gas is up almost 4.5% after a 6.5% gain yesterday.It fell nearly 14% last week. Europe's benchmark is unwinding yesterday's 5.5% gain plus more today. China's warning against speculation and hoarding took a toll on iron ore prices. They are off around 7.2%, for the third consecutive decline. Copper prices are edging higher for the second session. 

Asia Pacific

Japan's economy returned to growth in Q4 22, but it was not quite as strong as expected, and deflationary forces seemed to strengthen. The world's third-largest economy expanded by 5.4% at an annualized rate in the last three months of 2022, missing forecast for 6% (median in Bloomberg's survey). The contraction in Q3 was revised to 2.7% from 3.6% with the help of an upward revision to consumption, which was also a little stronger than projected in Q4.Business spending slightly softer. Net exports contributed 0.2% (not the 0.3% expected).The new social restrictions introduced last month is expected to be a drag on Q1 22 growth.The GDP deflator, which fell 1.1% in Q2 and 1.2% in Q3, fell 1.3% in Q4, the most in a decade. The January CPI figures are due late this week. Excluding fresh food and energy, prices are expected to have fallen around 1%, the most since 2011. 

The PBOC injected CNY100 bln ($15.7 bln) into the banking system via policy loans for the second consecutive month. This is understood to signal that Beijing is stepping up its support for the economy. The medium-term lending facility (1-year) rate was kept steady at 2.85%. It had been cut by 10 bp last month. Tomorrow, China is expected to report that both CPI and PPI moderated in January. Less price pressures are thought to underscore the scope for PBOC action, which is expected to spur additional monetary easing. 

The dollar is trading with a firmer bias against the Japanese yen, though within yesterday's (~JPY115.00-JPY115.75) range. There is an option for almost $765 mln at JPY115.75 that expires today. There is another set of options for $1.13 bln at JPY116 that also roll off today. The softer yen, if sustained, and the risk-on sentiment can help Japanese stocks on Wednesday. The Australian dollar is trading inside yesterday's range as well (~$0.7085-$0.7160). A move above yesterday's highs would lift the tone, but the expiring options (A$450 mln) at $0.7195 seem too far away. The US dollar slipped below CNY6.35 for the first time this month. It recovered after reaching about CNY6.3475.The PBOC set the dollar's reference rate slightly lower than expected (CNY6.3605 vs.CNY6.3607, the median in Bloomberg's survey). Separately, the PBOC's foreign exchange holdings appear to have risen by around CNY33.6 bln last month. 

Europe

Reports suggest the Russia's top diplomat Lavrov got Putin's permission to continue to pursue diplomatic solutions. At the same time.the head of Ukraine's National Security and Defense Council dismissed reports of a February 16-17 invasion. Some of Russia's troop movement may have been part of it military exercises. Press reports indicated that some of the exercises were completed in recent days, which was linked to today's news that some forces are returning to their bases. A key date may be February 20 with the end of the Russian-Belarus military exercises. As part of the pressure Russia is that the lower chamber of parliament, the Duma, is considering a bill to request Putin officially recognize the separatist region of Ukraine (Russia created in 2014). This seems like a non-military move that could further Russia's influence. Meanwhile, Germany's Foreign Minister Baerbock is encouraging other parts of the of German government consider China a "systemic rival" (like the EU has already done), but Chancellor Scholz, who is meeting with Putin today in Moscow, told Russia that Ukraine joining NATO is not a priority.

The UK's employment data underscore the strength of the labor market. The number of employees rose by 108k in January after a revised 131k in December (initially 184k). There are about 435k more workers than on the eve of the pandemic. The unemployment rate was steady at 4.1% in the three months to December. Vacancies reached a record high of almost 1.3 mln in the three months through January. Average weekly earnings rose 4.3%, up from 4.2%, while base wages (excluding bonuses) slowed slightly to a 3.7% pace from 3.8%. However, note that between taxes and inflation, real wage income is being squeezed. The swaps market is pricing in about a 70% chance of a 50 bp hike next month.

