Three Drivers: US, Europe and China

A quiet start to the new week is leaving the US dollar little changed as North American participants return from the weekend.  Gains in early Asia were reversed in Europe.   The standout in the subdued activity is the yen, which has sporting a softer profile across the board.  The greenback is testing a two-month downtrend line near JPY78.75.  The euro, Swiss franc and, to a lesser extent, sterling, are approaching one-month downtrend lines against the yen. 

Asian stocks were flattish, but European shares are advancing, with the Dow Jones Stoxx 600 up 0.65% near midday in London, lead by a 1.2% advance in financials.   European bonds are mixed, while most peripheral bond yields are lower, Spain's 2- and 10-year yields are up 4 and 7 bp respectively.  On optimism that Greece will receive new funds the 10-year bond yields is more than 60 bp lower today. 

Lost on many observers is the fact that despite the absence of a fiscal plan in the United States, the government sector continues to be one of the headwinds on the economy.  Just before the weekend the US reported September's budget balance.  As it is the last month of the fiscal year, the 2012 fiscal year figures available.  The US deficit fell by $208 bln to $1.089 trillion and has fallen by a little more than 23% since the FY09 peak.  Receipts rose by 6.4% and outlays fell by 1.7%.

The US economic data highlights this week include the first look at economic data for this month in the form of the Empire State survey (Monday) and the Philly Fed survey (Thursday).  These are expected to show modest improvement.  Housing starts (Wednesday) and existing home sales (Friday) may be mixed, but still consistent with gradual trending improvement.  Notably, foreclosures in the US fell to a five year low in September and represents about a 16% decline on a year-over-year basis

Retail sales (Monday) are expecting to be firm, even when excluding gasoline, autos and building materials. Headline CPI on Tuesday may be flattered by higher gasoline prices, but the core rate is likely stable. Industrial output by remain soft in the face modest inventory accumulation.   Lastly, the unexpectedly large decline in weekly jobless claims will likely be corrected this week, which is also the survey week for the October non-farm payrolls.  

The news stream from Europe is both unexpectedly good and disappointingly worrisome.  The favorable development include the IMF weighing on the side of relaxing the time frame for fiscal target and German Chancellor Merkel's trip to Greece and the clear indication the beleaguered country ought to remain in EMU.  Merkel also opened the door to possible tax cuts in Germany, while Italy's Monti surprised with a 1% tax cut to the lowest two income brackets and cutting the planned VAT hike in half to 1% (offset to some extent by additional spending cuts and an extension of wage freezes in the public sector).

The EU being named recipient of the Nobel Peace Prize was unexpected and controversial, but if anything draws attention to its importance and ought to be listed among the positive developments.  Lastly, we note that the real sector industrial production reports were considerably better than economists expected based on the PMI survey data.  

However, there were a number of troublesome developments.  Perhaps the most important may be the most under-appreciated.  The termination of the EADS-BAE merger talks illustrate the strength of nationalistic forces and the obstacles to a more integrated Europe.  There is enough blame to go around, but on balance reports seem to put the onus on Germany.  As an aside, recall that Greece spends more than twice Germany does on defense as a percentage of GDP.   In fact, at 1.4% of GDP, Germany spends among the least on defense (France spend about 2.3% and the UK 2.6%).  

While labor unrest Greece is widely noted, less so has been the capital strike.  The largest listed company on the Greek stock market, accounting for about a fifth of its capitalization, Coca Cola Hellenic Bottling Company announced it would move its listing to London and its headquarters to Switzerland.  It says its Greek presence costs it a premium and the sovereign downgrades have resulted in it paying higher rates.  It has nearly 1 bln euro bond maturity next year.  Turnover in the Greek stock market has fallen by nearly 90% since 2007, and of course liquidity at the LSE is much greater.

Foreign banks and retailers are also reducing their exposure, but it is not just foreign entities, the Greek dairy company FAGE announced it was moving its headquarters to Luxembourg, where it will secure better bank funding.  To be sure, what is being moved is the largely legalistic, as the plants are not expected to be closed or see their value-added work shifted abroad.  

The Troika has reportedly told Greece to agree to implement nearly 90 policies it had previously agreed to before the EU summit at the end of the week.  Sweden's Finance Minister Borg was quoted in the weekend press opining that it was "most probable" that Greece would leave the monetary union within six months. This goes against the stream of what seems like a fairly well coordinated effort to reduce precisely that risk.  Yet it does reflect the underlying concern that unless there is more debt relief for Greece  is forthcoming, it is still not on a sustainable path.  To this end, reports suggest that one of the potential initiatives was Greece to use some of its aid funds to buy back its own bonds (as a way to restructure its debt).  

The EU heads of state summit on October 18-19 is unlikely to see a resolution of numerous outstanding issues, including Greece, Spain and Cyprus.  The differences bank supervision is unlikely to be resolved this week.   The EU itself may unveil new proposals to enhance integration.  A program of joint T-bill issuance by the triple-A countries could be among the most promising.

China's yuan has trended higher and is extending its recent gains to reach the best level against the US dollar in nearly two decades.  We suspect that it has more to do with domestic considerations than the US presidential debate and the delay in the US Treasury's semiannual report on the currency market.  In recent sessions, the most of the 1% band (from the fix) has been seen and we suspect that this reflects the new official efforts to allow more volatility.   The NDF market continues to price in almost more than a 1.5% depreciation of the yuan in the coming year.  After the recent advance, we, on the other hand, look for broadly sideways movement. 

This is a big week for Chinese economic data, culminating in Thursday's Q3 GDP report.  China has reported a further increase in the monetary aggregates, though new loans were somewhat disappointing (CNY623 bln vs consensus of CNY700 bln).  Separately both the CPI and PPI were near expectations at 1.9% and -3.6% year-over-year respectively.  Of note, in the CPI food prices rose 0.2% on the month for a 2.5% yoy pace.  The non-food component rose 0.4% for a 1.7% yoy pace.  China also reported a larger than expected trade surplus, fueled by a 9.9% rise in exports (yoy).  Imports rose 2.4% yoy, but the details here are more promising.  Copper imports rose to four month highs and iron ore imports were at their highest level since early 2011. 

Under other conditions, such Chinese import figures may have given the Australian dollar a fillip, but given the dovish comments by the RBA's Stevens ahead of the weekend (underscoring room to ease policy) and ahead of the minutes from the last RBA meeting, the market's focus is on the interest rate outlook.  Indicative pricing suggests about an 80% chance of a rate cut for early November has been discounted.  The Australian dollar was turned away from the $1.03 level before the weekend and is consolidating at little changed levels today.  Against the New Zealand dollar, the Aussie is looking better.  New Zealand reports Q3 CPI figures in early Wellington on Tuesday and this seems to have encouraged some short-covering of the cross after a sharp trend lower (5%+) over the past two months.