Here's To A Better Second Quarter

The global capital markets have begun the new month and quarter on a good note. Equity markets were encouraged by yesterday's gains in the US.

Most markets in the Asia Pacific region rallied, led by Hong Kong, even though earnings reports saw trading halted in around 50 companies.

Europe's Down Jones STOXX 600 was edging closer to last year's record high, and US futures were trading with a clear upside bias, led by the NASDAQ. Benchmark bond yields were a little softer, with the US 10-year yields around 1.71%.

The dollar was mostly firmer, but the euro held the $1.1700 support. The greenback has remained below JPY111, which it approached yesterday. The Turkish lira, South African rand, and central/eastern European currencies were leading emerging market currencies higher. The JP Morgan Emerging Market Currency Index was posting back-to-back gains for the first time in three weeks.

Gold was extending yesterday's recovery but has met resistance at $1720. As the market awaits the outcome of the OPEC+ meeting, May WTI was straddling the $60-level.

Japan's Tankan survey results were a bit better than expected. Sentiment among all businesses improved more than expected. This was particularly true of large manufacturers, where reading rose above zero for the first time since Q3 19. Small businesses are less pessimistic than they were. Capex plans were stronger—a 3% increase expected rather than a 1.4% decline.

Separately, the March manufacturing PMI rose to 52.2 from 52.0 of the preliminary estimate and 51.4 in February. Taken together, investors and policymakers may be a little more confident of a stronger Q2 after the virus-related state of emergency, earthquake, and fire at the chip factory depressed growth in Q1.

The BOJ announced it would reduce its JGB buying across the curve in April. It is not seen as tapering—a step towards removing some accommodation and making it more sustainable for longer.

China's Caixin manufacturing PMI disappointed. It unexpectedly fell to 50.6 from 50.9. Economists had expected a gain to 51.4. Recall that the official manufacturing PMI rose to 51.9 from 50.9. Yesterday's IMF reserve data (more below) reported an increase in the use of the Chinese yuan. The media seems to exaggerate it. Over the past two years, to gain perspective, yuan holdings have risen by about $64.5 bln to $267.5 bln. Over the same two years, dollar reserves rose by nearly $382.5 bln. The dollar increase is more than 50% of the stock of yuan reserves.

Australia disappointed with a smaller than expected trade surplus as exports fell (1%) and imports rose (5%), more than anticipated. The trade surplus stood at A$7.53 bln in February, and the January surplus was shaved to A$9.6 bln from A$10.1 bln as exports were revised down to 4% from 6%. Domestic demand may be holding in better than feared.

Retail sales fell by 0.8% in February. Economists had projected a larger decline, and the January series was revised to show a 0.3% gain instead of a 1.1% decline as initially reported.

A worrying sign has emerged that will likely percolate in the coming months. The low-interest-rate policy in some countries is fueling house price appreciation. CoreLogic reported Australian house prices rose by 2.8% in March, the most since 1988, according to reports, after a 2% gain in February.

In New Zealand, CoreLogic reported, house prices accelerated to 16.1% year-over-year from 14.5% in February. It is the most in over a decade.

The Governor of the Bank of Canada has raised the tenor of his concerns about Canadians taking on too much debt to invest in housing and warned that price increases are not sustainable.

The dollar had been confined to about a quarter of a yen today. It remained below JPY111.00, where an expiring option for $770 mln is struck. The greenback had held above JPY110.55, where an option for $200 mln will expire today. Support was seen in the JPY110.40-JPY110.60 area.

The disappointing data (including China's Caixin PMI) saw the Australian dollarfall to almost $0.7530, a new low for the year. It recovered to test the $0.7580 area in the European morning. A move back above $0.7600 would improve the tone.

Although the dollar did not set new highs for the week/year against the Chinese yuan, the offshore market's close was a fresh high. The offshore yuan fell to new four-month lows. While the yuan was falling, the PBOC has been setting the dollar's reference rate very close to what the bank models have anticipated. Today's fix was at CNY6.5584, and the models were at CNY6.5587. We suspect that what officials are guilty of is not stopping market forces from selling the Chinese bonds and the yuan.

The final German manufacturing PMI was unchanged from the flash reading of 66.6, but the other large EMU countries' reports were better than expected. The French manufacturing PMI rose to 59.3 from the preliminary estimate of 58.8 and 56.1 in February. Italy's rose to 59.8 from 56.9, and Spain's manufacturing PMI rose to 56.9 from 52.9.

These led to the aggregate manufacturing PMI to tick up to 62.5 from the flash report of 62.5 and 57.9 in February. Although the pandemic still ravages, and several countries, including France and Italy, are extending social restrictions, the economic momentum appears to be building.