The euro recovered from the dip below $1.13 yesterday to reach almost $1.1355 today in the European morning. It stalled there where options for 1.35 bln euros will expire today (~$1.1340-$1.1350). The focus shifts one negative development (geopolitical tension) to another (diverging monetary policy). The US premium on 2-year month widened to around 195 bp, about 40 bp higher than on the eve of the January employment data. A move above $1.1400 would lift the technical tone. Sterling is going nowhere quickly. It stays mired in a $1.35-$1.36 range, which has largely contained it this month. Intraday penetration has taken place a few times, but the range has been respected on a closing basis. 

America

The Fed's Bullard did not walk back last week's hawkish remarks. He advocates front-loading the rate hikes and reiterated his call for 100 bp by July 1. He says the Fed's credibility is on the line with inflation much higher than expected six months ago. Bullard wants the central bank to ratify market expectations contained in the two-year note. The yield is up more than 20 bp since January CPI print. The swaps market implies a terminal Fed funds rate of 2.00%-2.25%. The Fed fund futures are discounting almost a 66% chance of a 50 bp hike in March. Almost 100 bp is priced by the end of H1.

The January US PPI is expected to have risen by 0.5%, but given the base effect, the year-over-year rate will likely pullback from the 9.7% year-over-year pace reported for December. The core rate may moderate to below 8%.  The first look at February survey data comes from the Empire State manufacturing survey. A modest recovery is expected after a dramatic slump in January (31.9 in December, -0.7 in January). The median forecast in Bloomberg's survey is for a rise to 12. Late in the day the Treasury's December capital flow report (TIC) will be reported. Capital flows increased markedly last year. Consider that the monthly average through November was about $102 bln. In the first 11 months of 2020, it averaged a little more than $47 bln and in 2019 $5.4 bln. The pattern with long-term flows is similar--almost $72 bln in Jan-Nov 2021, compared with around $42 bln in the same period in 2020 and $32.5 bln in 2019. 

Although the convoy protests in Canada that had paralyzed the capital, disrupted production and trade have dissipated, other border blockades (Alberta and Manitoba) persist. Downtown Ottawa was still reportedly occupied yesterday. Prime Minister Trudeau invoked the 1988 Emergencies Act for the first time, claiming a serious challenge to law enforcement. It will be divisive. Consider that a new Angus Reid poll found that nearly 75% of the surveyed wanted the convoy protesters to go home, but more than two-thirds think Trudeau has aggravated the situation. Under the emergency powers, the federal forces (police not military) will enforce municipal and provincial laws, and secure and protest places and infrastructure critical to the economy (e.g., border crossings and infrastructure). It authorizes financial institutions to prevent the funding of illegal protests without a court order. 

The motion must be presented to the House and Senate over the next week. However, once a declaration of emergency is made, it is considered to be in effect, unless it is revoked by parliament. If not extended it will expire in 30 days.  The opposition Conservatives are unorganized. A caucus during the protests dismissed the O'Toole and is now led Bergen, the interim leader. Bergen has been among the most supportive of the convoy protests. Before Trudeau’s announcement, Singh, the head of the New Democrat Party seemed to be opposed, saying use of the emergency powers was a failure of leadership. After Trudeau's announcement, Singh endorsed it, though in a backhanded way. He blamed Trudeau for allowing the "siege" of Ottawa to continue for weeks without addressing it.

The US dollar approached CAD1.28 yesterday, the upper end of its recent range and it held. The risk on mood, reflected in equity prices is overriding whatever negative impulse there may be from the softer oil prices. So far, the low for the day is slightly above CAD1.27.There are options for roughly $2.3 bln between CAD1.2695 and CAD1.2700.A break returns to the greenback to the shelf forged in the CAD1.2650-CAD1.2660 area. Meanwhile, the US dollar has returned to test the 200-day moving average against the Mexican peso. It is found a little below MXN20.35.It has not closed below the long-term moving average since last September. Last month's low was set near MXN20.28.The deputy governor of the central bank suggested that the magnitude of the Fed's rate hike will influence the next Banxico move. A 25 bp move by the Fed would be matched by Mexico.