Daily Kickstart With Bloomberg & Deutsche Bank

Happy Tuesday. Bloomberg’s Richard Breslow is out early this morning with an excellent summary of how we’re trading as we head into the new year. Traders are sticking with the story lines that seem to be working: all hail king dollar, it’s reflation time, geopolitics don’t matter.

All of that works precisely until it doesn’t. And indeed that’s one of the lessons of randomness – the naysayers are wrong right up until they aren’t. We learned this lesson the hard way in August of 2015 when the black swan came knocking.

I realize that it’s the holiday season and markets are thin, but they sure are interesting. Full of complexities. Or is it contradictions? So many assets, economic story lines and geopolitical risks can go either way. Yet traders seem to be set on their current leaps of faith and happy to ignore the rest as next year’s problem.

  • Despite all the debatable points there’s a remarkable, some would argue reckless, amount of confidence being espoused. People are sure that things are setting up quite clearly for us to be about to enter the year of the [fill in the blank]. How we close this year will have a lot of influence on market psychology as positions are rebuilt and P/Ls started anew come January

  • One favorite, no surprise, is the dollar is the place to be. Rates, safe haven, fiscal stimulus. USD/JPY is motoring and EUR/USD will have to test lower. Yet the minds of traders work in mysterious ways

  • Monday we made a multi-month high in USD/JPY and then had a sloppy close. Failure came the screams. Mostly from people who don’t have the trade. A month of fundamental analysis went out the window. Until the pair re-took 115 Tuesday. Sloppy closes should be a chapter heading when they write the history of this year and are not as informative as they were in the past

  • For now, the dollar index is between 100.50 and 102. Trade away in-between. Declaim outside

  • Treasury yields are certain to move resolutely higher. Follow the 10-year. New year excitement comes if we get out of 2.5%-2.3% range. Nice pivot in-between. Yesterday’s auction was not very good, even though the market was bid. Failure of the break-out? Not necessarily. More likely just a sloppy close

  • West Texas is easy. The pivot is $50. Just remember with these production cuts, you can trust but had better verify

  • Equities will be equities for the window-dressing and high water mark season. But if you want to watch for a tell going forward, follow the Shanghai composite as it flirts around its most excellent 55-day moving average. It’s back in play as of today

  • Investors seem to have once again managed to fool themselves that geopolitics won’t matter. be very careful with this one. Not every problem can be solved with monetary policy. And the response to every tweet won’t always be an editorial

And here’s Deutsche’s Jim Reid with the overnight summary:

