Dollar Softer On Spain Auction, Firm Euro Zone PMI Readings

BBH CurrencyView

• The dollar is broadly weaker as Spanish auction goes well, euro zone PMIs better than expected
• SNB held policy steady with no change to EUR/CHF floor
• China, Singapore data help boost sentiment; Hungary reaches deal with banks on CHF loans

The dollar is broadly weaker in narrow ranges as euro zone concerns lighten up a bit. The euro is stabilizing today after large losses this week, but rally back above 1.30 was short-lived and that support level is being tested again at the North American open. Markets still have eyes set on January low around 1.2867. We do not think this bounce in risk will last, but sentiment is being helped today by a variety of factors, including better than expected euro zone PMI readings as well as successful Spanish bond auctions that saw strong demand. Better than expected HSBC China PMI started the ball rolling during the Asian session. EM currencies are broadly firmer today, with KRW the worst performer on the day vs. USD and CEE currencies the best so far. European shares are higher, with the EuroStoxx 600 up 0.7%, while bank shares are up 1.0%. S&P future points to an up open. Periphery 10-year yields are all lower on the Spain auction results. JPY has traded in a 30 tick range despite weaker than expected Q4 Tankan report overnight, -4 vs. -2 expected and +2 in Q3.

There is an absolute deluge of US data today, but it remains to be seen whether it will be able to wrest market attention in the North American session away from euro zone events. We were a bit surprised by market reaction to no change in Fed policy this week. For now, the US economy is doing well enough to preclude any QE3. We expect the data today to continue to show decent growth in the US economy. Today sees the first survey indicators for December, which are expected to show ongoing improvement. Right now, consensus is for 2.5% SAAR US growth in Q4. Not great, but good enough to preclude QE3. On the flip side, ECB and other G10 central banks are back in easing mode, as evidenced by the Norges Bank’s surprise 50 bp cut yesterday. This divergence in policy is another supportive factor for the dollar going forward that is separate from the safe haven flows due to flare-ups in euro zone concerns. European data was slightly stronger than expected, but the recession call remains intact for now. Euro zone December PMI rose to 47.9 vs. 46.5 expected and 47.0 in November, with both manufacturing and service components showing a slight improvement. Spain sold EUR6 bln of paper, almost twice the targeted EUR3.5 bln. Borrowing costs were mixed across the curve, but larger than intended sale is helping sentiment a bit. Elsewhere in Europe, SNB met and left the EUR/CHF floor intact despite some speculation that it would raise the floor. Recent Swiss inflation data highlights rising deflationary risks, and SNP President Hildebrand warned that it stands ready to take further measures “at any time.” EUR/CHF has given back some of its recent gains, but we suspect the market is not going to test the 1.20 floor anytime soon. Whatever the merits of a potential adjustment to the floor, the current one at 1.20 has worked remarkably well at virtually zero cost. USD/CHF down sharply as a result, and could post an outside down day with a close below .9430, yesterday’s low. UK retail sales data was slightly worse than expected m/m.

Developments in the European banking system bear watching. There have been reports that the ECB is pushing regulators for changes in bank recapitalization rules in order to discourage balance sheet shrinkage that could deepen the recessionary risks. EBA has set a mid-2012 target for banks to reach 9% core Tier 1 ratios. Many European banks have already responded by selling off non-core operations, but it would appear that the ECB is worried that loan activity will be curtailed too, adding to the economic headwinds. This issue will remain alive for some time, especially as the euro zone economy heads further into recession. Banking sector stresses continue, with many peripheral banks continuing to rely on ECB funding even as interbank lending dries up.

Data out of EM has helped markets stabilize a bit today. HSBC flash PMI improved to 49.0 from 47.7 in November. While this is not the official PMI, the two series often move together, and our correlation studies suggest that both series track IP growth equally well. Official PMI is due out January 1 and the November reading was 49.0. Overall, the sub-50 readings for both series fit in with the slowdown being seen in the economy and we remain in the soft landing camp. Further monetary easing and possible pause in CNY appreciation loom ahead. Singapore October retail sales came in stronger than expected. We think MAS is on track to ease again at its next meeting in April. Note Singapore November trade data will be released Friday, and has been coming in very weak in recent months, reflecting the regional slowdown. Hungary reached deal with banks over CHF loan losses.