Overview: The foreign exchange market is quiet. The Lunar New Year holiday shut most Asian markets. That, coupled with the light news in Europe, have served to keep the dollar in narrow ranges against the G10 currencies. The Swedish krona, Norwegian krone, and Japanese yen are posting minor gains against the greenback. The New Zealand dollar, which was strongest major currency last week (1.4%) is off by almost 0.5% today, making it the weakest today. RBNZ Governor Orr underscored the recent message that inflation is still too high (~4.7%). Emerging market currencies are narrowly mixed (+/-0.2%). Of note, India reports December industrial production and January CPI shortly.

The few equity markets in the Asia Pacific region that were not on holiday today, including Australia, India, and New Zealand slipped. Political uncertainty in Pakistan saw its stock market tagged for 3%. On the other hand, Europe's Stoxx 600 is trying to snap a three-day fall (less than 0.4%). Of note, real estate is the strongest sector today, rising by more than 1%. US index futures are trading firmly after new record-highs before the weekend. Benchmark 10-year bond yields are 3-6 bp lower in Europe. The 10-year US Treasury yield is off a basis point to around 4.16%. Gold is trading with a softer bias near $2020. Last week's low was around $2015. April WTI set this month's high before the weekend near $77.15. It is approaching the pre-weekend lows slightly below $76. Support is seen closer to $75. 

Asia Pacific

The top two BOJ officials played down speculation that the central bank’s from negative interest rates will signal the start of a tightening cycle, and for good reason. First, inflation is already well off its peak and could easily fall below the 2% target before the April BOJ meeting that is widely expected to adjust policy. Second, despite a shortage of workers, (Japan's working age population peaked nearly 30 years ago) and the gradual opening to foreign workers, wage growth continues to lag inflation. Third, and related, domestic demand is soft. Toward the end of the week, Japan will publish its initial estimate of Q4 GDP. Consumption is likely to have recovered weakly from the contraction in Q2 and Q3 23. In the five years (20 quarters) before the pandemic, Japan's private consumption component in its GDP contracted by an average of 0.2% a quarter. Also, note that although the BOJ set the overnight target rate at minus 0.10%, the effective rate at the end of last week was 0.005%. Governor Ueda is determined to exit the negative interest rate policy for technical and strategic reasons. Arguably, there was windows of opportunity previously, where the macroeconomic setting was conducive to exiting the negative policy rate. 

Most Asian markets were closed today, and China's mainland markets are closed all week for the Lunar New Year holiday. We expect that after the holiday, more efforts to support the economy and fight deflation will be forthcoming. Despite the stimulus in H2 23, the economy does not seem responsive. The assumption that the state-owned banks are just arms of the government is challenged by the same banks not fully passing on the PBOC's lower rates. The one- and five-year loan prime rates will be set on Feb 20. The same state-owned banks have also been reluctant to lend to the property market and enact the support measures Beijing unveiled in 2022. Lastly, consider the offshore yuan. It does not have to but with few exceptions respects the onshore band (2% for the dollar around the reference rate). Why? While the PBOC could intervene there, but when it does it is fairly clear. The last reference rate creates a band of ~CNH6.9640-CNH7.2485. Is it too much to suggest that the same mechanism that keeps the offshore yuan within the onshore band explains a great deal of how the PBOC manages the exchange rate? To paraphrase an old Chinese saying, "kill an occasional chicken to scare the monkeys."  

The dollar edged a little closer to the JPY150 level ahead of the weekend (~JPY149.60) before settling virtually unchanged near JPY149.30. There are around $1.4 bln in options at JPY150 that expire tomorrow. During the six-week decline in the yen, speculators in the futures market have grown their net short yen position by more than 50% to 84k contracts (~$7 bln). The greenback is a narrow range of about a third of a yen above JPY149. The price action looks like a bullish pennant or flag, The Australian dollar's range last week, roughly $0.6470-$0.6540, is the key to the near-term direction. We favor an upside break and watching the possible bullish divergence with some of the momentum indicators but recognize the $0.6555-75 area to be an important hurdle. The Aussie eked out a small gain last week (~0.20%), the first of the year. Speculators in the futures markets added to their net short Australian dollar position for the fourth week in a row. It now stands at about 71.8k contracts (~$7.2 bln), up from 32.3k before the streak began. The Aussie is trading in about a fifth of a cent range above $0.6510.

