Chopped USD-uey

The US dollar has recouped a good part of yesterday’s losses as the choppy range trading that has characterized recent trading continues.  Despite a string of poor economic data, pointing to stronger deflation forces and weaker output in Japan, the yen is the strongest currency, posting across the board gains.   German retail sales were very disappointing, falling 2.3% in Sept (vs consensus forecast of +0.5%) and the Aug series was revised to -0.4% from -0.2%, but the euro’s retreat was well underway by then.   Nearby support is seen near $1.3780, but the lower end of the recent range comes in nearer $1.3700.   The market also may be sensitive to the heightened tensions in the peripheral European bond market.  Month-end flows are also a wild card in a market that is on edge ahead of next week’s key events and especially the FOMC’s QEII decision. 

Japanese stocks fell, sending the Nikkei down 1.7% as a strengthening yen added to concern about earnings growth and some companies missed their profit estimates.  The fall was led a 3.3% drop in technology stocks followed by a 2.2% decline in industrials, even though utilities were up nearly 3%.  China’s stocks dropped, too, on the outlook for inflation and the prospect that the government will intensify measures to curb prices.  The Shanghai Composite Index fell by 0.4%, led by a loss of financials.  Overall, the MSCI Asia Index was down 0.5% on the weaker-than-expected profit outlook.  In Europe, stocks slipped as a host of domestic economic data was weaker-than-expected, stoking fears that the current recovery will fail to be maintained.  The Stoxx 600 lost 0.4% led by a drop in basic materials and financials.  German stocks retreated, with the Dax falling 0.2%, led by a loss consumer services.

Greek 10-year bonds weakened for a fifth consecutive day, driving up yields relative to Germany, and stoking fears of future restructuring.  The yields on the 10-year tenor were up 37bp, leading to an 820 bp spread between the 10-year Greek and German spread.  At the same time fiscal concerns continue to hover around the non-core (periphery) as the yields on Portuguese and Irish debt climbed as well. Ahead of today’s budget meeting, for example, Portuguese yields are up 9bp while Irish yields are up 16bp.  And with the flare up in periphery debt, of course, German yields were down 3 bp.  Japan’s 10-year bond yield was up 2bp while the 2-year was flat.  US Treasuries yields were mostly down, as the 10-year dropped by 1bp, the 5-year dropped by 2bp and the 2 year was flat. 

Currency Markets

Next week’s event risk is substantial.  US elections, the passing of which alone will help lift some uncertainty that has hung over investors and businesses in a number of areas including next year’s marginal tax rate, the FOMC meeting which will proceed with a QEII, and although long discussed may still surprise, and a series of economic data expected to show relatively strong auto sales and the first rise in US nonfarm payrolls since May.  There are several take aways from this week’s developments.  First, stronger than expected UK Q2 GDP has prompted a swing in the pendulum of market psychology away from a new bout of asset purchases.   While this weighed on British gilts, it helped sterling outperform.  Second, the policy signal in a number of other countries was in the opposite direction.  Officials in Sweden, Norway, Canada and New Zealand have signaled a slower pace of normalization of monetary policy, while soft CPI figures, suggest the Reserve Bank of Australia need not be in a hurry tighten policy further.   Third, the European debt tensions have escalated again and the Greek, Irish, and Spanish bank accounted for 61% of the borrowings last month up from 51% in August, while the overall amount of ECB lending has fallen to its lowest level since the fall of Lehman.  Fourth, this appears to be the first week in five that the US-German 2-year interest rate differential has not moved in Germany (and the euro’s) favor.  This is one of the indicators we have highlighted that has tracked the euro-dollar exchange rate very closely.  Fifth, while there clearly strong portfolio capital inflows into emerging markets, there also is some hot money.  It is difficult to determine the relative proportions but as the dollar has entered a trading range, some profit-taking has been seen in emerging markets. 

Retail sales in Germany unexpectedly dropped for a second straight month in September, well below market consensus.  September m/m sales fell 2.3% (compared with a m/m revised August figure of -.4%), while y/y September sales rose 0.4% after a 2.2% y/y increase in August.  German retail sales account for less than 50% of overall consumption as they exclude cars and petrol as well as services.  Nonetheless, retail sales are the best proxy for consumption trends. With demand for exports waning this report is a bit of a drag to overall GDP sentiment as domestic demand is a key to continued German output growth.  Overall, the reports contrast with the strong consumer confidence figures reported earlier in the week so a clear trend is hard to extrapolate but with governments across the EMU cutting spending to rein in budget deficits, increasing uncertainty over the strength of recovery looms. Additionally, Eurozone October HICP unexpectedly accelerated to 1.9% y/y, from 1.8% in September and against the consensus view for a stable 1.8% rate. The fact that inflation is no longer below the ECB’s definition of price stability and M3 growth is picking up, suggest that underlying inflation pressures are slowly starting to pick up again. The euro began retreating before the data was reported, reaching a low of 1.3807.  Subsequently, the euro has made a bit of a comeback after finding the day’s low as rumors surfaced that there has been an agreement on the Portuguese 2011 budget. 

Japan September industrial production dipped -1.9% m/m SA, much weaker-than-expected with the y/y figure narrowing to +11.1% y/y from +15.1% in August. It represented a fourth straight m/m decline in industrial production, interrupting the rebound from February 2009 y/y record-low of-38.6%.  This runs parallel with the pattern in exports and producer shipments, which fell -0.7% m/m SA to +12.3% y/y after +15.8%.  Producer’s m/m inventories edged up +0.2% SA, with the inventory ratio +1.4% SA and trending sideways this year.  In a further reflection of the loss of momentum in manufacturing, the October PMI fell to 47.2 after 49.5 in September slipped below neutral 50 level for first time in 15 months.  And yet the yen continues to surge, reaching a daily low of 80.53 where it found support bouncing up to its daily high of 81.08.  The daily trend appears to be losing steam around this level as the long as becoming overbought. 

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT the US reports 3Q GDP figures.  In the past few days the market has increased the consensus from 1.9% to 2%, highlighting the expected recovery in the US economy.  Personal consumption is expected to increase to 2.5% from 2.2% last quarter.   At the same time Canada will report its GDP number also expected to increase from the previous month.  Additionally, Canada is expected to report industrial production figures which are expected to decrease from the previous month.   Later on in the day the US will report NAPM-Milwaukee figures followed by Mexico’s budget balance.  And finally, at 16:00 EST / 20:00 GMT the Portuguese state council meets about the budget.

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