Six Observations as Week Winds Down

There are six observations on the G10 to share ahead of the weekend. 

First, the ECB's Outright Monetary Transaction (OMT) scheme has continued to bolster perceptions that officials are moving to reduce tail risk.  Dragji's announcement did not differ much in substance from what was leaked the previous day.  As was the case prior to this week, it continues to be now.  The onus of the initiative is on Spain's shoulders.  

There is increase speculated that Spain can formally request EFSF support at the Eurogroup meeting at the end of next week, which in turn is thought to be in sufficient time to negotiate the memorandum of understanding and allow some countries, like Germany's parliament, to authorize the support prior to the large redemption Spain faces in late October.  We are more skeptical, especially with Draghi's inclusion of the IMF for conditionality. 

Second, the market suspects the OMT operations could first be tried in Portugal, though what it means to have access to the capital markets (another Draghi condition).  However, Spain is still key focus and that means that it should do better than Italy.  

Third,  the ADP data and the rise in the service sector PMI employment index to 53.8 from 49.3 helped lift expectations for the US monthly jobs report.  This is important because the employment report is seen as a key, if not decisive factor, for the QE3 at next week's FOMC meeting.  We have anticipated private sector jobs growth in line with July and thought that on balance the Fed was more inclined to change guidance than its balance sheet.  

Fourth, the UK reported considerably stronger than expected July industrial production figures.  The 2.9% month-over-month rise was nearly twice the consensus.  Manufacturing jumped 3.2% on the month.  The Bloomberg consensus was for a 1.8% gain.  However, the optics are better than the substance.  The July rise is largely a function of the sharp declines in June, which had been exaggerated by the Jubilee Bank holidays.  Leaving aside an Olympic effect in Q3, the UK economy still appears to be stagnating and an extension of  the BOE's gilt purchase operation remains the most likely scenario.  

Fifth, Germany industrial output was also well above expectations, rising 1.3% on the month with the Bloomberg consensus looking for a flat report.  The strength also seems to contradict the more dismal manufacturing PMI reading.   Earlier today Germany reported rise 0.5% rise in exports in July and yesterday it reported a stronger than expected 0.5% rise in July industrial orders.   While this suggests some greater resiliency in the Germany economy, the optimists are not talking much more than stagnation now.  

Sixth, talk that the Swiss National Bank is about to being the cap on the franc to 1.22 from 1.20 at next week's meeting seems misplaced.  It seems like too small of a move to justify the expense.  The IMF data on Swiss reserves was released earlier today.  It shows that the SNB foreign currency holdings rose another CHF10 bln in August.  While something on the magnitude of a quarter to a third of this can be traced to valuation adjustments, suggesting the pace of intervention may have slowed, the reserves are approaching 100% of GDP.  The recovery of the euro and perceptions of reduced tail risk may be doing the lifting more effectively than the SNB.  

I had expected the dollar to find more support for the combination of selling the rumor and buying the fact on the ECB and diminished likelihood of QE3, which I had anticipated.  While not inclined to chase the market, only a reversal ahead of the weekend will lend credence to my cause.  The kind of reversal pattern looked for so suggest the move that began in late July is over has simply not materialized yet.  That said, technicals are still stretched, but not turning.