Take Aways

The US dollar has recouped a good part of yesterday’s losses as the choppy range trading that has characterized recent trading continues. Despite a string of poor economic data, pointing to stronger deflation forces and weaker output in Japan, the yen is the strongest currency, posting across the board gains.

German retail sales were very disappointing, falling 2.3% in Sept (vs consensus forecast of +0.5%) and the Aug series was revised to -0.4% from -0.2%, but the euro’s retreat was well underway by then. Nearby support is seen near $1.3780, but the lower end of the recent range comes in nearer $1.3700.

The market also may be sensitive to the heightened tensions in the peripheral European bond market. Month-end flows are also a wild card in a market that is on edge ahead of next week’s key events and especially the FOMC’s QEII decision.

Next week’s event risk is substantial. US elections, the passing of which alone will help lift some uncertainty that has hung over investors and businesses in a number of areas including next year’s marginal tax rate, the FOMC meeting which will proceed with a QEII, and although long discussed may still surprise, and a series of economic data expected to show relatively strong auto sales and the first rise in US nonfarm payrolls since May.

There are several take aways from this week’s developments.

First, stronger than expected UK Q2 GDP has prompted a swing in the pendulum of market psychology away from a new bout of asset purchases. While this weighed on British gilts, it helped sterling outperform.

Second, the policy signal in a number of other countries was in the opposite direction. Officials in Sweden, Norway, Canada and New Zealand have signaled a slower pace of normalization of monetary policy, while soft CPI figures, suggest the Reserve Bank of Australia need not be in a hurry tighten policy further.

Third, the European debt tensions have escalated again and the Greek, Irish, and Spanish bank accounted for 61% of the borrowings last month up from 51% in August, while the overall amount of ECB lending has fallen to its lowest level since the fall of Lehman.

Fourth, this appears to be the first week in five that the US-German 2-year interest rate differential has not moved in Germany (and the euro’s) favor. This is one of the indicators we have highlighted that has tracked the euro-dollar exchange rate very closely. Fifth, while there clearly strong portfolio capital inflows into emerging markets, there also is some hot money. It is difficult to determine the relative proportions but as the dollar has entered a trading range, some profit-taking has been seen in emerging markets.