Action Insight

The recent selloff in Japanese yen and widening in US-Japan yield differentials have been driven by the FOMC rate hike and expectations of further tightening in US monetary policy. Indeed, BOJ’s action has minimal impact on the phenomena of late. BOJ on Tuesday left its interest rate targets unchanged with the short-term and -10 bps and the 10-year JGB yield at around 0%. The asset purchase program also stays at approximately 80 trillion yen of JGBs annually. The central bank also upgraded its current economic assessment and outlook.

Dollar jumps today on safe haven flows on report of "probable terrorist attack" in Germany. In addition, markets were also nervous on the Russia/Turkey issue after Russian ambassador to Turkey was fatally shot. Meanwhile, the greenback is supported by Fed chair Janet Yellen's upbeat comments on the employment conditions. The dollar index surges to as high as 103.65 so far, breaking near term resistance at 103.56 to resume recent up trend. The index is on course to medium term projection target at 105.19. In the currency markets, Sterling is so far the weakest one for the week, followed closely by commodity currencies and Euro. Yen, despite today's weakness, is supported mildly by risk aversion with the Swiss Franc.

RBA in its minutes for the December meeting cautioned the high levels of household debt due to low interest rates. It also warned of the 'considerable uncertainty' in the labor market. The central bank maintained a neutral bias at the meeting while leaving its cash rate unchanged at historic low of 1.5%. Note the meeting was held a day before the release of 3Q15 GDP growth which shrank -0.5%.

Yen weakens mildly today even though BoJ offered a brighter view on the economy after keeping monetary policies unchanged. Interest rate was held at -0.1% and the asset purchase program was also kept unchanged under the yield curve control framework. The vote on YCC was by 7-2 vote with policymakers Sato and Kiuchi opposing. The central bank noted in the statement that "Japan's economy continues to recover moderately as a trend", with consumption "moving on a firm note".Though, CPI is expected to be "slightly negative or about 0 percent for the time being. BoJ also noted that risks to the outlook including development in "emerging and commodity exporting economies", particularly China; developments in US; and Brexit. Separately, the Japanese government projected the real GDP to grow 1.5% in the year starting next April, revised up from prior projection of 1.2%. Nominal GDP growth is projected to be 2.5%, up from prior projection of 2.2%. CPI is forecast to be at 1.1%, down from prior estimate of 1.4%. Meanwhile, the initial budget for next fiscal year is JPY 97.5T, a mild 0.8% from the current year.

Euro stays soft against Dollar in spite of better than expected confidence data. German IFO business climate rose to 111.0 in December, up from 110.4, above expectation of 110.7. Current assessment gauge rose to 116.6, up from 115.6, above expectation of 115.9. Expectations gauge rose to 105.6, up from 105.5, above expectation of 105.5. Ifo president Clemens Fuest noted that "the German economy is in a festive mood."And, "assessments of the current business situation improved, reaching their highest level since February 2012. The business outlook for the first half of 2017 is also slightly more optimistic. The German economy is making a strong finish to the year."

Dollar surged broadly last week as Fed delivered the expected rate hike and painted a more hawkish rate outlook for 2017. Dollar index resumed the long term up trend and reached a 14 year high at 103.56 before closing at 102.95. In particular, EUR/USD took out 1.0461 key support level and reached the lowest level since 2002. Nonetheless, Yen and commodity currencies were hardest hit. Rally in Dollar was accompanied by extended rally in treasury yields as 10 year yield breached 2.6 handle before closing at 2.597. Gold suffered deeper selling on dollar trend to close at 1136.8 while WTI crude oil pared back much of the post OPEC gains to close at 51.90. However, stocks turned mixed despite Fed raising GDP projection for next year. DJIA struggled to power through 20000 handle and closed the week slightly higher at 19843.31. The markets may turn into consolidation mode as holidays approach. But strength in Dollar will likely carry on to early next year.

Of the three major European central banks held monetary meeting on Thursday, all left their policy rates unchanged. Moreover, all pointed to higher uncertainty in the global economic outlook. BOE kept its Bank rate unchanged at a record low of 0.25%. The sizes of government and corporate bond purchases also stayed unchanged at435B pound and up to 10b pound, respectively, in December. Policymakers warned that the recent strength in sterling might cool inflation in the medium-term. SNB held deposit rate steady at -0.75%, while Norges bank left kept its deposit rate steady at 0.5%.

The Fed increased the policy rate by +25 bps for the first time in a year. While this had been widely anticipated, the 'dot plot' indicated that the members expect three hikes in 2017, up from two previously. The accompanying statement was in a hawkish tone, upgrading the assessments to the economic outlook. The members reinforced that 'near-term risks to the economic outlook appear roughly balanced. Fed Chair Janet Yellen made no hint on how the new fiscal policy would affect the monetary stance. Yet, she stressed there is non-negligible uncertainty regarding the new policy.

