Thursday December 29

Stocks drifted marginally lower for the third consecutive day of losses. The S&P 500 and the Dow Jones each fell less than 0.1% to 2,249 and 19,819 respectively. Economic data showed that the trade deficit widened more than expected, which will be a headwind for fourth quarter GDP. On the other hand business inventories rose which could support 4Q GDP. The DJ Utility average rose 1.3% while financial shares lost 1.1%. Additionally the two year Treasury yield fell 5bp to 1.22%. The ten year Treasury yield fell 3bp to 2.48%. 2yr vs 10yr bull steepened to 1.26%. The dollar was lower today against developed and emerging market peers. USD fell 0.7% against EUR to $1.0491. USD fell 0.6% against JPY to Y116.59. USD fell 0.3% against GBP to $1.2266. Movements in fixed income and FX markets today mark a small reversal of the “Trump trades” from the end of the year. It seems that heading into the new year investors could be tempering expectations or taking gains that they experienced at the end of the year. On a similar note, gold prices rose 1.7% to $1,159. Oil prices finished lower. WTI fell 0.4% to $53.82 and Brent fell 0.1% to $56.14.

The PBoC is changing the currencies against which it values the yuan. This is an attempt to prevent further depreciation in its currency. It will adjust the basket of currencies, the weighting of each currency, and increase the number in the basket that it uses to value the yuan each day. The number of currencies will rise from 13 to 24 and the dollar’s weighting will fall from more than 26% to 22%. Increasing the number and decreasing the dollar’s weighting is advantageous for the PBoC. As the dollar strengthens, if the yuan is weighted towards the dollar that is disadvantageous for Chinese exporters. The basket will now include currencies such as the Saudi riyal, Swedish krona, and the Korean won. It is expected that widening the scope will give the PBoC more flexibility in guiding the yuan lower. They want to prevent the currency from falling too far too quickly. The yuan is down 7% against USD this year, and that trend is expected to continue as interest rates rise and the US dollar continues to appreciate. This will not do anything to stop or prevent capital outflows, which is the underlying cause of the yuan’s depreciation.

Bonds in Europe have been rallying over the last few days, leading into the new year with some momentum that wasn’t expected. Many analysts and investors are of the belief that developed market interest rates will continue to rise due to fiscal and monetary conditions heading into 2017. However high indirect bidding at a recent Treasury auction, trades placed in ETF options market, as well as this rally in Europe suggest otherwise. Even in the United States, where the headwinds to Treasuries are the highest, the selloff in rates has eased over the last few weeks with the ten year holding around the neighborhood of 2.55%. As of today ten year German bunds and U.K. gilts traded at 0.18% and 1.24% which were the levels they were at before the election in the US, which initiated the selloff in developed market sovereign debt. Two year yields in each of those countries are both at record lows as well. That could suggest that investors are decoupling their expectations between the United States and Europe as it relates to inflation and growth. Even in the United States, the outlook may be priced in as indicated by the stable yields over the last two weeks.

Thursday December 29

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