Dollar Mixed, Market Looking Elsewhere for Inspiration

After unwinding the pre-weekend move yesterday, the global capital markets are quiet even if mixed. The partial shutdown of the US government and the political impasse remains the most important factor. Many are also recognizing that the longer the government is closed, the more likely that the Fed's exit strategy from QE3 is delayed. The recent string of non-government data, including the ADP jobs estimate, auto sales, and consumer confidence all softened from the previous reports.

The most important news today is arguably the reports suggesting that the European Banking Association will penalize banks who are relying on the ECB's LTRO when it conducts the stress tests next year. On one hand, this makes sense. LTRO borrowings are done below market rates and is a means of support that needs to be assessed in conducting meaningful stress tests. However, it conflicts with another ECB goal of insuring adequately liquidity.

The EBA decision will likely encourage banks to repay their LTRO borrowings quicker. Already a little more than a third (352.9 bln euros of 1.1 trillion) have been repaid. Excess liquidity in the euro system is near 200 bln euros, below which could lead to higher and more volatile money market rates. In addition, it would seem to diminish the chances of the ECB offering another LTRO, as we had thought likely late this year or early next. It may increase calls for the ECB to cut rates, though we doubt this is very likely, though if the threat of deflation increases in the coming months, the risks may increase.

Japan reported a much smaller than expected current account smaller than expected current account surplus, but it is the seventh consecutive surplus. The trade deficit was pared to JPY885.9 bln from JPY943.3 bln. The reduction in the broader current account surplus (to JPY161.,5 bln from JPY577.3 bln) was largely a function of the drop in the investment income balance from JPY1.793 trillion to JPY1.253 trillion). As we have noted before, the swings in the investment income balance is increasing the driver behind swings in the current account, not the trade balance, as was historically the case.

We note that the dollar briefly traded below its 200-day moving average against the yen for the first time since the election that resulted in Abe's victory was called in mid-Nov 2012. It came in near JPY96.75 today and the dollar was bought back up after the 20-tick penetration. The most constructive thing for the dollar would be to finish the North American session above JPY97.45-50.

China's market re-opened after the week-long national holiday. The Shanghai Composite rose almost 1.1%, led by a 10% jump in the telecom sector. The forwards imply anticipation of further yuan appreciation, which was fixed at a new high, while an index of Dim Sum yields have fallen for six consecutive weeks. The market shrugged off new that the HSBC service sector PMI eased to 52.8. The official release, which appears to rely more on larger state-owned firms, showed an increase to 55.4 from 53.9, when it was released last week. Separately the PBOC injected CNY65 bln via seven day repos to ensure ample liquidity in the banking system as people come back from the holiday and ahead of maturing bills and repo this week that will drain an estimated CNY80 bln.

News from Germany was mostly disappointing today. The August trade and current account surpluses were a bit smaller than expected at 13.1 bln and 9.4 bln euros respectively. One bright spot was the exports rose 1.0% after falling a revised 0.8% (initially reported as a 1.1% decline) fall in July. Imports rose 0.4%, almost half of what the market expected while the July increase was cut to 0.3% from 0.5%. The soft imports does not speak well of domestic demand.

The biggest disappointment was with the August factory orders. They fell 0.3%. The Bloomberg consensus called for a 1.1% increase. It warns of downside risk to tomorrow's industrial production report. The consensus forecast is for a 1% increase. In fairness, the miss on the factory orders was largely offset by the revision in the July orders to show a 1.9% decline instead of the 2.7% fall initially reported. Our larger point, however, of the apparent gap between the improving PMI data and the less inspiring real sector data, is still applicable.

This was also evident in Spain's 2% year-over-year decline in August industrial output. The market had expected a 1.6% decline and the PMI for manufacturing stood at 51.1 in August.

Sterling appears more sensitive to the second consecutive slower BRC sales than to the RICS house price survey at it highest level since mid-2002. Sterling is trading just inside yesterday's ranges. It continues to flirt with the 20-day moving average (comes in near $!.6035), which it has not closed below in over a month. It probably takes a break of $1.60 to indicate anything important.

The Australian dollar is the strongest major against the US dollar today, gaining about 0.5% to new highs since Sept 19 and extending this month's recovery.  The only news was an uptick in business confidence, but this seems just an excuse.   The immediate target is $0.9525-30.  The Aussie's gain are consistent with the upticks being seen in a number of emerging market currencies, like South Africa, Turkey and Mexico. 

Canada reports housing starts and trade figures today, but the larger market forces likely remain dominant. The US dollar appears largely range bound between CAD1.0300 and CAD1.0350. Technically, we are inclined to see a firmer US dollar.