Dollar Steps Back Ahead of ECB Meeting

Highlights
The US dollar rally was interrupted against most of the majors as strong Chinese data supported risk.  The fears engulfing the euro toned down a little amid speculation that the ECB could take action tomorrow to contain the debt crisis, despite the news of Portugal’s potential debt downgrade. But the euro continues to maintain yesterday’s trading range and will need to get above yesterday’s high ($1.3150) to garner further support. Meanwhile, the risk-on sentiment, coupled with an astonishingly high manufacturing PMI boosted sterling, reaching $1.565 and subsequently falling back.  And the combinations of strong global PMI’s and rise in risk appetite eased demand for safe haven currencies, thus weakening the yen and Swiss franc both of which are down versus the dollar.  Elsewhere, despite the soft domestic data (with GDP and PMIs both below consensus) the Australian dollar is buoyed by the strong Chinese data with the currency reaching $0.965 and then falling back after some profit taking. 

Global equity markets are solidly higher, boosted by strong risk appetite as Chinese data outperforms and the ECB considers additional liquidity injection.  Namely, Asian stocks are markedly higher with MSCI Asia index up 1.1% while EM stocks posted their biggest gain in two weeks.  Meanwhile, the Nikkei is up 0.5%, led by gains in energy.  At the same time, the Shanghai Composite is up 0.1% with large gains in utilities.  European bourses were up, after hitting an eight-week low, as a host of strong economic data (including strong German retail sales and UK PMI) with the Euro Stoxx up 1% led by financials and materials. 

European sovereign bonds yields started to decline with Portugal and Ireland leading the decline on speculation the ECB will boost bond purchases to calm markets. Namely, 10-year Irish yields are down 15bp followed by a 11bp decrease in Portugal.  In addition, Portugal’s T-bills outperformed as the government raised all of the intended €0.5bln amidst solid demand as the issue was 2.5 times oversubscribed which helped supported the drop in Spanish and Italian yields.  Meanwhile, 10-year German yields are up 8bp with the 10-year US Treasury up 7bp, increasing the Germany’s yield advantage and aiding euro strength.  Elsewhere, The Bank of Thailand surprised the market by hiking its official repo rate by 25bp to 2% while Indonesia is being vetted for a possible credit upgrade by Moody’s. 

Currency Markets

Ideas that at its meeting tomorrow the ECB may take additional measures to stem the financial crisis that has threatened this week to spread outside the periphery and toward countries like Belgium, are prompting some position adjustment in both the foreign exchange and fixed income markets.  While observers are not at a loss at making recommendations to policy makers, the immediate challenge, however, as ECB President Trichet pointed out yesterday is that many of the recommendations, like a European bond, is for the governments to decide, not the central bank.  However, one possible course that Trichet specifically did not rule out was that the ECB could step up its purchases of sovereign bonds.  Recall that thus far the ECB has purchased about €67bln of sovereign bonds through last week and attempts to sterilize the impact on money supply.  The initial decision to buy sovereign bonds in the first place was controversial and opposed by Germany’s Weber and Stark.  Yet, as Trichet noted yesterday, the decision is made by the 22-strong governing council.

We have argued before that the critical difference between the ECB and the Fed may not lie with a formal inflation target or a dual mandate, as both get blurred in practice.  Rather, the more significant difference is that at the Fed the Board of Governors is a strong core, with a few exceptions outnumbering the regional presidents.  The ECB is the opposite, though, with a smaller core and larger representation by the regional (national central banks). On the one hand, if the ECB does extend its bond purchase program and especially if it ceases its sterilization operation, some will sell the euro on quantitative easing, but as we have seen in the dollar’s case it is not always that simple.  On the other hand, a large scale bond purchase program would likely help stabilize the debt crisis through that channel fuel a stronger recovery in the euro.

UK PMI Manufacturing for November soared to a stellar 58.0 from a revised 55.4 in Oct (initially 54.9) and in doing so posted its strongest reading since September 1994. Market expectations were centered on a modest drop to 54.6, and the outcome even topped the most sanguine analyst which expected a rise to 55.8. The output index rose by 1.6 points to 58.5 while the new orders index reported a 5.1 point rise to 59.1. New export orders were also stronger at 56.9 compared with 55.3 in October as companies reported increased sales to clients in France, Germany, the US, China, India and the Middle East. The CIPs survey pointed to strength in the manufacturing output index, which climbed to its highest level in 6 months, whilst employment surged to 57.6 vs 55.4 – a record high print since the current series began in 1992.  But keep in mind that manufacturing only account for only 8% of jobs so will have a small impact on growth.  Arguably, the outcome concurs with this week’s OBR report which slashed the number of public sector job losses over the next four years to 330k from 490k.  Yet the PMI clip has now been above 50 for 16 consecutive months but austerity measures implemented next year may dampen the outlook.  Nonetheless, sterling moves continue to be driven by economic data surprises, along with risk appetite, as the BoE continues to balance inflation and growth prospects but this report puts QE banter on the sidelines for now.

Upcoming Economic Releases

At 8:15 EST / 12:15 GMT US reports November’s ADP employment whereby the market consensus is for an increase to 70k from 43k in October.  Next, the US reports 3Q nonfarm productivity which is expected to increase to 2.3% from 1.9% in Q2 with a marginal drop in unit labor costs expected as well. At the same time, ISM manufacturing is expected to decline to 56.5 from 56.9 while prices remain flat.  Vehicle sales close out the day at 5 PM / 21:00 GMT.  Meanwhile, Mexico reports USD remittances which are expected to increase to $1.8bln from $1.7bln.  Events: Fed’s Beige Book along with a host of speakers – – Yellen (voter), Tarullo (voter), Fisher (non-voter).