Ten Observations as the Week Winds Down

The US dollar is going into month and quarter end on a soft note.  The greenback had been generally firm against most of the major foreign currencies, but the Japanese yen, since around mid-month, but the news stream appears to have turned against it.  Yesterday the euro traded in both sides of Wednesday's range and closed near the highs.  The euro is posting follow through gains today.  Yesterday the S&P 500 snapped a 5-day losing streak and may have helped underpin gains in Asia.  European shares could not match suit and are mostly lower, led by utilities and financials. 

In addition to the month end and quarter-end flows and portfolio adjustments there are several other factors at work.  

1.  The generally poor US economic data released in recent days suggest Q3 GDP may not be better than Q2.  The uncertainty over the fiscal cliff, related tax uncertainty, and the debt ceiling appear to be paralyzing important business decisions.  One of the consequences of this, despite the preliminary employment revision that found the US crated another 360k jobs in the year to March 2012, is that many, if not most observers expect QE3+ to run through at least all of next year, with the Operation Twist purchases being replaced by MBS/Treasury purchases starting next year.   The early call is for the Sept private non-farm payrolls, to be released next Friday (Oct 5) to rise by around 125k.  

2.   Japanese economic data warns that the world's third largest economy is struggling to sustain positive growth.  Industrial output fell 4.3% in August, about half again the decline the market expected, and is now at levels seen in May 2011.  The Sept PMI came in at 48 from 47.7 in August, but is the 4th month below 50.  Japan still has not broken the grip of deflation.  Core inflation in August was -0.3% year-over-year, a touch more than the market expected.  Tokyo Sept core inflation was -0.4%.  Household spending and retail sales were reported better than expected (2.2% and 1.5% respectively) and unemployment unexpectedly fell to 4.2% in Aug from 4.3% in July.  However, the stronger consumption figures do not appear to be a change in the underlying trends and both domestic and foreign demand remains sluggish.   Japan reports the quarterly Tankan survey early Monday and a deterioration in sentiment is  expected for large businesses and, in turn, are likely to project weaker capex plans.  

3.   Spain's 2013 budget was initially well received as most of the measures reportedly exceeded EU recommendations.  However, the 10-year bond yield is higher today and remains within striking distance of 6%.  Spanish stocks are also struggling to build on yesterday's gains.  The issue, frankly, is not Spain's deficit projection of 4.5% of GDP.  It is that Spain typically overshoots is deficit.  Recall that the 2011 deficit has been revised up to 10% and this year's revised target of 6.3% is also at risk.  Some observers see the budget as bringing Spain closer to a formal request for aid.  However, political considerations still suggest such a request is not imminent.  It should not be surprising if Spain's does not come until well into next month if not November.  In addition, on top of the Spain's three-headed debt problem (the government, the regions and banks), a constitutional crisis has erupted.  

4.   The French cabinet approved the 2012 budget that projects a 3% deficit, as widely anticipated.  It looks like of the 30 bln euro in savings, two-thirds is coming from tax increases on "rich" households and large corporations.  In Spain's case, almost 60% of the savings was coming from spending cuts.    There has been little market.  

5.  China's central bank has been seemingly exceptionally generous with its liquidity provisions.  By some calculations, the injections have been roughly the equivalent to a 40 bp cut in required reserves.  However, this seems misleading as the injections seem to be in anticipation of the quarter-end imbalances and next week's holiday.  The yuan had a large move, among its biggest since day advances of the year today (~0.30%) and has now appreciated 1.75% against the dollar since July 25 to approach its best level since 1993.  Since mid-week the Shanghai Composite has rallied 4.7%, including the 1.45% advance today.  The advance in the past couple of days was thought to be in anticipation of new measures to stimulate the economy, but today the focus appears to have shifted to new measures to support the stock market.  Local press talks about reducing transaction fees.  HSBC's final PMI reading is due out of the weekend. 

6.  The euro zone preliminary Sept CPI came in at 2.7%, which is a few tenths of a percentage point.  Part of this reflects Spain's jump to 3.5% from 2.7% due largely to the hike in the VAT.  The ECB meets next week and few, in any, really expect a rate cut.  However, a rate cut later, as in November at the earliest, or in Q1 13, is still largely anticipated. 

7.  The Australian dollar initial extended its recover since mid-week, but ran out of steam near $1.0475.  The RBA meets next week and the market recognizes a about a 65% chance of a rate cut after a three month hiatus.  The RBA has underscored the importance of external variables and the news of Japanese industrial output decline, soft Chinese data and the third consecutive decline in South Korean industrial production (released earlier today showing a 0.7% decline in July, twice the expected decline,  after a 1.9% fall in June) will likely be taken into account.  Initial support is seen near $1.04. 

8.   Sterling is trading heavily today against both the dollar and euro despite (or because?) the speculation of quarter end private and official flows.  The BOE meets next week.  Although recent data suggests the economy may have broken its three-quarter contracting streak here in Q3, the BOE is widely expected to extend its gilt purchase program that is due for completion in November.  A rate cut is still unlikely.    A break of $1.6140 would strengthen our case that a top is being carved out.  

9.  US S&P 500 posted strong gains yesterday, but follow through today may prove elusive.  It requires a move back above 1455-1460 to strengthen the technical tone.  Meanwhile, initial support is near 1440.  That said, the 15% gain this year is among the strongest for the G10, with Germany being the main exception, where the DAX is up abut 23.5%. 

10.  Despite the heavier tone in European equities and likely weakness, at least early in the S&P 500, gold prices are steady-firm.  It initially was bid above yesterday's high and remain within striking distance of the year's high recorded in Feb near $1791.    However, the advance has not been confirmed by technical indicators, warning that like equities and other "risk-on" plays, it may be subject to a near-term setback.