Dollar Mixed After Strong European Data and Asian Reserve Diversification

Highlights
The US dollar is mixed today and the real feature is the euro’s strength.  Asian central bank reserve diversification and model-driven leveraged accounts appeared to help drive the euro higher.  News that US Treasury Secretary Geithner suggested that the major currencies were in rough alignment sparked a short lived dollar bounce, with the greenback rising toward JPY81.85 and the euro slumping below $1.3900.  Participants sold into that dollar bounce aggressively.  Sterling continues to be a laggard.  Dollar weakness has concealed sterling’s soft underbelly.  Speculation that the BOE is not far from its own version of QEII and the rise in European core interest rates has pushed sterling to six month lows against the euro.   Ideas that the G20 can hammer out the basis for a truce in the so-called currency wars kept Asian regional currencies mostly bid. 

Asian stocks had a mixed day following the Chinese economic news, while news that China Mobile missed earnings forecasts didn’t help the mood. The MSCI Asia Pacific index, however, still rose by 0.03%.  China’s Shanghai Index fell by 0.6% while the Shenzhen Composite rose by 0.6%, offsetting the changes in each index.   Japan’s Nikkei slipped 0.05%, meanwhile there were mild declines in Shanghai, Singapore and Australia. Still, benchmarks in Taiwan and Korea eked out small gains.  In Europe German stocks advanced for a second day after a report that showed manufacturing and service industries climbed more than expected.  The Stoxx 600 was up 0.2% while the DAX climbed by 0.6%, led by a gain in industrials.  And despite the weaker-than-expect retail sales the FTSE was driven by a strong performance in consumer goods which led the index to a mild increase of 0.7%.

In Asian trading bonds were steady as Japanese bonds edged higher, with the 10-year JGB yield down 1 bps to 0.875%.  With the yen continuing to surge he drop in bond yields arose as speculation of another round of Japanese intervention mounts.  Yet the key story was in the UK where the yield on 2 and 10 year gilts dropped by 2 and 7 bps immediately following the disappointing retail sales, marking a new low in the 2-year.  Additionally, in Europe 10-year German yields rose by 1bps while the yields on similar-dated periphery debt rose by an average of 2 bps. 

Currency Markets

US Treasury Secretary Geithner has further articulated the strong dollar policy over the past couple of days.  He has indicated that the US would not seek a depreciation of the dollar to boost exports.  This is important.  It was needed to be articulated in light of the accusations by some G20 members.  This was the “original intent” of Rubin’s strong dollar policy—to differentiate his stance from Lloyd Bensten and James Baker who had used threat of dollar depreciation in negotiations with Japan and Germany, respectively.  The US dollar policy is that markets should determine its value and that it is the consequence of the pursuit of monetary and fiscal objectives.  Geithner also reportedly indicated that the major currencies were roughly aligned.  This is important too.  It sets the basis for a united G7 front at the G20.  The G7 grouping has been downgraded to a caucus within the G20.    A draft version of the G20 communique has been leaked and seems largely a reiteration of boilerplate diplomatic-speak:  competitive devaluations should be avoid (easy enough, leaving aside the Hong Kong dollar, most Asian currencies and emerging market currencies in general have appreciated against the dollar, euro and sterling this  year), markets should determine exchange rates and excessive volatility is counter-productive.    This last part is the cover for potential BOJ intervention, but rumors that the BOJ has told local banks to be prepared for such seems wide of the mark.    While there apparently is no line in the sand being defended, players may turn cautious as the JPY80 is approached. 

Eurozone October manufacturing PMI unexpectedly rose to 54.1 from 53.7, while the services reading slipped to 53.2 from 54.1 in the previous month. The consensus had been for declines in both readings. The pickup in the manufacturing number, which still left the composite lower over the month, was due to a sharp improvement in German confidence stoked by the strong increase in exports which account for nearly 45% of GDP. Mixed data suggested that current conditions, especially in the manufacturing sector, are more robust than market confidence suggests and that the recovery continued in Q3 and into the fourth quarter of the year. Although the strong EUR and uncertainty about the outlook for the U.S. economy heightens uncertainty (especially in the light of government austerity measures), burgeoning trade with Asia represents a viable outlet for German goods.  But as today’s report signaled, China’s economy is set to slow down, which implies that the key for eurozone strength going forward would be structural reforms aimed at opening the service sector and increased domestic demand which are impervious from exchange rate movements. 

UK retail sales fell, stoking speculation that the BoE will follow the Fed in another round of quantitative easing. September retail sales including auto fuel came in far weaker than expected (down 0.2% m/m and up just 0.5% y/y) compared the market consensus of 0.3% and 0.9%. Comparatively in August the figures were -0.7% m/m and 0.8% y/y in August (revised from -0.5% m/m and 0.4% y/y). Weaker fuel and clothing demand contributed to the tame September headline reading. Meanwhile, food sales rose just 0.1% m/m which likely impacted by higher prices. Excluding fuel, retail sales were unchanged on the month, versus -0.6% m/m in August (revised from -0.4% m/m).  Overall, sterling remained defensive following the release of the data which down nearly 0.5% versus the greenback and more so against European currencies.  More importantly, subsequent the print the 10-year gilt yields dropped by nearly 2.2%, increasing the probability of further quantitative easing down the road.  Additionally, the BoE’s Miles suggested publically that the official central bank stance on monetary policy is open and can be used further if necessary.  This confluence of data and opinion has opened the door of quantitative easing that much wider. 

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT the US reports last week’s initial jobless claims with expectations of a small drop to 455k from 462k.  Continuing claims are expected to follow suit with a marginal drop to 4420k from 4399k.  Meanwhile the leading index for September is expected to remain unchanged at 0.3%from last month.  And finally, the Fed’s Bullard speaks about policy followed by a Hoenig speak at 21:45 EST.