Dollar Gets Punished on Policy Outlook

Highlights
The US dollar is getting punished; suffering steep broad based losses today.  The spark that has driven the euro and sterling through their recent caps near $1.40 and $1.60 respectively, the Australian dollar, Swiss franc and Japanese yen to new highs and the Canadian dollar through parity, appears to have been initially triggered by unexpected tightening by the Monetary Authority of Singapore, which is achieved through the currency appreciation against an undisclosed basket.  With the US Treasury report on currency market manipulation expected tomorrow, and pressure mounting ahead of the G20 meeting next month, there is speculation that quicker Asian currency appreciation may be at hand.  This hit the already fragile dollar.  The beleaguered buck remains vulnerable to headline risk in North America if the PPI is lower than expected and/or the trade deficit larger than expected.

Asian stocks climbed strongly on optimism about economic growth and corporate earnings. The MSCI Asia Pacific index advanced 2%, the biggest one-day gain since June. Japan’s Nikkei led the way higher among the regional benchmarks, up 1.9%. There were advances of more than 1% in Hong Kong, Taiwan, Korea and Australia, while indexes gained across Asia. Futures on European and US indices are trading higher.  In Europe, German stocks climbed, extending a 2-year high, as better-than-expected earnings boosted confidence in the global economic recovery.   The Stoxx 600 was 0.2% higher, led by stronger gains in telecommunications and utilities.

Japanese bonds were steady after an auction of 600 billion yen ($7.4 bln) drew 5.4 times the amount on offer, the highest bid-to-cover ratio since May 2002.  Whereas South Korea’s bonds surged after the central bank unexpectedly left interest rate unchanged.  In Europe German 10-year government bond yields were near their highest level in two weeks as rising equities sapped demand for bonds.  More specifically, by mid-afternoon in Europe 10-year bunds were up 2bps.  Greek yields were up 7bps followed by a 4 bps rise in Portugal. In addition, Italy sold €5.5 bln of 2015, 2023 and 2037 bonds today. Treasuries were little changed, with the 2-year at 0.3% and the 10-year at 2.4%.

Currency Markets

Singapore has a unique and rather nuanced currency peg, but the measures taken would seem to suggest officials are embracing a stronger currency after already seeing about 8.5% currency appreciation thus far this year.  The driving force appears to be Singapore’s concern of inflation where the 2-3% target (which the central bank has warned will likely overshoot) stays elevated in the first half of next year.   Even though there was some market talk that a couple of Asian central banks may have intervened, Singapore’s move has captured the market’s imagination as spurred talk of a “secret” agreement to allow the Asian currencies’ rise to defuse the so-called currency war.  Talk that the quid pro quo is for the Fed to hold off QEII seems wide of the mark.  The US Treasury is set to release its report on currency market manipulation tomorrow and, based on the recent heightened rhetoric coming from Washington, the odds seem to favor the citation of China.  This, coupled with the nearly $200 bln jump in Chinese reserves in Q3 (which Chinese officials suggest is due to the valuation effect of the rise in the euro) has fanned expectations, which after the weekend G7/IMF meetings had seemed to lower those very expectations.   Even though the dollar’s slide has left short-term technical indicators over-extended, the greenback faces headline risk early in the North American session.  Given the Fed’s concern about inflation, a soft PPI would likely weigh on the dollar.  The consensus is for a 0.1% increase.  If anything the import prices warn of downside risk.   The August US trade balance report also poses risk.  A poor figure could weigh on GDP expectations for Q3, which are coming in just below 2%.  Seasonally, August often sees an increase of imports as the holiday season is prepared for.  Data from the West coast ports point to a multi-year high in inbound containers.  Also, July’s exports had been flattered by a 62% rise in aircraft exports, but Boeing reported a decline in shipments in August to the lowest of the year. 

A consensus appears to be emerging in the BoE towards maintaining the status quo and not providing further monetary stimulus.  Yesterday, the BoE’s Andrew Sentance, who spoke with the British American Business council, reaffirmed his position as the ultimate hawk at the BoE.  Since June he has been voting for a 25bp rate hike and his speech yesterday underpins the view that he did so again in October.  In particular, he feels that the so-called output gap is not as wide as others suspect and that short-term austerity would in fact lead to stronger economic growth by ways of renewed confidence in the bond market and aid economic growth.  Although his hawkish views place him directly outside the fray, another voting member, Paul Tucker, spoke to the Daily Mail about his outlook for monetary policy.  In particular, he has turned less hawkish but still appears to be opposed to further stimulus.  He describes inflation as uncomfortably high and notes that in normal times he would be a strong advocate for withdrawing stimulus.  Consequently, this means he is unlikely to be voting for further easing anytime soon and the prospect of near-term stimulus appears to be dwindling, especially in November.  According to their recent press statements, Andrew Sentance, Spencer Dale, David Miles and Paul Tucker appear to be opposed to further easing.  In fact, the bond market has already priced in a 10bps increase in the next 12 months from the price overnight interest rate swaps.  And according to the market consensus, economists expect the BoE to increase the bank rate by 25bps in Q3 2011.

New Zealand said retail sales were flat in July, while house prices dropped in September, dampening any talk of further rate increases from the Reserve Bank in coming months. Overall retail sales were flat compared with the 0.3% gain expected, while core sales dropped for the second month, down 0.6%. House prices fell 0.3% in September from a month earlier, according to figures from the Real Estate Institute of New Zealand.  Additionally, in the past couple of weeks the majority of key New Zealand data have disappointed and indeed the data released in the past 24 hours confirms this trend.  More specifically, New Zealand economic data surprises are now 1 standard deviation below its one month average, signaling that, overall, New Zealand’s economy is not as buoyant as Australia’s.

Upcoming Economic Releases

At 8:30 EST/ 12:30 GMT the US reports the August trade balance.  The consensus is for the balance to widen to $44bln from $42.8 bln.  At the same time, September’s producer prices will be reported.  The market expects the m/m to downtick to 0.1% from 0.4% in August, while core is expected to remain unchanged.  In Canada the August Int’l Merchandise Trade index will be reported at 8:30 EST / 12:30 GMT as well. Survey expects a small drop.  At 17:00 EST the Fed’s Minneapolis President, Narayan Kocherlakota, speaks at a payment conference.