Dollar Firm, but Mostly Range Bound

The US dollar is somewhat firmer, but still largely confined to recent ranges.  Its strength against the yen is an exception.   The greenback neared JPY80 for the first time since May 23.  The dollar's gains against the yen may be partly a  function of the Fed opting for Operation Twist over QE.   The US-Japan 2-year interest rate differential is slightly above 20 bp for the first time since early April. 

There is not much expected from the Eurogroup of euro zone finance ministers meeting today or the meeting tomorrow between Germany, France, Italy and Spain.  These should be understood as negotiating ahead of the EU Summit at the end of next week.  Headline risks stem from the meetings, but no revelations are likely.  The market will also be watching for the Wyman and Berger independent audits of Spanish banks.  A formal request for aid by Spain (and possibly Cyprus) is anticipated in the next day or two. 

Given the Fed's announcement yesterday and downgrade of its economic assessment (though the exact magnitude is difficult to ascertain as two new board members, and seemingly doves cast their votes and revealed their expectations for the first time) it may have stolen some thunder from today's data.   That said the weekly jobless claims cover the week that the next nonfarm payroll survey will be conducted.  Separately, Markit offers its preliminary reading of the US June PMI may attract some attention, but it is probably the Philly Fed survey that will be scrutinized to the extent that any of the US data is today.  

The euro zone flash PMIs were largely in line with expectations and underscoring the fact that region is contracting here in Q2.  The manufacturing PMI came in at 44.8 from 45.0 in May and was a touch weaker than expected.  The service PMI stands at 46.8 in June from 46.5 in May, and a bit above the 46.4 consensus.  In the flash estimates, only German and French country data is available.  

Of note, the German data were below expectations and France above.   The important take-away is that, even though it is just a flash reading, the PMI readings can only add to the case of an ECB rate cut as early as next month.  The resistance posed by the fact that the deposit rate, which is floor for rates, would have to be cut to zero no longer seems insurmountable.  

Whereas the weak flash PMIs support the case of ECB easing, the stronger than expected UK retail sales does not affect expectations that the BOE is prepared to restart its gilt purchases next month.  Retail sales rose1.4% compared with expectations for around a 1.2% gain.  However, there are a couple mitigating factors.
  

First, the April decline was revised to -2.4% (from -2.3%) and suggests that consumption remains an important drag on the UK economy here in Q2 after a poor Q1.  That is a key source of weakness of the UK economy.  Recall that despite the government's austerity agenda, the government sector was a net contributor to Q1 GDP.  

Second, deep discounts apparently helped boost sales.  The price deflator was cut in half to 0.95 from 1.7% previously.  This dovetails nicely with the softer than expected CPI report.  Lastly, it is interesting to to note that yesterday's minutes revealed that Governor King was outvoted and that he had favored a GBP50 bln increase in gilt purchases.  

It is the fourth time as governor that he was outvoted and arguably was vindicated each time.   Although he let what seems like a democratic process run its course and then a week later, pulled an end-run around the MPC by working with Treasury to increase the availability of credit and signal QE.  

The French and Spanish bond auctions went off without a hitch.  The focus was on Spain, where the bonds, where the 10-year bond yield is off more than 60 bp since the start of the week.  The push by France, Italy and Spain has shifted from focusing on the ECB to resume its bond purchases to getting the EFSF/ESM to do so.  Last summer, the EFSF and ESM were authorized to buy sovereign bonds in the secondary market, while the latter can also buy bonds at auctions.   

The rub is that a sovereign must formally request and none has.  There would be conditions attached and a memorandum of understanding would be required.  ECB purchases require no such conditions.  As an aside, the ECB and EFSF have claimed senior status, subordinating the private sector, as seen in Greece.  Reports suggest that it is possible to construct an ESM offering that is not .  

In any event, members would have to approve of a sovereign request and indications suggest Germany and Finland are not very sympathetic.  While the markets seemed to react positively to news that Merkel herself said it was "legally possible", she quickly dismissed it as  a "theoretical point" and that it was "not up for debate now".  

HSBC's flash Chinese PMI was soft coming at 48.1.  It has been below the 50 boom/bust level since Oct '11.  Of note, the export orders index stands at 45.9, the lowest since Mar 2009.   We anticipate further easing of monetary conditions.  Chinese officials also announced some relaxation in rules on foreign investment in equities and fixed income.  in addition, the PBOC announced that banks could offer 20% discounts on benchmark lending rates and a 10% premium on deposit rates.  This is seen as modest liberalization measures.