Fresh from Bronte’s 2nd birthday last night where her present was to lick the dirty dishwasher plates and cutlery completely clean before we put it on. Normally she’s sternly told off for doing this. Prior to this my wife was going crazy as whilst she was writing Xmas presents labels and cards Bronte kept on creeping up on her and stealing her biro and probably digging it deep into a sofa cushion as if it were a bone. There are now 3 biros unaccounted for in our house which is a worry given that Maisie is starting to get to that age where wallpaper and a writing implement go together like President-elect Trump and fiscal stimulus. Talking of which, with the recent Donald Trump victory, the oil price rally and with the ECB announcing tapering last week (the first cut is the hardest to paraphrase the song) it feels increasingly likely that we’ll get periodic rates market shocks in 2017. This fits in with view of higher rates and credit volatility and ranges from our 2017 outlook  3 weeks ago. Giving us even more confidence on this was our US rate strategists’ major forecast changes over the past weekend. The head of the team, Dominic Konstam, has been a fellow paid up member of the secular stagnation camp and generally had a lower yield forecast than the street in recent years. However he’s now at the higher end after the forecast changes. He now expects the US 10y to trade at 2.75% by YE2016 (i.e. in 2 weeks) and comfortably above 3% in 2017 (YE2017: 3.10%; 2017 Q2 peak of 3.6%). The rationale is that the market is quickly looking through the Fed to the new government administration and the scope for higher inflation to come before stronger real growth. The new administration’s policies could certainly drive this view as both the Trump plan and the original Ryan plan (as detailed in a “Better Way”) involve a huge expenditure switching effort to boost exports at the expense of imports whilst encouraging domestic production – this may boost growth substantially in the medium term but should be more inflationary in the short run. Furthermore they expect Ricardian equivalence to hold initially in many respects, which is why inflation remains more of a concern than real growth early on. Thus the strategists’ outlook is less a story about normalizing the real neutral Funds rate but more about shifting inflation expectations to become rich to the Fed’s target. The forecast revision also reflects the team’s view that the market needs a much better risk/reward profile for a Fed that might end up looking to be behind the curve – so this won’t be about raising the dots but rather about the markets possibly front running the dots. With all that said, it seems appropriate then that the last 24 hours in markets has largely been characterised by rising oil prices and a subsequent leg up in bond yields. WTI closed +2.58% last night and just below $53/bbl following the non-OPEC agreement news from the weekend (and also the positive Saudi comments) although in fairness it did close well off the peak level of $54.51/bbl early in the Asia session before the focus turned towards possible higher US supply. Brent was also up +2.02% and above $55/bbl although again a fair distance off the $57.89/bbl high mark. Bond yields peaked as the European session opened. 10y Treasury yields broke through 2.500% at one stage and touched an intraday high in yield of 2.526% (which was nearly 6bps higher on the day) before giving most of that up as oil faded into the close to end the day up just 0.4bps at 2.471%, albeit the highest since June 2015. A weak 3y Treasury auction – which attracted the lowest demand since 2009 – didn’t seem to help although a subsequent 10y auction saw demand bounce back from the seven year low set last month. Elsewhere in Europe 10y Bund yields edged up 3.3bps to 0.393% and are now back to the highs last seen back in January. It’s amazing to think that yields are now back to within 23bps from where we started the year. Meanwhile, although energy shares got an unsurprising boost from that move higher for oil, the Santa Claus rally for equity markets finally hit a bit of a road bump yesterday. The S&P 500 closed -0.11% with weakness across financials and consumer discretionary names dragging the index lower while in Europe the Stoxx 600 (-0.46%) declined for the first time since December 2nd. Credit markets were a bit more mixed (weak in the US but slightly firmer in Europe) although it was another decent day for Italian bank sub spreads. Indeed spreads across the 4 banks in the iTraxx sub-fins index were on average 6bps tighter. As expected new Italy PM, Paolo Gentiloni, confirmed that Padoan will remain in his current post as finance minister. To the latest in Asia now where the November activity indicators in China have been released this morning. The data has largely come in in-line to slightly better than expected. Industrial production has risen one-tenth to +6.2% yoy (vs. +6.1% expected). Retail sales were up a bumper eight-tenths to +10.8% yoy (vs. 10.2% expected) and fixed asset investment remained unchanged at +8.3% yoy, matching the consensus. That retail sales reading is in fact the highest this year. Despite the supportive data, Chinese bourses have continued to track lower this morning. The Shanghai Comp is currently -0.15% as the focus seemingly remains on the crackdown on insurers’ equity investments that we highlighted yesterday, along with concerns about recent volatility in money market rates. Elsewhere, the Hang Seng (-0.31%) and ASX (-0.32%) have also dipped lower, with just the Nikkei (+0.29%) and Kospi (+0.16%) in positive territory. Meanwhile oil is little changed and sovereign bond markets are generally mixed. Moving on. While we’re still a few months away from the start of ECB tapering, it was interesting that yesterday we saw the announcement of the lowest full week of CSPP purchases since the end of August. They confirmed holdings at 9th December of €49.906bn. This implies net purchases settled last week of €1.663bn or an average daily run rate of €333m. The average daily run rate since the program started is €384m. The numbers will no doubt naturally fall again over the next 3 weeks with the holiday nearly upon us. Before we look at today’s calendar, UK Chancellor Philip Hammond also spoke yesterday and confirmed that there is an emerging view amongst both businesses, regulators and politicians that a longer transition period to manage Britain’s exit from the EU will be needed. Indeed Hammond said that ‘the further we go into this discussion, the more likely it is that we will mutually conclude that we need a longer period to deliver’. Those comments align somewhat with Carney last week who said that it was ‘absolutely desirable’ for companies to be given time to adjust and ‘to restructure after the deal is agreed with the EU’. Hammond’s softer comments yesterday helped Sterling (+0.85%) to outperform. Looking at the day ahead, this morning in Europe we kick off in Germany where the final revisions to the November CPI report will be made. Later this morning we turn over to the UK where the November inflation data docket gets released. Market expectations are running at +0.2% mom for headline consumer prices. Thereafter we’ll get the Q3 employment data for the Euro area before the focus turns to Germany with the December ZEW survey due to be released. It’s pretty quiet across the pond again this afternoon with the only data due in the US being the NFIB small business optimism reading for last month (expected to tick up to 96.7 from 94.9) and the November import price index reading. Away from the data the ECB’s Hansson and Nowotny are both scheduled to speak this morning.

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