The final UK manufacturing PMI was also better than expected. It stands at 58.9 in March, up from the initial estimate of 57.9 after 55.1 in February. The UK economy also enjoys upside momentum after contracting at the start of the year. The upward revisions to Q4 GDP (1.3% vs. 1.0%) were driven by increased government spending, business investment, and stepped-up exports.

The euro already seems to be on the long holiday weekend. It has been confined to yesterday's range (~$1.1705-$1.1760). It had tested the $1.1950-level last week and has been subsequently sold to almost $1.1700, where a tentative base has been found. However, the single currency has not been able to rise above the previous session's high since Mar. 22.

Sterling also has been confined to a narrow range within yesterday's price action (~$1.3715-$1.3810). It has stopped today just shy of $1.38, where a nearly GBP400 mln option is set to expire. Note that the euro has tested the GBP0.8500 area. It has held and may be spurring some position adjustments. Today's high so far has been about GBP0.8530. A move above GBP0.8560 would encourage ideas that a bottom may be in place.

Ahead of tomorrow's holiday, during which the US will report monthly jobs data, there is a slew of economic reports. Of note, weekly jobless claims are expected to show another decline. The final estimate for the March manufacturing PMI will be reported. Recall it finished last year at 57.1 and rose to 59.2 before falling to 58.6 in February. The preliminary estimate for March put it at 59.0, but it will likely be revised higher and could match or surpass the January peak.

Construction spending is expected to have pulled back 1% in February after a 1.7% gain in January. The ISM manufacturing will draw some attention, and the prices paid may cool a bit from high levels (86.0 in February). Lastly, March auto sales are expected to have rebounded from February's softness (15.67 mln seasonally adjusted annual pace).

Canada reports February building permits (a decline of around 1.4% is expected after an 8.2% jump in January) and March manufacturing PMI. A gain is likely as the Canadian economy picks up momentum.

Mexico's manufacturing PMI will be released next week. Note that the finance ministry boosted its forecasts for 2021 and 2022 growth, apparently encouraged by increased access to vaccines and US stimulus/growth. However, Espinosa, the Deputy Governor of the central bank, warned that inflation risks were tilted to the upside, citing shifting consumption patterns of households and businesses, increased service prices, the peso's weakness, and global forces. While the government seems to be relying on the external sector, Espinosa advocated strengthening domestic demand.

The IMF reported Q4 20 reserve data (COFER). It is the most authoritative data on global reserves. Many market observers seized on the fact that the dollar's share of global reserves slipped below 60% for the first time since 1995.

It was understood to signal the shift away from the dollar that has long been the subject of news reports, analyst commentary, and speculation. However, be skeptical—very skeptical. First, the amount of dollars held in reserves reached a new high of a little more than $7 trillion. Rather than sell dollars, central banks accumulated more.

Second, the value of the non-dollar currencies held in reserves is converted into dollars. It makes little sense to talk about the reserves without taking valuation changes into account.

The dollar fell against other reserves currencies in Q4 20. Sterling appreciated by 5.8%, the euro by 4.2%, and the yen by 2.2%. The Chinese yuan appreciated by 4%. Imagine you are a central bank, and at the start of the period, you have half your reserves in dollars and half in euros. The euro appreciates by 10% at the end of the period. The allocation of your reserves changed. You now have 55% of the dollar value of your reserves in euros and 45% in dollars without doing a thing.

Central banks, like some private asset managers, may periodically seek to rebalance their reserves. In Q4 20, the COFER data showed that the dollar value of euro reserves increased by 7%. If we adjust for the shift in exchange rates, the quantity change (as opposed to price) is a more modest 3%, for example.

What can we say going forward？ The dollar has appreciated relative to many of the reserve currencies in Q1 21, including 6.7% against the yen and 4% against the euro. Sterling and the Canadian dollar were exceptions. They rose by 1.2%, about 0.8%, respectively.

The Fed offers custodial services for foreign central bank Treasury and Agency holdings. These reached a record high in mid-March of almost $3.58 trillion.

Lastly, we note an article in the BIS quarterly review (Dollar Funding of Non-US Banks through Covid) concludes: “Overall, these findings indicate that the domination of the dollar in international finance and the attendant policy issues are likely to endure.”

The US dollar was trading firmly against the Canadian dollar, but it is also within yesterday's range (~CAD1.2540-CAD1.2635). The greenback has flirted with the CAD1.2600 level in late Asia/early European turnover. An option for about $815 mln at CAD1.26 expires today.

Last week, the US dollar peaked near MXN21.00. On Mar.31, it fell through MXN20.50 for the first time in nearly two weeks. The greenback slipped a little further today and eased below MXN20.39. March's low was set in the MXN20.28-MXN20.29 area. While that is the next target, the light participation may make it difficult to see until maybe next week.

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