The Big Week Begins

The US dollar starts a critical week on the defensive. A new round of long-term asset purchases by the Federal Reserve coupled with a stronger than expected Chinese PMI weighed on the dollar and encouraged purchasing of so-called risk assets. Although the euro has flirted with the $1.40 level, we note it has only managed to close (the North American) session once above there and that was on Oct 14.

With the help the first increase in the UK’s manufacturing PMI (54.9 vs a revised 53.5—from 53.4 in Sept) sterling reached its best level since briefly pushing through $1.61 on Oct 15. The greenback popped to JPY81.40 in early Asia amid speculation, likely unfounded, of intervention. The gains were short-lived and the dollar sunk back toward the lows, just above JPY80.20. The dollar is also heavier against most emerging market currencies, with the notable exception of the Chinese yuan, which declined by almost 0.5%, the largest single day decline in almost two years.

This is arguably the most important week remaining in the year. The US mid-term elections are tomorrow and the Republican Party looks poised to wrest control in the House of Representatives and leave the Democrats with a smaller majority in the Senate. The Republicans also may secure a majority of state governor offices. It lags behind the Democrats by 2 governorships (26-24), but there are 37 on the line tomorrow and half of the races do not feature an incumbent. The size of the Republican victory will influence the way the current Congress addresses the outstanding legislative issues, including the extension of the 2001 and 2003 tax cuts, the 2009 payroll tax credit and the extension of unemployment benefits (set to expire at the end of Nov). Wednesday is the much awaited FOMC meeting. The key issue is how much and how fast the Fed will be Treasuries. The consensus seems to be for around $500 bln over the next six months.

There is also the usual start-of-the-month economic releases, including the manufacturing PMI today, where after the better than expected Chicago reading at the end of last week, may have seen expectations creep higher for the national report from the 54.0 consensus (54.4 in Sept), auto sales, which look to have been among the strongest since the end of the cash-for-clunker program. The event-packed wee finishes with the non-farm payrolls report. It is expected to post its first increase since May.

This week there are several central bank meetings. The Reserve Bank of Australia kicks it off early Tuesday (3:30 GMT). Sentiment has swung against a rate hike after core CPI fell back within the RBA’s target range. Manufacturing continues to slow, house prices are leveling off and the softer RBA commodity index warns that the terms of trade may be peaking. An RBA hike would be a surprise for the market at this juncture. The BOE and ECB meet the day after the FOMC. The risk of QEII in the UK has eased following the recent string of economic data, especially the 0.8% quarter-over quarter rise in Q2 GDP. The ECB will also remain on the sidelines. At the press conference, Trichet may push his case for less discretion in imposing sanctions on fiscal violators and may suggest more on the exit strategy at next month’s meeting. The Bank of Japan brought up its meeting from next week to this week and there is some speculation that it may increase its own bond purchase program.