Dollar Pulls Back After Brief Rally

Highlights
The US dollar was largely up in Asian session as concerns about debt in the European periphery continued to weigh on markets but sharply reversed course. EUR/USD dropped from $1.3920 to $1.3823 where it subsequently climbed back to a new intraday high of 1.3947. GBP/USD also initially dropped back in early Asia, from $1.6140 to a low of 1.6067, before snapping right back and ended up trading a little lower on the session around $1.61 after the RICS house price balance came in much worse than expected. China’s SAFE said it would impose new rules on bank handling of foreign exchange which would help limit the growth in China’s official FX reserves. Japan’s current account surplus widened as exports ticked higher but the yen was larger gainer versus dollar after the new announcement of China to stem hot money flows weighed on risk appetite.

Asian stocks were mixed, with the gloomier tone sparked by the continued concerns about European sovereign debt. The MSCI Asia Pacific index lost 0.02%, bringing an end to its six-day gaining streak. Around the region, there were small gains in Taiwan, Korea and Singapore, despite the rumors of an eventual Chinese rate hike, which could potentially weigh on exporters that are reliant on Chinese growth and may dampen the earnings outlook.  In Europe stocks climbed, sending the Stoxx Europe 600 Index to a two-year high, after some telecom earnings were better-than-expected.  The Stoxx 600 was up 0.7% led by a 1.6% gain in basic materials while financials were a laggard.   Elsewhere in Europe, particularly Ireland, financials are up nearly 6% on the day as rumors surfaced that central banks were purchasing Irish shares.

Bonds were mixed with another flare up in the periphery with the Portuguese 10-year up 16bp on banking liquidity concerns.  Meanwhile, Spain and Ireland followed suit widening by 3bp and 2bp with Greece’s 10-year yield increased by 2.5bp with Germany down 2bp. On the whole, the average 10-year periphery yield has now widened to nearly 530 bp, higher than the peak of the Greek crisis.  Japanese bonds slipped back again, with the 10-year JGB yield up 2 basis points to 0.97%. Treasuries yields were down, however, with the 2-year yield down 1bp, the 10-year down 2bps.

Currency Markets

The Federal Reserve’s QEII is going to face criticism at the G20 meeting that begins Wednesday night in South Korea.  However, the demand by Russian President Medvedev that he will insist that the Fed consults other countries ahead of major policy decisions is a non-starter.  The idea that the US is exporting prodigious amounts of capital is simply mistaken.  The mirror image of the US current account deficit is that it is a net importer of capital.    The most recent TIC data covers the period through August and US investor purchases of foreign bonds and stocks was in the most recent 3 month period was $10 bln .  Foreign investors bought about $235 bln of US assets in the same time.  For the same year ago period, the US investors bought $64 bln of foreign bonds and stocks.   China’s tightening of its management of foreign exchange quotas and new rules regulating special purpose vehicles and equity investment by foreign corporations will likely force banks to hold more foreign exchange and thereby some of the sources of short-term capital flows (hot money).  Meanwhile, ahead of the inflation (due Thurs in China), which is expected to rise to 4% from 3.6%, the PBOC let the yield on the 1-year benchmark bill rise (5 bp) for the second time in three weeks (20 bp on Oct 26).  There is speculation China may raise rates again or hike reserve requirements.   The central bank of what could be the world’s second largest economy will not consult with others in determining the appropriate monetary policy. 

Overnight in the UK, the RICS house price index was weaker than expected at a balance of -49%. This is the lowest reading since April 2009. The composition was also weak, with the only positive being the expectation that future transactions might increase, albeit against a background of further price declines.  In addition, UK September manufacturing production rose 0.1% m/m and 4.8% y/y, just below the market consensus of 0.2% and 4.9%.  Therefore, the UK manufacturing sector is still on track for positive growth but the pace of recovery is clearly slowing.  This is heightens the risk of a much more protracted slowdown next year.  Overall, the weakness in the housing market, coupled with the slowdown in big-ticket spending, poses a serious downside risk to growth in the ensuing months.  Indeed, this slowdown is likely to be exacerbated by the implementation of new austerity measures and January’s VAT hikes.  With household spending accounting for nearly 55% of domestic output (GDP), the potential for weak consumer spending keeps the possibility of extending QE next year fresh on the minds of policy makers.  This may be highlighted by the MPC tomorrow in its inflation review which poses downside risks to sterling.  But, at this point, the flow data may be overwhelming negative economic data as sterling may have been buoyed by potential M&A activity that may keep potential demand firm.  For one, Vodafone plans to sell interests in Japanese wireless for £3.1 bln and there is speculation that Norway’s sovereign wealth fund may invest in UK real estate ventures. 

Japan’s current surplus widened in September, boosted by an increase in exports, supporting the notion that demand from Asia has helped offset the impact of the yen’s strength.  The surplus expanded 24% from a year earlier to 1.96 trillion yen ($24 billion), more than the forecasts for a surplus of 1.684 trillion yen. Exports climbed 2.3% from the previous month, and 15.9% from a year ago, while imports fell 1.6% from the previous month, and rose 10.5% on the year. The MOF released portfolio investment flow data for September showing JPY3.2 trillion ($39.6bln) of net outflows, the ninth straight month of outflows. Total net outflow from January to September reached 24.1 trillion JPY. Of the net outflow in September, 68% consisted of movements into US dollars, while most of the rest, 30%, consisted of yen – given that this figure used to be close to zero, this suggests a caution about the prospects of further yen strength.

Upcoming Economic Releases

At 10:00 EST / 14:00 GMT the US reports wholesale inventories.  In Mexico at 10:00 EST / 14:00 a host of important data will be released, including CPI, vehicle production, sales and exports and the trade balance.  Events: There are no Fed speakers but the RBNZ publishes its Financial Stability Report at 12:00 EST / 16:00 GMT followed by the BoC’s Carney and a US Treasury Auction at 1 PM / 17:00 GMT.