Six FX Drivers

This is a momentous week.  The two largest economies have political transitions, three central banks meet, and Greece's parliament votes on key reforms, which if approved, will avert an immediate crisis. as the beleaguered country is now projected to run out of funds within the fortnight.  

At the same time, nothing changes.  The fiscal cliff in the US is still looming and it will be no clear on Wednesday, the day after the election, how the fiscal cliff will be averted.  

Despite the relative calm few, if any, really think the European debt crisis has been resolved.  Some frame the issue in terms of indecision.  Greece has to decide once and for all if it wants to be in the monetary union.  Spain has to decide whether to ask for additional assistance.  

And yet every day, Greece chooses monetary union over some greater economic and social misery.  Every day that has passed, Spain's Prime Minister Rajoy, the most powerful Spanish leader in a generation, given this parliamentary majority and the number of regions his party controls, has chosen not to ask for assistance.   These will not change in this momentous week ahead.  

1.  It is ironic then that of the three G10 central banks that meet this week, the European Central Bank's meeting may prove the least interesting.  It is most unlikely to cut the refi rate that stands at a record low, even though the regional economy is most likely contracting.  The manufacturing PMI, we learned last week, has been below the 50 boom/bust level for nearly 1 1/2 years.  The service sector PMI due out later this week is likely to confirm it.  

Draghi has to wait for a formal request to trigger the Outright Market Transactions.  He is likely to get queried about the weekend report in the German paper Die Welt apparently claiming that Spanish banks  has been given preferential treatment (over Irish banks) regarding the discount attached to government T-bills.  The report seems to suggest Spanish banks have been "over-lent" some 16.6 bln euros.  

Spain itself will be engaged in a notable test just prior to the Draghi's press conference.  It will seek to issue a new 5-year benchmark bond.  What makes it particularly noteworthy is that it is the long maturity Spain has sought to bring to market since May 2011.  A poor reception would be seen as adding more pressure on Rajoy.  

2.  The Reserve Bank of Australia meets.  Its decision will be announced as the polls begin closing in the US.  The cash rate stands at a relatively lofty 3.25%.  A strong case can be made for it to cut rates as it did last month.  If it hesitates, market expectations will simply shift to next month.  The Australian dollar could rally quickly if the RBA stands pat, but will likely surrender those gains.   

Even with a rate cut, Australia's real and nominal rates are the highest among the high income counties.  Moreover, despite the talk of the Chinese yuan becoming an important reserve currency, the Australian dollar is a larger beneficiary of the diversification of reserves. 

3. The Bank of England's meeting will conclude just prior the ECB's meeting.  With its gilt purchase winding down, the Monetary Policy Committee can decide to do nothing or extend the program further.  With the expansion in Q3 GDP ending three consecutive quarterly contractions and the funding-for-lending scheme underway, a case can be made to stand pat.  

Yet it seems clear that Q3 GDP was a bit of a fluke and the UK economy remains vulnerable.     This may be driven home by the September industrial output report out on Tuesday, which is expected to show the first back-to-back declines in industrial output since the end of last year.  More austerity is in the pipeline and the UK's largest trading partner is in a recession (again).   However, just as sterling did not seem to be impacted by the current gilt purchases, there is no compelling reason to expect to weaken if the gilt purchases are extended by another GBP50 bln.  

4.  The Greek parliament will debate and then vote on the package of reforms negotiated with the Troika.  Although the government has 175 of the 300-seat chamber, the smallest coalition partner, the Democratic Left with 16 seats, has rejected the new (and what Prime Minister Samaras says is the last) labor concessions.  It leaves room for only 9 defects from the New Democracy and Socialists.  The failure to approve the measures can potentially spark a dramatic risk-off response by investors.  Even though a Greek exit is not imminent that is what will be feared.  It will make it difficult for the November 12 Eurogroup of finance ministers to approve tranche of aid.  On November 16, Greece has an estimated 4 bln euros of bills maturing.  It is not clear that it has sufficient cash to cover the redemption.  

