CHINA REMAINS THE EPICENTER OF THE MARKETS

 China remains the epicenter of the markets China’s central bank set the daily midpoint rate for the yuan higher for a second day, in an attempt to ease fears that it is trying to weaken its currency to gain a competitive export advantage. Nevertheless, the Asian equity markets continue to tumble and the carnage seems to have no end. The recent yuan’s depreciation and the recent weak economic data added to the possibility of more bad news out of China and that it might be hard for the nation to achieve economic growth above 6.5%. Australia and New Zealand, whose economies are heavily dependent on exports to China, saw their currencies weakening further. Now the focus shifts on Chinese trade data to be released on Wednesday.

• The dollar pared gains as worries over China kept demand for safe-haven investments, despite a strong US employment report. Nonfarm payrolls increased 292k in December from an upwardly revised 252k previously, and above expectations of 200k. Even though the jobs report seems to be solid, the flat average weekly earnings point to weak inflationary pressures. The minutes of the Fed’s December meeting showed that the debate over the outlook for inflation will be crucial to determine the future path of rate increases. If the inflation data going forward do not improve, the Fed may hold off on rate increases. As a result, we will need strong data going forward to give the bulls a good reason to buy USD back.

• Elsewhere, the South African Rand collapsed at the opening on Monday, falling more than 10% against the dollar. The move was most likely flow driven, as the lack of liquidity outside the major pairs and position liquidation hurt ZAR, which has unwind most of the move. Even though today’s move was not based on fundamental reasons, the currency continue to make new record lows against the dollar as global markets trembled in response to the deepening turmoil in China and other major emerging markets. On top of that, South Africa’s President fired two finance ministers in four days raising frustration among businesses and investors with his leadership skills. Economists believe the country’s growth could decelerate for the 3rd consecutive year to less than 1% annually, as the soft demand for SA’s minerals continues to fall. USD/ZAR is likely to correct most of its extreme move today but the pair is poised to move higher.

• Today’s highlights: Norway’s CPI rate for December is expected to have slowed slightly to +2.7% yoy from 2.8% yoy previously, but to still remain above the Norges Bank target of 2.5%. The Bank has shown no significant concern regarding the level of the inflation as it is mainly attributed to the weak NOK. Therefore, market participants are most likely to watch the oil prices as a proxy for the krone’s near-term direction.

• From Canada, the housing starts for December are due to be released.

• As for the rest of the week, the spotlight will be on the Bank of England monetary policy meeting on Thursday. No change in policy is expected while consensus is that the vote will once again be split 8-1 with Ian McCafferty to maintain his call for a rate hike. The minutes of the meeting are released at the same time as the decision, which makes meeting days more interesting than before. This gives us the opportunity to get additional insights about members’ views on the UK economic outlook and future decisions, especially with the “Brexit” referendum looming and sterling testing its lowest levels since June 2010 vs USD. The minutes of the last meeting showed that the committee expected the CPI rate to have returned to positive territory and to continue rising as the effects of falling energy prices last year dropped out of the calculation. While inflation did marginally emerged above zero, oil prices fell even further since the BoE’s meeting and the country’s economic data have been mixed. That said, we will closely monitor the meeting for any hints on just how far market expectations for the first increase in the Bank rate have been pushed back.

• On Tuesday, we get the UK’s industrial production for November. Expectations are for the industrial output to have remained flat, a slowdown from October’s +0.1% mom rise. The construction and manufacturing PMIs for the same month were not particularly encouraging. As such, we see an increased likelihood for a soft industrial production figure, which could weaken GBP at the release.

• On Wednesday, China’s trade surplus is forecast to have narrowed somewhat in December, with imports once again expected to have fallen at a faster pace than exports. Both imports and exports are also expected to fall faster than the previous month, reflecting sluggish domestic demand in the world’s second largest economy. Since Australia and New Zealand are heavily reliant on exports to China, the rapid fall in Chinese imports in particular could put AUD and NZD under renewed selling pressure.

• On Thursday, besides the BoE meeting, Australia’s unemployment rate is expected to have ticked up a bit in December, after printing two consecutive months of solid employment gains. Net employment is expected to fall by 12.5k after rising 71.5k in November. Even though we would expect overall employment to have remained supported due to the holiday season demand, if the forecast is confirmed, it could weaken AUD a bit on the news.

• From Sweden, we get the CPI and CPIF for December. Both rates are forecast to have remained unchanged from the month before. In the minutes of its latest policy meeting, the Riksbank stated that there was an upward trend in inflation, but noted that the upturn is volatile and not yet on a firm footing. A possible positive surprise in the CPI rate could solidify the Bank’s view and support SEK a bit, at least temporarily.

• On Friday, the US retail sales for December are expected to have slowed from November. Nevertheless, due to the December holiday period and the low energy prices, we see a possibility for a higher-than-expected reading. This could encourage USD-bulls to add to their positions.