Four Key Developments

The US dollar is broadly mixed here at midweek.  The euro is at its best levels of the week and is consolidating the break below $1.2800.  The Swiss is being dragged for the ride, but is trading near two month highs against the euro.  

The yen is the weakest of the majors and sterling fell out of favor following a more dovish BOE inflation report.  The dollar-bloc is little changed, with the Canadian dollar out-performing, even though late yesterday the finance minister acknowledged that the balance budget goal is going to take longer than previously anticipated.  

Germany auctioned 2-year notes with a net yield for the first time in four months today, but bond markets are narrowly mixed throughout Europe.  Spanish and Italian 10-year yields extended yesterday's decline.  Greek yields are lower as well.  Core bond yields , including the UK, France and the Netherlands are a bit firmer.   

There are four developments to note today.  First, after much consternation, Japan’s parliament will be dissolved at the end of the week to prepare for elections in the middle of next month.     

The DPJ will most likely turn the reins of power back over a center-right coalition led by the LDP.  The most head of the LDP, Abe is already staking out his agenda.  It will include a large supplemental budget and a more earnest commitment to ending deflation.    

Abe wants  the government to have a bigger say in picking the next head of the BOJ and wants it to have a new and higher inflation target (suggested 3% recently) and an open ended commitment (see ECB and Fed).  The yen has weakened across the board.  The dollar is testing resistance just above JPY80.00  and the next target is the recent highs near JPY80.70.  The euro has gained 1% against the yen and is testing the JPY102.00-20 resistance area. 

Second, the Bank of England’s quarterly inflation report was more dovish than anticipated and this knocked sterling to new session lows after it had appeared poised to take out resistance near $1.59.  The key elements included a warned that after expanding for the first time in four quarters in Q3, the UK economy may contract again here in Q4, warning the economy may be “weaker for longer” and that another round of  gilt purchases has not been ruled out.   

King indicated that the inflation outlook was behind the BOE’s decision did not extend the gilt purchases last week, but that there was not a loss of confidence in QE itself.  Separately the UK reported soft employment figures with the claimant count rising 10.k.  The consensus had expected no change.   

Third, European officials are not only have trouble reaching an agreement about Greece and the bank supervisory functions, but efforts to finalize the EU’s 2013 budget have been dashed.  Late last night, members of the European parliament boycotted a meeting, which prevented an agreement which means that whole process have to begin again.   

The European parliament, one of the few European institutions that has not been drafted to assist in the crisis, was objecting to the fact that the new budget did not cover the 9 bln euro shortfall from this year.  Finalizing the 2013 budget was one of the main goals of the Nov 22-24 EU Summit.    

Fourth, the US calendar is full with PPI (risk is to the upside following the stronger import prices), retail sales (risk is to the downside, with softer auto and chain store sales), President Obama holds a press conference (the negotiations over the fiscal cliff begin formally on Friday), and later today the minutes from the Oct 24 FOMC meeting will be released.  Usually those minutes are not the stuff that moves markets, but this time, especially in light of Yellen’s comments late yesterday, they may take on added importance.    

Yellen, who some see as a potential successor to Bernanke, whose term expires at the end of next year, endorsed using numerical thresholds to enhance the Fed’s forward rate guidance to signal the timing of the first hike.  This is slightly different than some others at the Fed who have suggested such thresholds to know when to stop the open-ended QE.  There does seem to be a consensus forming to use macro-economic numerical threshold rather than a calendar point.   

With Operation Twist set to finish in a few weeks, the market will be looking for signs of the Fed’s intentions.  In particular, the question is whether to roll the Treasury purchases into QE, which would effectively double the outright  purchases being conducted.