Much Noise but Pattern Holding

The pattern in the foreign exchange market remains intake by which the major currencies often move in the direction of the recent trend and some follow through on Monday before some consolidation kicks in. The euro and sterling made new 7 week highs today in early Europe and the Australian dollar made new six week highs. However, as the European session began in earnest the currencies have surrendered their earlier gains and in fact the euro and sterling have slipped to new session lows in late in the London morning.

The poor euro zone flash PMIs did not help matters, but the focus is really on the debt crisis and the cacophony of voices still being heard. The euro zone flash mfg PMI came in at 47.3 down from 48.5. The consensus was for a 48.0 reading. The service sector flash PMI came in at 47.2 down from 48.8 and well below the consensus 48.5.

All else being equal, the risks of a contraction in Q4 in the euro zone has clearly risen. The details are noteworthy. German mfg fell to 48.9 from 50.3. The market was looking for 50. The service sector rose to 52.1 from 49.1. In France, the mfg rose to 49 from 48.2. The market had looked for a slight decline. However, the service sector plummeted to 46 from 51.5. It is a 27 month low.

Early HSBC's PMI for China was reported at 51.1 from 49.9 as new orders and output helped return the headline above the 50 boom/bust and reinforce ideas in some quarters that the world's second largest economy is still on track for a soft landing.

Japanese stocks rose their most in two weeks, helped by the China news and news that the trade balance swung back into surplus from the deficit in Aug. The Sept merchandise trade balance was JPY300 bln vs a JPY775 deficit in Aug. The market expected less than a JPY200 bln surplus. Exports rose 2.4% year-over-year. The consensus was for 1%. Imports rose less than expected at 12.1%. The consensus was for a 13% increase.

While there is more talk about the possibility of QE3 aimed at the mortgage market, the direct foreign exchange implications are less clear. We note that the BOJ is still engaged in QE and the yen remains strong. Since the BOE announced QE on Oct 6, sterling has risen roughly 7 cents. It is also possible that rather than the Fed trying to support the US mortgage market the federal government does so. That is to say, the housing market may be addressed more by fiscal policy than monetary policy and the impact on the dollar is far from clear or obvious.

The dollar slipped to new record lows against the yen before the weekend. Japanese officials responded with stepped up verbal intervention, but the market has really been convinced and the greenback did spend much time above JPY76.5.

Initial support for the euro is seen near $1.3770-$1.3800. Sterling's initial support is seen near $1.5840-80. Watch the JPY104.80-JPY105 level for the euro. A break would likely signal another push lower for dollar-yen below JPY76 and may point to steeper euro losses against the greenback too.