After Advancing, Dollar Pulls Back

The US dollar is mostly softer as North American participants prepare to return from what for many was a long weekend. The greenback had initially moved higher, hitting JPY119.15 while the euro slipped to $1.2420. 

The proximate cause was the continued fall in oil prices and news that Moody's cut Japan's credit rating to A1 from Aa3. However, the dollar shed its gains in the European morning. Falling equity markets sent the dollar to almost JPY118, and the euro recovered to almost $1.2480. 

Don't think that the euro recovery was a function of a better manufacturing PMI, because it wasn't.  The region's PMI fell to 50.1 from 50.4 of  flash reading.    Germany's PMI was the most disappointing, slipping 49.5 from 50.0 of the flash and 51.4 in October.  It is the lowest since June 2013 and the second sub-50 reading in the past three months. 

France offered a pleasant surprise.  The manufacturing PMI rose to 48.4 from the 47.6 in the flash reading.  This still represents a small decline from the 48.5 reading in October.  France's manufacturing PMI has not been above 50 since April.  However, recall that France's GDP rose 0.3% in Q3, which was above expectations shaped by the contracting PMI reports. 

The European periphery has actually taken over from the core the mantle of economic leadership as it were.  Greece, Spain and Ireland were among the fastest growing in Q3.  Spain's manufacturing PMI rose to 54.7, a new cyclical high from 52.6 in October.  The consensus had expected a small decline.  Italy was unchanged from October at 49.0. 

The UK also surprised.  The manufacturing PMI rose to 53.5 from a revised 53.3 in October (initially 53.2).   It is the highest reading since July.  The market had expected a little slippage. In Asia, sterling had recorded a new low for the move, slipping to almost $1.5585.   However, in the European morning, it has recovered to near the pre-weekend high of nearly $1.5740.   Although sterling recouped earlier losses, its gains appear fragile as short-term interest rates, implied in the December 2015 short-sterling futures contract has fallen to new low (~86 bp).  

Gold and oil fell initially.  The former was a result of the Swiss rejection of the “Save Our Gold” referendum.  Oil fell as a continuation of last week’s response to OPEC not cutting output.  The front month Brent futures contract plummeted to almost $67.5 (pre-weekend low ~$69.80).  However, it has recovered to close the opening gap.  Gold had not gapped lower but fell nearly $25 an ounce from the pre-weekend close before it too found a bid and is now higher on the day. 

With the help of a surprisingly good manufacturing PMI (51.3 from 50.8), the Norwegian krone that had been so beaten up at the end of last week is the strongest of the majors today, rising 0.75% against the dollar and 0.60% against the euro.  Sweden’s PMI also was better than expected at 52.7 (consensus was for 52.1 after 52.5 in October).  The krona has responded positively to the news.  

China’s manufacturing PMI was a touch weaker than expected at 50.3 (from 50.8), which was just above the HSBC measure, which was unchanged from the flash at 50.0.  Output fell below the 50 boom/bust level for the first time since May.  Separately, news over the weekend suggests officials are preparing to institute deposit insurance.  It is not clear when it will be implemented, but the draft version calls for a cap at CNY500k (~$81.4k) per person per account.  Deposit insurance is seen as another key step in the financial reform efforts.  

We do not put much stock in Moody’s downgrade of Japan.  It matches the earlier Fitch move, which leaves both one notch below S&P.  It remains investment grade, and the lion’s share of Japanese government bonds are in the hands of domestic investors, especially the BOJ.   The reasons Moody’s cited, especially the uncertainty over Abenomics, is hardly new news.  It acknowledges that the delay in implanting the second leg of the sales tax increase and the call for snap elections could be a favorable, but is concerned about the medium term risk to JGB yields and the fiscal credibility. 

The Reserve Bank of Australia is the first of four major central banks that meet this week.  It meets first thing tomorrow.   It is widely expected to keep the cash rate unchanged at 2.5%.  However, expectations for a rate cut next year are increasing, and the RBA’s statement tomorrow is unlikely to dissuade the market.  The 3-year note yield is below the official cash rate.  The Aussie fell to almost $0.8415 (finished NY ~$0.8505 before the weekend).  It has since recovered, in line with the general pattern today, but is the only major currency still lower on the day. 

The North American session features manufacturing PMI reports from the US and Canada.   More importantly, two Fed officials whom we regard as keys to policy, Vice Chair Fischer and NY Fed President Dudley speak.  Even though as the FT noted, the Fed’s statements are not only getting longer, but more difficult to understand (higher reading level required), we find that focusing on the signal from the Fed’s Troika (Yellen, Fischer and Dudley) is most helpful.