Holiday Update

UK and US markets are closed. Quieter trading has seen the US dollar pare some of the late Friday gains scored in the wake of the Fitch downgrade of Spanish sovereign risk.

The combination of only a one notch move, when many observers, including ourselves, believe more is justified, and a stable outlook has seems to be a case of "it could be worse". Despite the lack of follow through euro selling, few think the decline is over.

Even pressure from the European sovereign debt crisis eases for the time being, the other force we expect to underpin the dollar will likely receive more of the limelight this week. This is the relative strength of the US economy. The main focus here will be on US employment data at the end of the week. We note that the Bloomberg consensus is creeping up to now stand at 508k.

A combination of soft Japanese economic data, stability in the capital markets and domestic political anxiety have weighed on the Japanese yen. In terms of economic data, Japan reported April industrial output rose 1.3%, about half of what the consensus had expected. Housing starts rose 0.6%, a tenth of what was expected.

The Social Democrat Party withdrew from the DPJ coalition in protest over PM Hatoyama's decision to keep the US base in Okinawa. The DPJ has an majority in the more powerful lower house of the Diet, but needed the 5 SDP seats in the upper house. The latest poll (Nikkei) show support for the Hatoyama at a lowly 22% with nearly 2/3 calling for his resignation. The dollar rose to JPY91.62, posting a higher high for the fourth consecutive session. Resistance is seen in the JPY91.85-JPY92.20 band.

Developments in Europe have been light. Spanish 10-year yields are 3 bp higher, while the similar German yield is 2 bp lower. Other peripheral bond markets are quiet, though Portugal is outperforming a bit, where the 10-year yield is off 5 bp. Meanwhile, most European equity markets are mostly posting modest gains though the Spanish stock market is under-performing and, as one might expect, financials are the worst performing sector. There are three observations to note: First, there has been little discussion of last week's German bond auction failure, the first since Sept 2008. The government had intended to sell 7 bln euros of 5-year paper and ended up selling 5.45 bln. The main problem seemed to be too low of yields--(1.47% vs 2.2% at the April sale). Second, euro zone money supply M3 contracted 0.1% in the year through April.

The three-month annualized pace is 0.2%, the same as for the previous three month period. This contraction in money supply, coupled with the intensification of fiscal consolidation, bodes poorly for the economic outlook.

Third, the new coalition government in the UK suffered its first casualty--Treasury Minister David Laws (Lib-Dem) left over revelations about his personal expenditures. This has largely been shrugged off, though the London market is closed. The key focus is the June 22 budget.

Other developments to note:

1. Czech elections--the koruna is recovering from pre-election jitters, posting its largest advance in more than a year-- on the center-right victory on a platform that called for reducing their budget deficit (3% by 2012), emphasizing spending cuts as opposed to tax increases. Preliminary reports indicate the center-right three parties won 118 of the 200 seats.

2. The Reserve Bank of Australia and the Bank of Canada meet on Tuesday. No one is expecting the RBA to hike rates again after delivering three hikes already this year. In addition, the risk is on the downside for tomorrow's economic reports (retail sales and building approvals (0.3% and -5.0% are the Bloomberg consensus forecasts respectively). The Australian dollar is a laggard today.

In contrast, the Canadian dollar is one of the leaders today. All the primary dealers in Canada expect the central bank to deliver its first hike tomorrow. It would be the first G7 country to do so. Moreover, the same primary dealers expect another hike to be delivered in July as well. Today Canada reports both the March and Q1 GDP. The former is expected to have risen 0.5% after a 0.3% gain in February and the latter is expected to have grown by a heady 5.9% annualized pace. Canada reports employment data at the end of the week. The blowout 108.7k increase in jobs that was initially report in April cannot be sustained of course, but a small rise is still expected. The Canadian dollar continues to be among our favorite currencies.

3. Israeli forces clashed with pro-Palaestinian ships carrying supply it Gaza has weighed on Israeli shares (-1.7%) and the shekel. Due to MSCI shifting Israel's classification to its major country indices and out of the emerging markets spurred an increase in activity in the shekel in recent days. It has generally trended lower.

It is near the lows for the year last week, when the dollar rose just above ILS3.88. A move above ILS3.90 could signal another 2-4% dollar advance.