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What a difference a week makes.   The nervousness that gripped financial markets at the beginning of last week has abated for the moment, with equity investors using the wash-out in the stock market to re-enter at more attractive levels, pushing the S&P back within striking distance of the 1,800 handle.   Moody’s upgrade of Mexico’s credit rating has helped quell some of the worries surrounding Emerging Markets, with the Lira and Peso being able to grind higher throughout the majority of last week.   Another soggy employment report from the US failed to shake investor confidence into the end of last week, discounted slightly by the fact that the FOMC will get another look at the employment picture ahead of their next meeting in March, and the fact that the unemployment rate edged down to 6.6% while the participation rate increased to 63.0%.   As it stands, the FOMC is likely to stick to its guns in terms of forward guidance on rates and the cutting back of monetary stimulus, with the market seemingly more comfortable with the notion of low interest rates for a sustained length of time past the end of QE.  

Keeping with the theme of QE and the Fed, the new chair of the FOMC is due to deliver her first semi-annual monetary policy report to Congress  on Tuesday.   While Janet Yellen hasn’t spoken on monetary policy for a number of months, the testimonial is unlikely to provide any earth-shattering revelations, as the message is likely to focus on the continuity of policy the Fed outlined in December.   Yellen is likely to echo her former boss by outlining the gains in the labour market, as referenced by the unemployment rate, suggest the prudent course of action is for the QE program to be phased out, while keeping rates at accommodative levels for long past asset purchases are finished as inflation is still stubbornly below target.  

It will be interesting to see if Yellen is questioned about the Fed’s taper acting as the spark that ignited the Emerging Market wildfire, although the likely response will be that a slowing of asset purchases is consistent with a stronger US economy; one that is likely to benefit those very emerging economies down the road.   While a message from the Chairwomen that emphasizes continuity would likely reassure global investors, it is too early to pop the champagne and assume equities are heading for new all-time highs; price action from last week still illustrates a market in a corrective phase, with equities likely to struggle to hold outsized gains over the course of the next month.

The overnight session saw a continuation of positive investor sentiment from  Friday, with equities playing catch-up to the action witnessed on Wall Street last week, as the Nikkei and Shanghai Comp finished higher by 1.77% and 2.03% respectively.   The yen is slightly stronger against the USD this morning, gaining strength after Japan’s current account deficit widened to a new record in December, highlighting concerns that Abenomoics still has yet to have the intended effect on the region’s export sector.   The 23% slide in the yen since late 2012, combined with the increased energy demand from abroad due the closure of nuclear plants has pushed the value of imports to outstrip the gains in the export market, increasing worries that Japan’s economic woes aren’t as easy of a fix as just weakening its domestic currency.   USDJPY is grinding towards the 102 handle ahead of the opening bell, after trading in the mid-102s before the data was released overnight.    

In the wake of a volatile week in equity markets, the Loonie had its best week in five months against the USD, solidified by a stronger than expected employment report  on Friday.   Although the overall picture for the Canadian economy is one that exudes mediocrity, the upside surprise caused a bout of Loonie short-covering, which pushed USDCAD for a downside attack of the 1.10 area.   The downside defense of the psychological 1.10 area illustrates the tough slog Loonie bulls are in for, with strong demand from corporates as willing buyers of USD on dips in the pair.   While the speculative players in the market remains well-short the Loonie (the net short position last week according to the CFTC was trimmed to just over 60k contracts), it is also helpful to look at the options market and the recent price action witnessed.   Implied volatility and spot have moved almost in lockstep fashion since the beginning of January, marching higher in tandem until implied vol broke down and turned lower  on Friday.  

In addition, the value of calls relative to puts on the USD have been steadily decreasing since the middle of January, signaling hedgers are more willing to bid up the price of puts on the USD in order to protect against downside moves.   While it possible for momentum to continue to put pressure on USDCAD and move the pair lower, the relative price of calls to puts hasn’t been this cheap since January of last year, and may offer hedgers with ongoing short exposures attractive opportunities to implement option-based hedging strategies.   The Loonie is weaker against the American buck this morning, with USDCAD trading up into the mid-1.10s after housing starts for the month of January came in with an annualized reading of 180k.   The housing starts print was slightly below the median expectation from analysts, and combined with a small downward revision to December’s numbers, the CAD is modestly weaker against the USD.

Heading into the North American open, US equity futures are groggy after the weekend, dragged lower by a strengthening yen and some give back from the major advancement  on Friday. Speaking of some profit taking on massive spikes, after the impressive run for energy  on Friday, front month WTI is lower by 0.32% this morning, with profit-taking sending the black-gold into the mid-$99/barrel region.   On the other side of the spectrum, gold is happy to generate safe-haven related flows, up by 1.06% this morning as risk-correlated asset struggle to generate momentum.

Looking ahead to  tomorrow, China is back in full-swing after their new year’s celebrations, and expected to release economic data on trade, money supply, and new loans.   While we have spoken at length about the de-leveraging phase China’s economy is trying to navigate, the most susceptible currencies to soft numbers out of China will be the commodity-currency bloc.   Given that the AUD, NZD, and CAD all exhibited stellar performances last week, tonight’s numbers could take some wind out of their sails if the economic data crops up concerns about the viability of the government trying to rein in the credit-fueled growth that has led to a precariously over-leveraged shadow banking sector.   To some extent a slowdown in demand from China can be supplement by a pick-up in the American economy, but in the interim period, weaker numbers out of China will weigh on currencies correlated with commodity prices and global growth.  

Further reading:

US employment figures send mixed signals to the Fed

Lessons Learned about Leverage and Time Frames