Recent releases in China's November macroeconomic indicators suggest that growth continue to stabilize. Yet, weakness in renminbi means that capital outflow should remain a headache. China's growth in industrial production (IP) improved to +6.2% y/y in November, from +6.1% a month ago. This came in better than consensus of +6.1%. Retail sales expanded +10.8% y/y in November, compared with expectations of +10.2% and +10% in October. Indeed, this is the fastest pace of consumer spending growth so far this year. A key contributor to the upside surprise was auto sales, thanks to government tax incentives. Meanwhile, 'single's day earlier in November also helped boost sales of electronics and telecom products. Urban fixed assets investment gained +8.3% in the first 11 months of the year, unchanged from the year through October. This came in line with expectations.

ECB surprised the market by announcing tapering plan for its bond purchases program. The Governing Council decided to extend the program until December 2017. However, the pace would slow down to 60B euro per month from April 2017, compared with the current 80B euro. The market generally anticipated ECB to extend the program for 6 months without changing the pace of purchases. The market was disappointed. German yields spiked to a one-year high. The single currency soared to a one-month high of 1.0872 immediately after the announcement. However, gains were erased with EURUSD dropping more than -1%, as ECB left the door open to extend QE further beyond December 2017 and/or pick up the pace of bond buying again if the economic conditions deteriorate. Despite disappointing in first sight, the ECB has indeed delivered more than the market had anticipated: 9 months*60B euro = 540B euro vs consensus of 6 months*80B euro = 480b euro. Has the ECB has again disappointed the market by doing more?

BOC, as widely anticipated, left the policy rate unchanged at 0.5% in December. The central bank maintained a dovish tone as in recent meetings. While acknowledging that global market conditions have 'strengthened', 'undiminished' uncertainty has continued to undermine 'business confidence and dampening investment in Canada's major trading partners'. Of particular note is that BOC explicitly indicated its different from the Fed, attempting to dampen hopes that BOC would follow the Fed in raising interest rates. It also attributed the recent increase in Canadian treasury yields to US factors, instead of domestic fundamentals. We expect BOC to leave the policy rate unchanged, as well as maintaining a dovish tone, throughout 2017.

RBA left the cash rate unchanged at 1.5%, as widely anticipated. Little news was seen in the accompany statement with the more notable change was policymakers' acknowledgement in the rise in commodity prices. However, they stopped short of projecting its impacts on growth, for now. Today's announcement lacks indication for the central bank's monetary policy outlook. We expect future moves remain data-dependent but the central bank is not urgent in making another change in the policy rate.

The official manufacturing PMI for China climbed +0.5 point higher to 51.7 in November, another month of big increase after October's 0.8-point gain. The non-manufacturing PMI (services and construction activities) soared +0.7 point to 54.7. The services PMI added +1.1 points to 53.7, while the construction PMI slipped -1.4 points to 61.4. The Caixin/Markit version of manufacturing PMI, by contrast, fell to 50.9 in November from a 27-month high of 51.2 a month ago. Despite the fall, Markit noted that it remains the second-highest reading in 2 years and indicates that 'the manufacturing industry continued to pick up steam'. Moreover, although index readings for both output and new orders declined, those 'tracking input and output prices rose at a faster pace to hit their highest levels in 5 years, pointing to further intensification of inflationary pressure'.

To the market's surprise, OPEC announced to cut production to 32.5M bpd, the lower end of the target range indicated in the "Algiers Accord" in September. It also represents a -1.2M bpd, or -3.7%, reduction from October levels. Meanwhile, OPEC noted that non-OPEC countries have also agreed to cut output by -0.6M bpd with half of the contribution coming from Russia. Initial market reaction was buoyant with crude oil prices rallying the highest levels in a month. However, performance of commodity currencies under our coverage was not as robust as expected. Indeed, all of aussie, kiwi and loonie ended the day lower after initial rally, mainly due to a stronger US dollar. Higher oil prices as a result of output cut lift inflation expectations, lifting US dollar and Treasury yields.

Following Brexit and Donald Trump's victory in US presidential election, the Italian referendum this coming Sunday is the latest event that could cause huge volatility in the financial markets. Indeed, with the "no" camp leading in opinion polls, Italian shares and bonds have underperformed of late. The banking sector has suffered most with the FTSE Italia Banks Index losing almost -9% in November. Italy's FTSE MIB index has fallen -2.65% this month, compared with a -0.74% drop in the pan-European Stoxx600 index. Meanwhile, the 10-year Italian/German yield spread widened to a 1.5-year high of 1.874% last Thursday. The market's key concern is that a "no" vote leading to resignation of Prime Minister Matteo Renzi would trigger massive selloff in bank shares, forcing the debt-ridden Banca Monte dei Paschi di Siena to suspend plans for a critical 5B euro capital increase and then making other banks, such as UniCredit, to delay similar plains too. Such risks might be contagious, spreading to other peripheral countries and result in another European financial crisis.