5.  By expanding its asset purchase program for two consecutive months, the BOJ is now "out of play" until at least next year.   The focus in Japan will shift to the private sector and the government.  The corporate news last week was startling.  

The corporate icons, Sharp and Panasonic reported incredible losses.  Sharp previously had projected a JPY250 bln profit and now warns of a JPY450 bln loss in the full year ending March. It has apparently been hit by falling prices for liquid crystals and weak demand in domestically and in China.  It admitted that it might not survive.  

Panasonic, Japan's second largest television maker, warned of a JPY750 bln full-year loss.  This is reportedly 30-times larger than analysts expected.  Restructuring costs and falling demand prompted  it to suspend its dividend for the first time since 1950.  

Meanwhile reports suggest that the government has only spent about half of the (~JPY19 trillion) funds earmarked for reconstruction.  Another quarter of the funds apparently were used for projects not associated with reconstruction.  It is within that context that we should understand the government's new initiative to spend "an additional" JPY2.7 trillion to try to revive the economy.  

Japan is approaching a fiscal cliff of its own.  The opposition is blocking the government from issuing bonds finance its spending.  The Noda government has claimed it will run out of money by the end of the month.  This is probably a bit of an exaggeration as there may be some innovative ways to buy a bit more time (talk to Robert Rubin who did oversaw that in the US).  The LDP may only be able to eek out a firm election commitment by Noda, something that has evaded them since the passage of the controversial retail sales tax hike, late this month or maybe not until next month.   

6.   Before some turning to the US election, let us share some observations about the US employment report.  It is difficult to sufficiently stress the noisy nature of the monthly nonfarm payroll report.  Take the August for example.  Initially it was reported 96k net nonfarm payroll jobs were created.  Now after two revisions, it turns out that 192k net new jobs were created.  

The 171k increase in the October nonfarm payrolls is smack in line with the average since July (~173k).  The monthly average this year is 157k and the 12-month average and the 2011 monthly average was 153k.  That relative stability is noteworthy.  The fiscal uncertainty is not freezing up hiring.  Capital investment is a different story and there the near-term outlook signaled by the orders data is poor. 

In some ways, more importantly than the net new jobs created is the length of time current employees are working.  Aggregate hours rose by 0.1%in October to bring the seasonally adjustment annual rate over the past three months to 1.3%, the best in six months. 

On the other hand, wages in the private sector was unchanged and at 1.6% the year-over-year rate represents a new cyclical low.  American's willingness to finance consumption out of savings may not be deterred as consumer confidence (Conference Board measure) is at a 4 1/2 year high. 

The performance of the economy in Q1 13 has little to do with the economic data that is being reported.  It has every thing to do with what happens to fiscal policy and it will not be resolved this week.  

While we have suggested argued that Romney had to tack to the right to win his party's reluctant nomination, had relatively weak ground game and failed to move back to the center in a convincing and compelling way.  Yes the first debate was fortunate for Romney; he couldn't have planned Obama's milquetoast performance.  

However, in recent days, Obama has caught a few breaks.  The human tragedy left in the wake of super storm Sandy pushed the election off the front pages.  Obama was presidential and commander-in-chief.  The ability to work with and it appears, appears the straight-shooting Republican NJ governor was another unscripted piece of fortune for the incumbent.   

While the Obama is most likely to be re-elected, as we have long maintained, it is not clear that his coattails are sufficient to capture control of the House of Representatives.  The Democrats are likely to hold on to the Senate, but only barely.  

Regardless of who is elected, Bernanke will most likely be heading up the Federal Reserve in the year ahead.  The same cannot be said of Treasury Secretary Geithner, who has indicated he will be stepping down.  In order to offset the President's weakness in developing a working relationship with the Republican leadership and wanting to demonstrate the intent to address the looming fiscal crisis, Erskine Bowles would be an interesting and market-friendly nomination as Treasury Secretary.  

We conclude by noting under admittedly different macro economic circumstances, the dollar sold off hard in the uncertain aftermath of the 2000 election.  Some pundits have warned of a potential split between the popular vote and electoral college vote.