Economic Data Saps Euro Strength

The euro correction hit a wall after reaching a five day high in Asia near $1.2540.  The wall was in the form of poor data and the ongoing policy paralysis in Europe.  European officials are acting analog in a digital world.  They are moving to toward something, but it is not for several weeks and their track record does not instill confidence.  

The economic data was poor and can only increase the pressure on the ECB to do something at tomorrow's meeting.  The euro zone service PMI came in at 46.7 from 46.5 at the flash reading at 46.9 in April.  Yet, the German and French readings deteriorated from the flash report.  The composite reading came in at 46.0 down from 46.7 in April.  The forward looking new orders component fell to 44.6 from 44.8.  This is the lowest since level since July 2009.  

Separately, retail sales collapsed in April. The 1.0% decline was 10-times larger than the market expected.  Retail sales had risen 0.3% in March.  This was followed by a 1.9% decline in German manufacturing orders in April.  The market had expected a 1% decline after the 3.2% rise in March.   Industrial production figures to be released tomorrow now risk declining more than the 1% the market consensus forecasts.   

The rationale for an ECB rate cut has nothing to do with the financial stress in Spain or the periphery.  The rate cut would be meant to address the prospects of a deeper and more prolonged economic downturn.  

After selling-off in the European morning, the major foreign currencies are stabilizing ahead of the  G7 conference call.   The only thing that looks likely to come from is support for European officials to take more urgent action.  In that setting, Germany appears isolated.  However, within Europe, Austria, the Netherlands and Finland tend to agree with Germany as the creditors interest are similar.  

Meanwhile, the Spanish government's quest for alternative to seeking EFSF aid does little to bolster market confidence--just the opposite as the 5-year CDS edges to new highs. 

The Reserve Bank of Australia was the first of four central banks that will meet this week.  It delivered a 25 bp cut after last month's 50 bp move.  The Australian dollar initially rallied, and poked through $0.9800 briefly but dropped 3./4 of a cent, giving back every thing it scored quickly, as we warned was likely as the market quickly recognizes the likelihood of additional rate cuts in the months ahead.  Separately, its current account deficit swelled in Q1 to A$1.489 bln from A$963.9 mln in Q4, which itself was revised from A$837.4 mln.  The Aussie is finding support just above $0,9700.  A close below there today would of a return to the recent lows below $0.9600.  

The Bank of Canada meets today.  It has the least risk of surprising the market.  It is not going to do anything, but what its says may be important.  Clearly, the risk, given global developments and the slow down in the US, that the Bank of Canada is somewhat less hawkish/more dovish than previously.  The market had begun pricing in the likelihood of a rate hike by the end of the year.  This seems increasingly unlikely. 

The Nikkei rose 1% today with the help of the recovery in the US stock market yesterday.  This was in line with the MSCI Asia-Pacific Index.  Over the weekend, Prime Minister Noda reshuffled his cabinet in hopes of winning LDP support for his controversial plan to double the retail sales tax in the coming years.  He was unable to convince his rival in the DPJ Ozawa of the merits of the tax.  The retail sales tax threatens to split the DPJ and allow the LDP to return to power.  Taxing an activity one wants to promote seems backwards.  Tax savings to promote consumption.  

Lastly, given the recent string of data, the risks are that the US service ISM is softer than the 53.5 that consensus calls for, which would be unchanged from April.  Although other Fed officials speak (Fisher, Bullard and Evans today), Bernanke's testimony on Thursday is most important for policy cues.