UK Goes Shopping (sort of) and Euro Observations

The US dollar is mostly softer against the major currencies.  Its five week high against the yen is an exception to the generalization and is coinciding with 4-week rise in US bond yields.  That move began prior to the string of better US data that now includes jobs report, retail sales, and industrial output.  Other core bond yields have risen, including Japan's, but US rate have risen more.   

Sterling got a bit of a fillip from the better than expected retail sales report (0.3% vs -0.1% consensus and the June series being revised to 0.8% from 0.1%).   Although it is continuing to flirt with the 200-day moving average (~$1.5720), the market seems reluctant, perhaps appreciating the stronger cap a bit closer to $1.5800.  The yen's weakness translated into a 1.9% rise in the Nikkei with led the MSCI-Asia Pacific Index to a 0.5% gain.  Comments by Chinese Premier Wen suggesting scope for new stimulus weren't enough to offset the dramatic weakness in direct investment in China, which fell 8.7% year-over-year, more than three times the decline the market expected.  The Shanghai Composite is approaching the multi-year low set in late July.  European shares are mixed, though Spain and Italy are continuing to out perform. 

The data calendar is light and has primarily featured the UK July retail sales report.  It covers through July 28 and hence picks up a couple of days of the Olympics.  Surveys of retailers have suggested little impact.  The market was surprised then that retail sales rose 0.3% instead of decline 0.1%.  The optics seem better than reality though.  The headline was flattered by a 2.6% rise in gasoline sales, without which retail sales were unchanged on the month.   

The June series was revised sharply higher to 0.8% from 0.1%.  However, ONS warned that the revision would have little impact on the 0.7% contraction in Q2 GDP, though this has not stopped some economists from raising their forecasts.  The retail sales deflator slipped to 0.2% from 0.3% in June and this represent the lowest since Oct 2009.  

On balance, we do not see the new retail sales data as materially changing the outlook for BOE policy and expect the gilt purchases to continue after the current tranche is completed in November.    The Lib Dems are pushing for a relaxation in the government's austerity efforts, but no movement yet by the Tories.  The political tension between the coalition partners is likely to grow.

We bring to your attention a few of observations about the euro's price action.  

1. The euro remains in a consolidative phase and has largely been confined to trading range $1.2240-$1.2340. 

2.  Below 10%, the benchmark 3-month implied volatility is near the lower end of the range it has been in since Lehman's collapse.  Together these two observations are suggestive of a spring coiling awaiting the decisive developments and events that are looming in the weeks ahead.  

3.  The euro's rolling 60-day correlation with the S&P 500 (percentage change) has tended higher since early June to stand now at 0.61, the highest in six months.  The 30-day correlation is at 0.71, which is upper end of where has been historically.  

4. The implied (3-month) euro volatility and the S&P volatility (VIX) are highly correlated.  They moved in the same direction about 94% of the time in the past 60 days and 92% of the time in the last 30-days.  

5.  The 2-year US-German interest rate differential widened to 34 bp at the end of last week, which matches the largest US premium since the financial crisis began five years ago.  It has consolidated in recent days. The euro is inversely correlated with the 2-year interest rate differential.  As the US premium grows the euro tends to fall.  That inverse correlation is now just below -0.51, the deepest inversion since the crisis began.