Headlines: Japan leadership contest, German confidence and UK inflation


The US dollar is mostly higher as a result of disappointing German, UK and New Zealand economic data. However, Prime Minister Kan succeeded in holding off the challenge at the DPJ leadership contest, easing the threat on the margins of intervention, which helped lift the yen to new 15-year highs against the dollar. Like the yen, the Swiss franc also drew succor from the reduced appetite for risk and the dollar briefly traded through CHF1.00 for the first time since late last year. Euro support is seen near $1.2800 and sterling already successfully tested support near $1.5340. Risk-off sentiment may in some ways be seen as a correction to yesterday’s near-euphoria. Currencies perceived as leveraged for growth, the dollar-bloc, the Scandis, and most emerging market currencies are on the defensive.

Weak German confidence numbers appear to be the catalyst for the recent market sell-off. European stocks declined as the ZEW Center for European Economic Research index of investor and analyst expectations dropped for a fifth month, to minus 4.3 from 14 in August. In addition, UK housing data increased the sentiment in risk aversion, leading to the decline in UK stocks. Meanwhile, high-beta countries like Norway, Greek and Spain sold off the most as stocks in those countries were down by 1.0%, 0.85% and 0.42%. In addition, Asian stocks were mixed as the surprise elections results in Japan were seen to maintain the status quo. The prime ministers challenger Ichiro Ozawa was viewed as the interventionist hawk and suggested last week Japan needed unilateral action to stem the currency’s rise. With Kan’s re-election currency intervention seems unlikely which has weighed on the Nikkei.

The focus continues on Europe as Greece sold 26-week Treasury bills at a yield of 4.82%. The takeaway is mixed as the Greeks were able to hold a successful auction. The cost, however, continues to rise. Greece sold €1.17B of the 26-week bills to yield 4.82%, more than both the 4.655 rate at the previous sale in July and the 5% charged by the EU for its bailout loans. Subsequent the auction the yields on the periphery continued to rise. At the two year tenor, for example, Spanish, Irish and Greek yields continued to rise. The increase in risk aversion, not surprisingly, have led to a marked drop in German yields. In Asia the recovery of the Japanese bond market was fuelled by the victory of Kan. Ozawa, for example, was viewed as an advocate of further stimulus so the Kan victory aided the recovery in JGBS.

Currency Markets

There are three key developments today. First, Japan’s Prime Minister Kan won the DPJ party leadership contest against Ozawa. Ozawa had been a advocating material intervention and new fiscal stimulus. His defeat reduces those risks and has been a factor helping lift the yen today. The rating agencies quickly responded. S&P indicated it would maintain Japan’s rating, but that the quality was “slowly sinking”. Fitch said that the continuity of the Kan Administration was not something that drives its assessment, but it cautioned that a DPJ split could be negative for the ratings. Japan-watchers will be closely monitoring the potential cabinet reshuffle to see what happens to Ozawa supporters. If they are forced out, it would increase the likelihood that Ozawa himself would bolt. The yen may have also received a boost from speculation that China is not alone in buying Japanese paper to diversify reserves. Market contacts report that talk suggests that Singapore and Malaysia may have also done so.

The second important development was the stronger than expected UK inflation. August headline CPI rose 0.5%. The market consensus was for a 0.3% increase. This left the year-over-year rate at 3.1%. The core rate ticked up to 2.8% from 2.6%. The report means that again the BOE must write a letter explaining itself to the Chancellor. This inflation report may have more important implications too. After the triple-disappointing PMI reports, widening trade deficit and decline in property prices, talk of renewed QE had been picked up. The resilience of inflation is likely to cut short such speculation or at least postpone a more serious discussion. Earlier sterling had fallen to test support near $1.5340 in response to the sharp fall Nationwide home price index, with apparently less attention paid to the first rise in its consumer confidence measure after three months of declines. Resistance is now pegged near $1.5440.

The third important development today is the weaker than expected German ZEW survey. The key here is the that economic sentiment collapsed to -4.3 from 14.0 in August. The consensus had forecast a 10.0 reading. The fact that the current assessment actually improved was less material. It rose to 59.9 from 44.3. The discrepancy is troublesome and is consistent with a flattening out of the German economy, consistent with some of the recent PMI readings. Separately and earlier Germany had reported a unexpectedly strong rise in wholesale prices in August. The market forecast was for a 0.3% increase, which would have offset the 0.3% decline in July. Instead wholesale prices rose 1.6%, lifting the year-over-year rate to 6.4% from 5.3%. There has been some talk in the markets that the ECB’s stance may be too tight for some in the periphery, but it may be too easy for the booming German economy.

The Chinese yuan has appreciated at a faster rate in recent days. Of the past five days it has risen 0.66%. Most regional Asian currencies have risen a bit faster, but the yuan’s appreciation is notable. It is now at levels not seen since the unification of exchange rates in 1993. There are several possible explanations. Domestic considerations include greater confidence in the economy, as Premier Wen said, the economy is in “good shape”. Inflation stands near a 2-year high and a stronger currency is perceived to help on the margin (though with negative real rates on the key 1-year deposit rate, it is not clear how much a modicum of currency strength is worth). There may have been some international considerations. We note that Treasury Secretary Geithner has sounded a bit more disappointed with the pace of change. Yesterday some 93 members of the House of Representatives signed a letter requesting to vote on a bill that would allow the US to impose countervailing and anti-dumping duties on countries that consistently have undervalued currencies. House Ways and Means Committee is to hold hearings China tomorrow with Geithner expected to testify and Thursday more of the same before the Senate Banking Committee.

Upcoming Economic Releases

With the uncertainty of the US recovery all eyes will be on this mornings retail sales report for August. The consensus for Advanced Retail Sales is a marginal drop to 0.3% from 0.4% last month. In addition, Retail Sales less Autos is expected to increase from 0.2% to 0.3%. And finally the market is calling for a big jump in Retail Sales ex Auto and Gas with a 0.4% gain month, compared to a 0.1% drop the previous month.

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