Will the Risk Appetite be Sustained In North America?

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Highlights

The US dollar is broadly lower to start September as stronger data, especially from Australia and China encourage new risk taking. Yet this has not seen the yen and Swiss franc, beneficiaries of risk aversion, lose ground against the greenback, though they are under-performing on the crosses. This, coupled with the fact that some countries like the UK, Norway and Sweden, which have reported disappointing PMIs, have also seen their currencies raise against the dollar today, provides a sense that in addition to the risk-on story, there is a weak dollar bias. Given the over-stretched short-term technical studies, the risk is that if the US data disappoints (ADP and ISM), the price action could be reversed.

Global equities are rallying as the new month gets underway. The commodity sector helped lead the MSCI Asia-Pacific Index 1.1% advance. Stronger than expected Australian Q2 GDP (1.2% vs 0.9% consensus) helped lift the S&P/ASX 200 by a bit more than 2%. News that continued growth in Korea’s exports saw the Kospi rise 1.25%, and the helped lift the won by a sharp 1.2% against the dollar. Foreign investors were net sellers of both Taiwanese and Koran shares last month, but may return. European bourses are also fully participating in the rally with most major indices up 1%-1.5% near midday in London. Basic materials and consumer services and goods are leading the way, but all major sectors are advancing. US indices are called a bit more than 1% higher, though the ADP data will be out before the open of the NYSE.

The general increase in the risk appetite is also being reflected in the sovereign bond markets. Bond yields are mostly 4-6 bp higher in the core Europe. This includes the UK and Sweden where the PMI was considerable weaker than expected. Peripheral bonds are outperforming the core resulting in a modest narrowing of spreads, a little less in Ireland and Portugal and a little more in Italy and Spain.

Currency Markets

Given the slump in equity markets in August and the heightened concern of a global economic slowdown, there seems to be a collective sigh of relief, not just that the month is over, but that the economies, generally speaking, may not have performed so badly. Australia got the ball rolling with a stronger than expected Q2 GDP. Exports rose 5.6% in the quarter. The Australian dollar is the strongest currencies today, rising about 1.5% to test resistance in the $0.9050-$0.9080 band. China’s PMI rose to 51.7 from 51.2 in July. The market expected a 51.5 reading. What investors are most interested in is the forward looking aspect and here the China news seemed particularly promising as new orders rose to 53.1 from 50.9 and new export orders rose to 52.2 from 51.2. The fact that input prices leapt to 60.5 from 50.4 warns of upside risks to the upcoming inflation reports.

The euro zone PMI was largely in line with the flash reading (55.1 vs flash of 55.0), which is still off from 56.7 in July, but consistent with modest expansion. However, disappointing was the German retail sales report. Retail sales in July fell 0.3%. The market had expected a 0.5% increase. It is the second consecutive decline and the fourth decline in five months. It drives home a key concern: German growth is not a function of its own internal dynamics but remains heavily export oriented. As a percentage of GDP, Germany exports are on par with China, who faces international pressure to rely less on foreign demand. Nevertheless, the euro has rallied to its best level since Aug 20 and is approaching the 20-day moving average, which comes in near $1.2850, and retracement objective of the decline since early August and is found around $1.2875. Hourly momentum studies are over-extended and it should not be surprising if North America pares these euro gains. Initial support will likely be found in the $1.2750 area.

Other currencies are also advancing against the dollar despite reporting disappointing data today. They UK PMI came in at 54.3 vs expectations of 57 and, adding insult to injury the July series was revised to 56.9 from 57.3. New orders were particularly weak, falling to 52.0 from 58.5 and is the lowest reading since the middle of last year. Sterling is trading nearly a cent above yesterday’s lows, but remains well below yesterday’s $1.5475 high. Switzerland’s PMI also disappointed, but at 61.4 remains at relatively lofty levels. The market had expected a 65.8 reading after the July’s 66.9. The SNB meets in two weeks and policy there is little chance that policy is changed. Nevertheless, the dollar slipped to a new low for the year against the Swiss franc of about CHF1.0125.

Norway and Sweden’s PMIs also disappointed, but their respective currencies are not just gaining on the dollar, but unlike sterling and the Swiss franc, are advancing over the euro. Norway’s PMI was particularly disappointing with a sub-50 reading. The 49.2 headline is the lowest of the year and compares with a 55.2 reading in July. Although the krone appears well bid, it appears vulnerable. If the euro does turn lower in North America trading today, the krone might fall further. The dollar is approaching support in the NOK6.18-NOK6.20 area. Note that local reports suggest the central bank governor may be subtly signaling a more dovish stance and that the government’s crisis committee is potentially considering a transaction tax on equities and foreign exchange. Sweden’s PMI slipped to 60.6 from 64.2 in July and expectations of a 64.0 reading. Like Switzerland, these are still quite elevated numbers. The euro has recorded new lows for the year today against the krona near SEK9.3275. This level has not been seen since mid-2008.

The BIS released its triennial foreign exchange turnover survey. It estimates that turnover stands around $4 trillion a day compared with $3.3 trillion in the previous survey. Of note, London’s share increased to 36.7% from 34.6%. The US accounts for about 18% of the turnover, followed by Japan, Singapore, Switzerland and Hong Kong. The dollar is included in about 85% of the trades, which is down from the 90% peak in 2001, but remains the dominant currency. The euro’s share rose 2% to 39%. Emerging market currencies also saw their share increase, led by Turkey and Korea. The industry has become more concentrated as the top ten banks account for 77% market share compared with 70% in the previous survey. The growth rate of the foreign exchange market has slowed considerably from 72% between 2004 and 2007 to about 20% over the past three years. High volatility may have dampened the pace of growth.

Upcoming Economic Releases

At 8:15 EST/12:15 GMT, ADP reports its private sector employment estimate. The consensus is for a 15k increase, down from 42k in July. The ISM is due out at 10:00 EST/14:00 GMT. It is expected to slow to 52.7 from 55.5. The new orders component may be more important than the headline. At the same time, July construction spending will be reported. It is expected to decline by 0.5%.. Auto sales will be reported and this may be another disappointment as anecdotal reports suggest consumers were not enticed by incentives. Poor US data may discourage risk-taking.