Dollar Stabilizes, but Remains Fragile

After extending recent losses in Asia, the US dollar stabilized in the European morning.  Nevertheless, with no perceptible progress on the US fiscal talks, prospects for a exceptionally soft jobs report in 48 hours, and the anticipation that next week the Federal Reserve will expand its QE3+ operation, the greenback will remain vulnerable.  

 There have been four main developments to note, China stock market rally, Australia's Q3 GDP, the European service sector PMI reports and continued Swiss franc weakness.  

China's stock market built on yesterday's recovery from a multi-year low of 1949 (the year the Communists prevailed) and rose almost 3% today, the most in nearly three months and on heavy volume.   Two drivers are cited.  First, there is talk of new spending on urban development.  Second, the government limited caps on insurance companies' ability to invest in banks.   News that a foreign bank was selling its holding in a Chinese insurance company also help some uncertainty. 

Australia's Q3 GDP expanded by 0.5% for a 3.1% year-over-year pace.  This was in line with expectations and among the strongest of high income economies.  However, the details are weak, and although the RBA's statement, following yesterday's rate cut, did provide much insight into the next move, the easing cycle does not appear over.  We'd pencil in the likelihood of the next cut toward the end of Q1 or early Q2.  Of note, household spending rose 0.3%, the weakest in ten quarters.  

Mining investment, which officials warn is near a peak, rose by 4.5%, making a key driver of GDP.  It is important that investment outside of mining picks up, but thus far it hasn't.  Part of the bullish Aussie story had been a favorable terms of trade shock.  That has ended and gone into reverse.  Australia's terms of trade fell 4% in Q3 for a 13.7% drop on a year-over-year basis.   

In turn, this makes the Australian dollar's over-valuation more biting. Separately we note that the Reserve Bank of New Zealand meets tomorrow, ahead of the BOE and ECB.  The RBNZ is expected to keep the cash rate steady at 2.5% and not change its economic assessment. 

The euro area service PMI came in at 46.7 from 45.7 in the flash reading and 46.0 in Oct.  New orders and activity improved and the Markit economists suggest that the low may be in.  If so, it is quite uneven.  Much of the improvement is due to Germany, where the final reading stands at 49.7 from 48 flash and 48.4 in Oct.  The rise of new business was particularly noteworthy.  

France, in contrast was disappointing and this is a theme we expect to continue in the new year.  The final French PMI was at 45.8 from 46.1 flash reading.  It does show improvement over Oct's 44.6 to stand at a three-month high.  New business fell, though to a 3 1/2 year low.  Elsewhere, Spain and Ireland beat expectations, while Italy disappointed, with its first decline in three months.  New business and employment were particularly weak.  

Following the yesterday's soft construction PMI, the UK reported a disappointing service CIPS service PMI today.  The 50.2 reading is down from 50.6 in Oct and defies expectations for an improvement above 51.  Though above the 50 boom/bust level, it is the weakest showing since late 2010 and is the third month of weaker reports.  New orders fell to 49.6 from 52.9, which a a two -year low.  Osborne's Autumn Statement is awaited.  He is expected to acknowledge that the government's fiscal plan is off course and a longer period of retrenchment is necessary. 

The Swiss franc is selling off against the euro for the third consecutive session.  News that a large Swiss bank was going to charge large clients for holding franc deposits is the ostensible trigger.  The euro, which is actually at pixel time (~$1.3085) lower on the day against the dollar is pushing to new 3-month highs against the franc (~CHF1.2170).  

We suspect the market is getting ahead of itself.  There have been a few others banks that have given negative rates on franc deposits with out generating nearly the same impact.  In addition, the current strip shows that Switzerland's 2-year note and 4-year notes have negative yields (-24 bp and -13 bp respectively).  We have suggested the negative rates are like an option.  Investors have driven rates below zero in several countries whose currencies could be expected to appreciate if the euro zone were to break-up.