Dollar Firms, Euro Area Contracts, Sterling Recovers and the Nikkei Soars

The Dollar Index is trading at new 2013 highs, encouraged by the continuing sell-off of the yen and the weaker than expected euro area GDP, which contracted by 0.2% in Q1. However, the dollar's upside momentum appears to be stalling a bit. 

Japanese investors did not extend the yen's decline seen in North America yesterday. Europe did and managed to run the stops and barriers believed to have been struck near JPY102.50, but has since begun consolidating. Sterling edged below $1.52 briefly and has since recovered on the back of an optimistic BOE Quarterly Inflation Report.  The euro is trading heavier, but may be finding a bid near $1.2880.  

In terms of foreign exchange, Mr. Market does not fight Abe and Kuroda, but when it comes to government bond market it is a different story. We have argued that the net consequence of raising inflation expectations and a weaker yen, one would expect Japanese interest rates to rise. However, the move has been disorderly. JGBs initially extended their recent slide into a fourth session. The BOJ managed to calm the market and reverse the early losses by injected JPY2.8 trillion via money market operations.  The Nikkei tacked on another 2.3%. led by telecoms, consumer goods and industrials, while financials and oil/gas sectors slipped.    

The real economic news today comes from Europe. German, French and Italian GDP reports were weaker than the consensus. Germany managed to eke out a 0.1% expansion, though the market had been looking for a 0.3% expansion Q4 contraction was 0.7% rather than 0.6%. France contracted by 0.2% rather than 0.1% and Q4 GDP was revised to -0.2% from -0.3%. Italy contracted by 0.5%. The consensus was for a 0.3% contraction. The Italian economy has contracted now for seven consecutive quarters and the eighth one appears to be under way.

The UK reported a somewhat better than expected employment report in the sense that the unemployment rolls fell by 7.3k, roughly twice what the market expected and the unemployment rate slipped to 4.5% from 4.6% in April. However, this was accomplished it appears with cheaper wages. Average earnings, reported with an additional month lag rose 0.4% in March on a 3-month year-over-year basis, which is the way it is reported. This is nearly half that pace that was expected and follows a 1.0% rise in February.

Even more important for sterling and gilts today was the Bank of England's Quarterly Inflation Report. It is last under Governor King's stewardship. King is going out on an optimistic note. Growth, he says, may be 0.5% this quarter, after a 0.3% expansion in Q1. King also brought forward when inflation peaks (Q3) and when the 2% medium term target is achieved.  Sterling has been bolstered, while gilts have weakened in response.  

He revealed that the May MPC meeting, a "modest and sustain" recovery was anticipated. This warns of the possibility that three members, including King, that has been advocating new gilt purchases, may have seen some defections. The minutes will be released May 22.