Dollar Heavy While Waiting for Bernanke

The US dollar is trading softly in the lead up to Fed Chairman Bernanke's speech at Jackson Hole.  The price action is still one of position adjusting.  While the euro and Swiss franc have made new multi-week highs against the dollar, sterling ad the Australian and Canadian dollars have moved through yesterday's highs only in early North American activity, dragged up apparently by the euro. 

The dollar has made a marginal new low for the week against the yen, by around 4 ticks.  The range for the week is now JPY78.40-JPY78.84, according to Bloomberg.  Participants are also aware of month end adjustments and the long-holiday weekend in the US as factors impacting the price action.  Our views have not changed, but see that a Reuters poll finds our views are not in such a minority any more.  The poll found 44% expected QE to be announced at the next FOMC meeting,  down from 70% last month.  

 

What does not appear to be having much impact are the fundamental news developments.  In terms of data, this includes disappointing retail sales from Germany and Spain.  German retail sales fell 0.9% in July.  The consensus expected a 0.2% rise.  

It is true that the June time series was revised to 0.5% from -0.1%, but net-net, over the two months retail sales were considerably weaker than expected.  This dovetails with recent VDMA orders data showing foreign demand is holding up but domestic demand has weakened considerable.  

Spain reported a 7.3% year-over-year decline in July retail sales, a marked acceleration from the 5.2% decline in June.  A new 3-percentage point hike in the VAT goes into effect tomorrow.  Often ahead of a consumption tax, one sees a bit a of a fillip in demand as people and businesses try to "beat " the tax.  Not so in Spain.  

Moreover, provides some insight into vicious cycle in the periphery.  Spain raises the VAT to raise funds to close the deficit, while the economy is contracting.  The revenues it generates falls shy of expectations because fewer goods are bought.  The missed revenues then lead to missing deficit targets and spur increased pressure for more austerity.   What ? 

Meanwhile, reports in the German paper "Bild" claims that Bundesbank President Weidmann has threatened to resign over the ECB bond purchase.  Recall when Trichet's bond program was initiated, both the BBK President Weber (who was seen as the most likely successor to Trichet) resigned as did Executive Board member (from Germany) Stark.  The report suggests that the German government (Merkel?) has persuaded him to stay.  

Seemingly related is the story in the Spanish paper "El Mundo" that claims that Merkel has been urging Spain's Rajoy and Italy's Monti to to formally request aid.  Ostensibly the request is to allow some time to heal the internal dispute.  

While many observers seem to be taking this at face value, we suspect there is more to it that meets the eye.  First, there was not sign that Italy was about to ask for assistance.  Indeed, it is not clear that the technocrat government of Monti can really do this, in lieu of a dire emergency.  Monti may want the executive not to have to be totally accountable to parliament, but committing a country to a international aid package and a memorandum of understanding does not seem sustainable without broader support.  

Second, the reports suggesting that Spain is looking at the possibility to recapitalize Bankia without drawing on the emergency aid funds shows that Rajoy wants to maintain his degrees of freedom.  Using the EU/EFSF funds would likely require that junior debt holders realize losses (take a haircut).   However, many of these junior debt instruments are in the hands of retail investors.  Forcing a haircut on them, given the level of unemployment, rising VAT, and falling home prices, just to cite a few of the plagues on the House of Spain could only add to the social tensions.  

Meanwhile, reports suggest that Moody's reviews of Spain's Baa3 rating may be extended to late September.  The extra couple of weeks this entails is ostensibly to get the audit report on the banks' needs and after the German Court decision on ESM.  

The modest uptick in the yen does not reflect the poor economic news as much as the 1.6% decline in the Nikkei.  The Nikkei gapped lower following the losses in the US markets yesterday.  Today's losses carry the Nikkei to its lowest level since August 7.  That the Japanese data were disappointing is an understatement.  July industrial production fell 1.2%.  The consensus was looking for a 1.7% gain.  Household spending fell 1.3% in July.  The market expected a 0.3% decline.   

The government revised down its assessment of the Japanese economy this week and as the reconstruction spending eases and government incentives to purchase more environmentally friendly car runs it course, further weakness in the world's third largest economy is likely.  In turn, this will likely add pressure on both the government and BOJ to take remedial measures. 

Lastly, Canadian GDP figures came out in line with expectation with June output rising 0.2% and the year-over-year rate steady at 2.4%.   At an annualized pace Q2 GDP rose 1.8%.  The consensus had looked for 1.6%, but Q1 was revised to 1.8% from 1.9%, leaving the optics largely as expected.  The passing of the event risk has seen the Loonie firm to new session highs. 

We continue to believe that the position adjustment that has occurred through most of the month of August is complete or nearly so.  We think that there will some disappointment if Bernanke is not more forthcoming that the recent FOMC statement and minutes.  We remain concerned that the European debt crisis will intensify again in the coming weeks.