Data Theme: Economic Moderation

The US dollar is mixed.  The euro is consolidating its recent gains, despite softer PMI data.  

The UK reported a much weaker than expected PMI data and sterling dropped a cent after earlier testing $1.65.  Switzerland reported stronger PMI and retail sales data and this offset the impact of yesterday's somewhat soft Q1 GDP report. 

China reported weaker PMI for manufacturing as well.  At 52 it now stands at its lowest in 9-months.  While this particular time series may be weak due to seasonal factors in May, the larger point remains valid and that is that the Chinese economy appears to be moderating.  Many of the largest investment banks have revised down their growth forecasts for this year.  A soft landing is still regarded as the most likely scenario, but it could impact the pace of yuan appreciation.  The 12-month NDF posted its biggest decline in May in six months and now is assuming about a 1.3% appreciation.  If China does slow the pace of yuan appreciation, perhaps it will introduce another dimension of flexibility by widening the curernt dollar-yuan band from 0.5% to 1.0%.  Since the full range of the current band is not explored often, the wider band may be largely symbolic initially. 

Despite the differences between the US and Europe, perhaps the similarities are more striking and Churchill's observation about the US--doing the right thing after exhausting the alternatives--applies to Europe.  Officials are being dragged into innovation and institututional evolution to address the debt crisis. 

There is a bit of a chicken and egg story going on with IMF saying it can't give the next tranche of aid unless there is a secure strategy for funding over the next year.  Germany says it cannot provide the next tranche of aid unless the IMF does.   

Meanwhile a compromise is being worked out.  In exchange for more encroachments on Greece's sovereignty, and a more aggressive privatization program, Greece will likely get funding for next year and the next IMF/EU tranche.  In addition, complimenting and supplementing may be a Vienna-like effort to win some bond holder support by encouraging current holders to roll over their maturing debt. Reports suggest such efforts may be focused on the 2012-2014 maturities.    They will likely have to be induced and this could be done through a number of possible ways, like increasing the preferred status (raise creditworthiness?), high coupon payments or collateral. 

Meanwhile, the risk is for soft US economic data today in the form of ADP and manufacturing ISM.  April's ADP of 179k was the slowest in five months and the forecasts for May are near there.  On the other hand the monthly private sector payroll figures were the best of the recovery.   Mexico and Canada appear vulnerable to disappointing US data. 

US-German interest rate differentials are moving against the dollar.  The 2-year spread which finished last week just below 109 bp is at 117 now.  And for the first time since early May, the US is not offering a premium on 10-year bonds. 

Having anticipated the pullback that began yesterday, I am not convinced it is over yet.  The euro made marginal new highs, but held below the retracement target of $1.4455.  Risk on the downside extends toward $1.4330-50 and ahead of there presents a better buying opportunity.   Sterling's downside also appears vulnerable and there is potential for around a cent from here (~$1.6430).    The yen is not very exciting.  Support is seen in the JPY81.00-20 area for the greenback and resistance near JPY81.80.