FX Update: New Year stumbles out of the gates

We start the year with USDJPY plunging well below 110 and EURUSD taking a half-hearted stab at 1.1500 before retreating again. The sharply stronger yen of late appears to be a delayed firing of its safe-haven tendencies, as it absorbs the worst December for US equities since the 1930s and US long treasury yields collapsing.

Overnight, a weak China Caixin Manufacturing PMI (49.7) confirmed the weak official data point from New Year’s Eve, and Chinese equities stumbled out of the blocks and closing at new lows for the cycle and S&P futures are down a full two percent as of this writing several hours ahead of the US open. The enormous bounce in the final week of trading in 2018 was likely in part driven by enormous rebalancing flows after a huge drop in equities for Q4 and significant rise in treasuries. That calendar and rebalancing factor of course disappears with the rollover into a new calendar year.

Markets have plenty to ponder as 2019 gets underway: a US government shutdown will affect some data releases and the Fed’s ability to get a signal from the economy if it drags on for much longer. President Trump’s position on the shutdown may prove weak and he is already now expressing hope for a deal with Congress. Also a factor is the idiotic US budget ceiling issue, as USD liquidity is affected by the run up to the next budget ceiling suspension expires on March 1 as the US Treasury is forced to draw down some of its enormous cash levels ahead of that date.

On the political front, Trump will find his seat almost unbearably hot as the new US Congress sits starting tomorrow and the Democratic house will come out with guns blazing. Trump also faces the challenge of a trade deal with China and as if there wasn’t enough on his plate, the North Korea issue is back, as Kim Jung Un’s latest moves have made clear that nothing concrete was accomplished the last time around.

Outside the US, the market frets about the quality of global growth, in particular whether and when China’s shifting attitude on stimulus will show up in the data. In the UK, the Brexit issue will intensify as the parliamentary vote nears, likely for the week after next. In Europe, political noise has ebbed as the Italian budget deal has put that issue on ice until at least later this year, but the challenges of populism in Europe can only mean that 2019 will prove a pivotal year for Europe.

Chart: USDJPY weekly

The USD has been somewhat neutral in broader terms, as EURUSD has failed to exit its seeming perma-range between 1.1300 and 1.1500, but the yen has increasingly made a statement over the last couple of weeks, rising across the board on weak Asian markets and as US yields have tumbled aggressively at the long end.

The proximate technical inflection technical inflection point is the 61.8% retracement of the prior wave coming in around 108.40 as USDJPY has been in a tightening coil over the last several years. If the market’s anticipation of a Fed direction change deepens and the Fed actually transitions to an easier stance in the year ahead, the USD could be set for a tumble here, while a misread of the situation and resurgence in bond yields or the failure of the US to fall into recession could reverse the slide.