Europe

The European economic calendar is light this week, and what there is, may be a sad reminder of the Europe's sad state. Eurostat will publish the details of Q4 23 GDP. The initial estimate had the regional economy stagnating after a 0.1% contraction in Q3. The dramatic 1.6% drop in Germany December industrial output (-3.0% year-over-year) underscores the lack of growth impulses to start the new year, and the weakness of what had been the European engine. At the same time, leadership is weak. Among the large members, Italy's Meloni, right-government seems among the strongest, and incidentally, the economy is doing better (but still not well). In 2022, Germany grew by 1.8%. Italy grew twice as fast. Last year, the German economy contracted by 0.3%, while Italy expanded by 0.7%. On the other hand, Italy's budget deficit was about 5.4% of GDP last year, while Germany's was less than 2.5%. Italy's 10-year premium over German narrowed to about 140 bp at the end of January, almost a two-year low, after rising to a nine-month peak last October over 200 bp. It is snapping back this month is near 155 bp. Italy's two-year premium peaked near 95 bp in the middle of last October and fell to almost 45 bp late last month. Last year's low was below 30 bp. It has jumped to about 65 bp now, the most since last November.

The Swiss franc was the strongest G10 currency in Q4 23 as dollar fell across the board. It rose 8.8% and so far, this year, the franc has fallen by about 3.9%. The dollar approached the (50%) retracement objective (~CHF0.8790). Above there is the 200-day moving average (~CHF0.8845) and the (61.8%) retracement near CHF0.8900. The euro is recovering from multiyear lows set against the franc in Q4 23 (~CHF0.9255). It traded up to almost CHF0.9475 last month but pulled back to support near CHF0.9300 earlier this month. There may be potential toward CHF0.9500-CHF0.9550. Switzerland reports January CPI tomorrow. The EU harmonized measure is expected to slip to 2.0% from 2.1%. Its own measure is seen easing to 1.6% (from 1.7%) and the core rate to 1.4% (from 1.5%).

The euro reached a six-day high late in thin Asia Pacific turnover near $1.0805. It was quickly sold to almost $1.0765 before finding a bid in early European turnover. It is the fourth session of higher highs. The pre-weekend low was almost $1.0760, and a break of the $1.0755 area would weaken the fragile technical tone. There are options for about $755 mln euros at $1.08 that expire today. There are large (1.4-1.5 bln euros) at $1.07 that expire tomorrow and Wednesday. Stiff resistance is seen in the $1.0830-40 area. Sterling recovered after breaking down at the start of last week (~$1.2520) but settled back into the $1.26-$1.28 trading range in the past three sessions. The $1.2640 area had capped but, like the euro, set a new six-day high before Europe opened and took sterling down to almost $1.2615. Before the weekend, sterling briefly frayed the $1.26 level. It is an important week for UK data, including the labor market report tomorrow and the January CPI on Wednesday. Soft data may encourage bringing forward the first rate cut to June from August. 

America

Interest rates and expectations are a key force driving exchange rates. The market has gradually reduced the odds May rate cut to about 73% from 90% chance after the strong January jobs growth. It also scaled back the magnitude of Fed cuts by about 50 bp (to ~112 bp) in the past month. Tomorrow's CPI, more than last week's historic revisions, is a key input into the Fed's reaction function. Fed Chair Powell recently indicated the central bank was looking for more confirmation that inflation was on a sustained path back to its target. The January figures will give the Fed that. Ahead of it, the results of the NY Fed's inflation survey are of little consequence.

Canada reported a loss of full-time jobs in January for the second consecutive month. Wage growth slowed. The decline in the unemployment rate to 5.7% (from 5.8%) can be explained by the decline in the participation rate (65.3% vs. 65.4%). The takeaway is that the market boosted the chances of a June rate cut (to ~77% vs. ~67%). Despite the risk-on mood, which lifted the S&P 500 to a new record high, the Canadian dollar found no traction. It fell slightly for the first time in three sessions. The US dollar made session highs near midday in NY ahead of the weekend near CAD1.3480. The greenback is in a narrow 20-tick range above CAD1.3450 so fat today. Nearby resistance is seen in the CAD1.3500 area but the greenback has been turned back from the CAD1.3540 area three times. There are options for about $630 mln at CAD1.35 that expire tomorrow. The Mexican peso weakened after the central bank seemed to prepare the market for a rate cut as early as next month. However, it recovered and returned to pre-central bank levels near MXN17.08. It has edged low today to MXN17.0640. MXN17.00 was tested early last week. Around $580 mln of options expire there on Thursday. The US dollar reached BRL5.0175 at the start of last week. On the pullback, it found support near BRL4.95. It settled last week just above there. There is a band of technical support between BRL4.91 and BRL4.93.

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