Dollar Flat, Euro Heavy

The US dollar is little changed against most of the major foreign currencies and is mostly firmer against the emerging markets. The two main exceptions are the euro, which, while holding above yesterday's lows, continues to struggle to sustain even modest upticks. Although the North American session may be less active on account of the bank holiday (closing the government, banks and the bond market), a break of the $1.3650 area (yesterday's low ~$1.3670) could spur another two cent decline in relatively short order as stale longs and model types join the fray. The other exception is the Australian dollar, where a jump in the unemployment rate (5.4% from 5.1% and consensus of 5.0%) and a loss of full time jobs, triggered a 1 cent decline quickly. Although it rebounded quickly and appears resilient, the longs still seem to be vulnerable. A break of $0.9950 may be needed to trigger a round of liquidation.

Equities in Asia were mixed, although the MSCI Asia-Pacific was up 0.4% to snap a 2-day decline. The Shanghai Index was up 1%, helped by generally as expected economic data. There was much excitement in South Korea, where the Kospi was sold off hard (-2.7%) in to the close as options expired and large scale foreign selling was reported. European bourses are lower and the Dow Jones Stoxx 600 is about 0.3% lower, with financials and technology sectors (disappointing Cisco news late yesterday) being the largest drags. Basic materials and energy are bucking the trend. US indices are called about 0.5% lower.

The key focus remains on the peripheral European bond market and pressure has let up. Irish and Greek benchmark 10-year yields are up 9-13 bp and Spain, Portugal and Italy are up 5-7 bp. Germany is off 3 bp. The widening spreads in Europe are favorable for the US dollar and supports our constructive outlook because it lowers German interest rates and we understand the euro-dollar (and dollar-yen) exchange rates as being heavily influenced by interest rate developments.

Chinese economic data dump was mostly unremarkable. The key exception is the 4.4% rise in CPI from 3.6% in Sept. Although the consensus was for 4%, the "whisper" number had increased to 4.4% in recent days and may have been behind the PBOC bank reserve increase and allowing the 1-year bill yield to rise this week. On the month, CPI rose 0.7%, as did producer prices. While currency appreciation may help, on the margins, curb imported inflation, it will likely prove insufficient and additional rate and required reserve hikes are likely.

The Federal Reserve announced it will buy $105 bln of US Treasuries over the near 30 days. If NY Fed President Dudley was correct that $500 bln of purchases was tantamount to 50-75 bp easing, these purchases over the next month are roughly the equivalent to 10-15 bp of easing.

Japanese machinery orders fell sharply in Sept (-10.3% vs -9.5% expectations). This is an ominous development, as this time series is thought to be a good lead indicator to capital spending. However, the month-to-month volatility is such that more data is needed. At the same time, the BOJ appears to have anticipated this and had recently revised down its economic assessment for the second consecutive month, saying the recovery was "pausing."

Little new developments in Europe. European officials seem to be at a loss of how to respond. The European central banks are thought to have stepped up their purchases of sovereign bonds, but with Irish 10-year yields well above 8%, there is increased speculation that the EFSF will be tapped. We suspect such a climactic event is not imminent.