Dollar Begins Busy Week on Backfoot

Highlights
The US dollar starts a critical week on the defensive.  A new round of long-term asset purchases by the Federal Reserve coupled with a stronger than expected Chinese PMI weighed on the dollar and encouraged purchasing of so-called risk assets.   Although the euro has flirted with the $1.40 level, we note it has only managed to close (the North American) session once above there and that was on Oct 14.   With the help the first increase in the UK’s manufacturing PMI (54.9 vs a revised 53.5—from 53.4 in Sept) sterling reached its best level since briefly pushing through $1.61 on Oct 15.   The greenback popped to JPY81.40 in early Asia amid speculation, likely unfounded, of intervention.  The gains were short-lived and the dollar sunk back toward the lows, just above JPY80.20.  The dollar is also heavier against most emerging market currencies, with the notable exception of the Chinese yuan, which declined by almost 0.5%, the largest single day decline in almost two years. 

The China PMI boosted regional stock markets, and the MSCI Asia Pacific rose 0.8%. There were gains across the region with the Shanghai index leading the way, up 2.5%, though Japanese stocks were down 0.5%.  The rise in the Shanghai Index was led by basic materials, up nearly 5%, while the drop in Japanese shares was led by consumer goods.  Hong Kong’s Hang Seng rose 2.4%, while there were advances in Taiwan, Korea, India and Singapore.  In Europe stocks were buoyed by the global PMI data as the Euro Stoxx 600 increased by 0.2%.  The gains were led basic materials and industrials while the Dax increased by 0.4%.  And finally, S&P futures are up nearly 0.5%.

Portugal managed to avoid a possible collapse of its government after the minority Socialist leaders and the opposition Social Democrats (PSD) managed to strike a last minute deal on Saturday that has ensured the country’s 2011 austerity budget will be approved when parliament votes on it this Wed.  Subsequent the deal the yield on the 10-year Portuguese bond dropped by 2.3% to 5.856, although it has crept up in this morning’s session as Ireland drives the periphery spreads higher.  Ireland’s 10-year, for example, is up 11bp, leading to a record high premium over the benchmark German yield and Greece’s CDS price is up 10% even though yields are lower as some believe that Greek bonds are being purchases through the ECB facility.  South Korea’s bond’s fell (yields were higher) after inflation accelerated to a 20-month high and exported climbed more-than-expected.  Meanwhile, US Treasuries at most tenors are flat.  And finally, in the EM space Ruling Party candidate Dilma Rousseff became Brazil’s first woman president after winning the run-off vote against Jose Serra.  Rousseff had 55.8% of the votes and pledged to continue Lula’s popular social programs as her main goal is to eradicate poverty. 

Currency Markets

This is arguably the most important week remaining in the year.  The US mid-term elections are tomorrow and the Republican Party looks poised to wrest control in the House of Representatives and leave the Democrats with a smaller majority in the Senate. The Republicans also may secure a majority of state governor offices.  It lags behind the Democrats by 2 governorships (26-24), but there are 37 on the line tomorrow and half of the races do not feature an incumbent.  The size of the Republican victory will influence the way the current Congress addresses the outstanding legislative issues, including the extension of the 2001 and 2003 tax cuts, the 2009 payroll tax credit and the extension of unemployment benefits (set to expire at the end of Nov).   Wednesday is the much awaited FOMC meeting.  The key issue is how much and how fast the Fed will buy Treasuries.  The consensus seems to be for around $500 bln over the next six months.   There is also the usual start-of-the-month economic releases, including the manufacturing PMI today, where after the better than expected Chicago reading at the end of last week, may have seen expectations creep higher for the national report from the 54.0 consensus (54.4 in Sept), auto sales, which look to have been among the strongest since the end of the cash-for-clunker program.  The event-packed wee finishes with the non-farm payrolls report.  It is expected to post its first increase since May. 

This week there are several central bank meetings.  The Reserve Bank of Australia kicks it off early Tuesday (3:30 GMT).  Sentiment has swung against a rate hike after core CPI fell back within the RBA’s target range.  Manufacturing continues to slow, house prices are leveling off and the softer RBA commodity index warns that the terms of trade may be peaking.   An RBA hike would be a surprise for the market at this juncture.  The BOE and ECB meet the day after the FOMC.  The risk of QEII in the UK has eased following the recent string of economic data, especially the 0.8% quarter-over quarter rise in Q2 GDP.  The ECB will also remain on the sidelines.  At the press conference, Trichet may push his case for less discretion in imposing sanctions on fiscal violators and may suggest more on the exit strategy at next month’s meeting.  The Bank of Japan brought up its meeting from next week to this week and there is some speculation that it may increase its own bond purchase program. 

Australia TD-MI inflation measure rose 0.3% in October following an 0.1% gain in September, taking the annual rate of inflation to 3.8% from the 3.2% y/y  in September. Yet the sharp acceleration in the annual comparison was due to base effects, according to TD-MI, as a petrol-driven 0.3% m/m drop last October fell out of the calculation. Meanwhile, TD-MI’s measure of underlying inflation (trimmed mean) rose 0.2% m/m in October following a flat reading in September. The pick-up on a month comparable basis left underlying inflation 3.1% above October of 2009, a sharp acceleration from the 2.3% y/y in September. Overall, this report does not change the outlook for tomorrow’s meeting — we expect the RBA to leave rates steady at 4.50%. The strong domestic CPI data, coupled with the strong manufacturing data in China, not surprisingly, led to AUD outperformance.  AUD was in fact the strongest performer in the G10 up nearly 0.4%.   Meanwhile, the AUD broke its 20d moving average (after the 5 and 20 day moving averages crossed on Friday) en route to a six day high of 0.9915.

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT the US will report September’s personal income figures.  The consensus for personal income is for a drop to 0.2% from 0.5% in August.  Personal spending is expected to remain flat at 0.4%.  At the same time m/m core PCE is expected to remain at 0.1%, while the y/y figure is expected to fall to 1.3% from 1.4%.  At 10:00 EST / 14:00 GMT we get the US’s October ISM which is expected to fall to 54.0 from 54.4.  Construction spending m/m is expected to fall by 0.5% from a 0.4% increase in August.  At 13:00 EST / 17:00 GMT the Treasury announces 10-year tips.  BoE’s Tucker’s summary of remarks from 9/30 are slated to be released this morning but no other central bank speakers.