The US dollar is suffering broad losses


The US dollar is suffering broad losses. Signs that European growth are moderating or that an Australian rate hike next week is not as easy of a call as it appeared a few days ago has done nothing to dent the persistent appetite for the major foreign currencies. Even a sub-50 reading on South Africa’s PMI did not deter rand purchases against the dollar. Japanese officials meanwhile are voicing more concern about the yen as the dollar edges closer to the JPY83 level. Although the BOJ is widely expected to provide additional support next week, the idea that the Fed is close to resuming a long-term asset purchase program remains the key focus. The contrast with the ECB, which has signaled intentions to continue to exit from its crisis response is stark and continues to undermine dollar sentiment.

Asian stocks rose as faster-than-expected growth in Chinese manufacturing supported confidence in the global economy. The Shanghai Composite was up by 1.72% by mid afternoon in London. Overall the strong Chinese numbers the MSCI Asia Pacific Index increased by 0.57%. In addition, Japan’s Nikkei 225 gained 0.37%, recovering from a 0.1% drop caused by the strengthening yen. The rally in the Nikkei was led by a gain in energy and financials, buoyed by the outlook for the global economy. On the flip side consumer services declined the most as Japanese numbers may have dampened the outlook for consumer spending. And European stocks rose, stoking a 0.45% increase in the Stoxx Europe 600, bolstered by M&A activity.

With the strong Chinese data in mind, Australian 2-year yields increased by 7bps. In addition, addition, Japanese 2 –year yields were flat but the 10-year increased by 3bps. In Europe, expectations of strong economic data have underpinned a strong rally in Swedish bonds. Swedish 10-year yields, for example, jumped the most in the European Union today after a string of indicators strengthens the view that the Riksbank will stick to its monetary tightening plans. Moreover, the 2-year yields on the periphery experienced a modest decline, as Ireland’s yield fell by 30 bps, Portugal’s by 29bps and Greece my a mere 8bps. German bonds were silent, increasing by 2bps.

Currency Markets

The US’s dollar’s slide that began in earnest in early September is set to continue. The prospects of QEII are deeply engrained. Some observers are emphasizing the sell-off in US Treasuries after the stronger Chicago PMI, but it seems the recovery was just as impressive. There seem to be two elements capture the forces at work. First, the euro continues to track the US-German two-year spread. The spread has moved from a about 9 bp in Germany’s favor as recently as Sept 7 to 47 bp today. This is a new wide read since the end of last year. The spread seems important not simply because one has to pay more for the “privilege” of holding dollars, but also because that spread appears to reflect and encapsulate the various forces at work. Second, and perhaps related is that the dollar’s weakness appear to be prompting intervention by a number of countries to slow the rise of their currency appreciation. This is not an issue of competitive devaluations as most currencies are appreciating against the dollar. In any event, the proceeds of the intervention are finding their way into US Treasuries. The Federal Reserve reports its custody holdings for foreign central banks every week. With yesterday’s report, we learn that custody holdings rose by about $32 bln in September to bring the Q3 figure to $132 bln. This is almost as much as custody holdings rose in Q1 and Q2 (~$142 bln). Asian and Middle East central bank in particular are thought to be taking some of the dollar proceeds and converting them into euros, diversifying the new inflow into reserves (not the existing stock).

These considerations are outweighing evidence that the Europe is slowing, in part because the slowing is not sufficient to prompt a policy response from Europe. ECB officials made it clear this week that they are going to continue to exit from the nontraditional measures adopted during the crisis. The low take-down at the ECB refi operations this week suggest that banks in aggregate are reducing their dependence on ECB financing. The peripheral countries remain in need, but the acute pressures are limited to Ireland and Portugal. And the fact that Greek bonds were the best performing in Europe in Q3 will not go unnoticed.

Spain, Ireland and Greece reported PMIs below the 50 boom/bust level. Greece’s 44.7 reading actually represents an improvement over August’s 43.6. However, both Spain and Ireland represent a clear slowing. Germany’s 55.1 was a little weaker than the 55.3 flash reading and this speaks the pace of slowing in Germany. Germany is important because it is its strength that obscures the weakness when looking at the euro zone on the aggregate level. Its retail sales report today was particularly disappointing. The 0.2% decline in August contrasts with consensus forecasts of a 0.4% increase and the July series was revised to a 0.4% contraction from a 0.3% decline in initially reported. On the other hand the French PMI of 56 was an improvement over the 55.4 flash reading and that helped lift the EMU reading to 53.7 from the 53.6 flash. This still represents a slowing from the 55.1 reading in August. The European Commission forecasts the euro zone economy to have grown 0.5% in Q3 after 1.0% (fastest in four years) in Q 2. Its Q4 forecast is for 0.3% growth. Non-EMU PMIs are also interesting and play up existing trends. The UK PMI fell to 53.4, weaker than expected and the lowest in about 1 ½ years. Norway and Sweden reported stronger than expected PMIs, though the euro is outperforming both of their currencies today. Switzerland disappointed (59.7 vs 60.4 consensus) with weakness in employment and output especially evident.

Japanese consumer prices excluding fresh food slid 1% in August from a year earlier after falling 1.1% in July. This was in line with the Bloomberg consensus of -1%. In Tokyo, the core CPI fell 1% in September, following a 1.1% decline in August. This, too, was in line with consensus yet marks the narrowing decline in the level of deflation. In addition, the jobless rate dropped to 5.1% from 5.2%, while the number of folks in the labor force dropped. Indeed, one of the key drivers in the narrowing of the rate of deflation has been anticipation of the cigarette tax. The cigarette tax is slated to begin on October 30 and may distort core CPI to the upside once implemented. And yet this narrowing of inflation may not be to ease concerns about the outlook for the economy. In fact, a recent Nikkei report has fueled speculation that the BoJ will take further monetary easing action when its policy board meets next week.

Upcoming Economic Releases

At 8:30 EST/ 12:30 GMT the US reports Personal Income and Personal Spending. Both numbers are expected to increase from the previous month, followed by the U. of Michigan Confidence index for the month of September. In addition ISM Manufacturing is reported at 10:00 EST / 14:00 and is expected to fall, along with Construction Spending. And finally, the consensus expects a marginal gain in vehicle sales.

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