US Economic Headwinds Restrain the Dollar

The US dollar advanced in Asia and Europe but news of the first outright drop in US consumption in 2 years has seen the greenback surrender much of its earlier gains.  

June personal consumption expenditures fell 0.2% in June.  The consensus had looked for a small increase. Consumer spending on durable goods, a good cyclical indicator, has been falling since the end of Q1and in recent months, non-durable spending has also been weakening.  The main culprit arguably is the slowing pace of real income increases and high level of job insecurity.

It is still "just" Q2 data, but it underscores the importance of Friday's jobs report.  It is the first official (and comprehensive) data for the beginning of Q3.  Those like me that recognize that while 3%+ growth seems unattainable while the de-leveraging is taking place, sub-1% growth is not the new normal either.   Our arguments about better growth, with the passing of series of one-off factors, including the deficit debate in Washington, were more about H2 than Q2.  

I had thought many investors would wait until after the jobs report to think more seriously about the prospects of QE3, and while this continues to seem to be the case for medium term investors, many short-term participants are already placing their wagers.  

Tensions in Europe remain acute.  The recent agreement has thus far failed to stabilize Spanish and Italian bond markets as both countries are today paying record spreads over Germany and both of their 10-year yields have moved back above the 6% threshold.  I note too that Belgium is paying a record premium over Germany as well today.  Over the past five sessions, Italy's 2-year yield has risen convincingly through Spain's 2 year yield.  Over the same time, the Italian market (FTSE MIB) is off 8% compared with Spain's 6% loss (IBEX 35).  

One of the arguments I made was that a Greek default would increase and not diminish the risk to the other large debtors in the euro zone, even though many were suggesting otherwise.  This is in fact being born out by the credit default swaps prices which for the five year CDS have made new record highs today.  In the past five sessions, the Italian 5-year CD has risen from 271 to 367 today , while Spain's has risen from about 285 to 424 today.  

Even if one can identify the drivers and have a sense of the strength of those drivers, finding the appropriate vehicle to express the view may require a different set of skills.  For example, yen bulls have been better served buying Japanese stocks than bonds, but Swiss franc bulls have been better served buying Swiss bonds instead of shares.  The weakness of the US economy appears to be being expressed in the foreign exchange market, while Europe's crisis is more reflected in bond spreads, equity markets, CDS.  

The euro is recovering from the downside follow through after yesterday's poor price action in which an outside down day was avoided by a close above Friday's lows.  Resistance is in the $1.4280-$1.4300 area and support is seen near $1.4150 and then $1.4100.   UK gilts reportedly seeing good demand, but sterling looks vulnerable.  The euro held support near GBP0.87 and cross rate pressure may see sterling slip toward $1.6200.   Swiss franc and yen continue to trade well.  Somewhat dovish RBA statements, fears that the soon to be reported Chinese inflation data may mean more tightening, and general growth concerns have triggered a bout of profit-taking on long Australian dollar positions.