North Korea Shell Attack Stokes Demand For Safe Haven

Highlights
The US dollar is higher as the markets seek safe haven after North Korea fired artillery shells at South Korea and the euro zone jitters continue. With the upcoming US holiday dampening volume the euro continued its choppy trading after testing $1.36 multiple times yet failing to sustain a meaningful rally, despite the better-than-expected PMI data.  Sterling continues to be caught up in the recent bout of risk aversion, reaching a new two day low around $1.589.  Besides the weakness in the core European currencies, the Swiss franc strengthened as the potential crisis unfolding in Korea stoked demand for safe haven currencies.  The yen is broadly up as well, especially versus the dollar where it remains around JPY84.  Elsewhere, the decline in risk appetite has led to a selloff of the dollar bloc, with the Australian dollar testing recent lows, although CAD bucked the trend with a strong inflation report.   

Global equity markets traded heavily after North Korea fired dozens of artillery shells at a South Korea Island and eurozone debt woes continue to weigh on risk appetite.  Japanese markets are closed for Thanksgiving but the MSCI Asia Pacific index is down 1.3% with the Shanghai index down nearly 2.0% and the Hang Seng down 2.6% led by technology and basic materials.  In Europe stocks were down as the market continued to decline as risk aversion accelerated due to the ongoing Irish bailout issues with the Euro Stoxx 600 down 0.5%.  The half a percent loss was led by a 1.2% loss in financials with Irish financials down 19%.  Meanwhile, the Dax and the FTSE are both down as well, led by materials and financials. 

European sovereign bonds yields continued to increase with the 10-year yield up 12bp while at the same time Portugal’s 10-year yield continued to increased at the same rate.  Despite the increase in periphery yields, the EU, ECB and IMF said the Greek consolidation program remains broadly on track. They suggest the economy is to begin turning around in 2011 but structural reforms are need to secure Greece’s competitiveness. The mission for the next program review is scheduled for February next year and approval of the conclusion of the second review will allow the disbursement of €9bln.  Furthermore, in one of its last two auctions Spain sold €3.26bln of treasury bills today, less than the maximum target set for the auction leading to a 10bp increased in the 10-year.  Meanwhile, German 10-year yields are down 3bp with the front of the US Treasury curve flattening.

Currency Markets

Asian markets were hurt by news that North Korea shelled a South Korean island, killing two.  South Korea returned fire in response to a continuation of recent provocations by Pyongyang that began with the sinking of a South Korean ship back in March.  Shelling also comes on the heels of the revelations made by North Korea to a visiting US scientist, who this week was shown a working uranium-enrichment plant that could be used to produce weapons-grade uranium.  Reports have emerged of a possible power struggle  in Pyongyang, as leader Kim Jong Il has been ailing and working to hand off power to his youngest son.  While this appears to be typical saber-rattling by the North to establish the son’s hawkish credentials, markets are already on edge from Ireland developments and so near-term market volatility is likely to remain high for now.  Asian EM currencies were hit hard, led by KRW, down 1% vs. USD on the day, while USD and CHF outperformed in the G10 space as a result of safe haven demand.  Elsewhere in EM, Brazil inflation was higher than expected and highlights the potential policy stresses developing as incoming President Rousseff’s wishes for lower interest rates collide with the inflationary reality in Brazil.  South African Q3 GDP growth was weaker than expected, and highlights the need for further easing by SARB. 

Eurozone November PMIs expanded at a faster pace than anticipated, beating the consensus. The manufacturing PMI rose to 55.5 from 54.6 in the previous month, much higher than the consensus of 54.4. The services PMI jumped to 55.2 from 53.3, against the consensus of 53.3. The composite reading rose to 55.4 from 53.8, which suggests economic activity accelerated in November, contrary to expectations for a gradual slowdown.  To a certain degree the improvement in manufacturing activity has been buoyed by the acceleration of activity in Asia which surprisingly has started to feed into the service sector.  More specially, employment continues to improve which is indicative of stronger domestic demand and a harbinger for inflation. At the same time, the robust numbers (notably in the core i.e., France and Germany) add to the arguments of the hawks at the ECB council and will only support the ECB’s decision to continue its exit from the extraordinary liquidity measures.  Although, the euro may find support down the road if the ECB withdraws the excess liquidity thus stoking an increase in euribor, the focus continues to be on the periphery and the immediate effects of contagion.  For one despite the better-than-expected PMI the euro continues to weaken from the overhang of eurozone uncertainty.  The euro continues to test the $1.36 area but continues to find little support but the direction will primarily be driven by the import US figures released this morning.   

Canada’s consumer prices rose at the fastest pace in two years, exceeding all economist forecasts, led by a surge in gasoline prices. The m/m and y/y figures were both better-than-expected with the m/m up 0.4% (compared to the consensus of 0.2%) and y/y up 2.4% (compared to the consensus of 2.4%). Around one-half of the 0.5% jump in the annual growth rate was due to a rise in gasoline prices. Excluding gasoline, the CPI expanded at a 2.1% y/y rate in October after a 1.8% y/y clip in September. The BoC’s core index rose 1.8% y/y, also above expectations from 1.5% y/y in September.  The report propelled the loonie nearly half a percent from $1.020 to $1.016 and is now one of the few currencies on the day versus the dollar, despite the weakness in commodities and equities. 

Upcoming Economic Releases

At 08:30 EST / 12:30 GMT the US reports the second reading of Q3 GDP.  The consensus is for an increase to 2.4% from 2.0% with q/q core PCE unchanged at 0.8%.   Meanwhile, after the large differences between the Empire and Philly Fed surveys last week this print will be important.  The consensus is for a rise to 6 from 5 in October. And finally the US reports October’s existing home sales which are expected to fall to 4.48M from 4.53 the previous month. Mexico reports retail sales at 10:00 EST /  14:00 GMT and Poland announces its interest rate decision.  Events: FOMC minutes and Geithner speech at 12:00 EST / 16:00 GMT.