Abe and EMU Data Disappoint, UK Surprises, US Data Awaited

The US dollar is firmer against most of the major and emerging market currencies, likely including the Brazil real, where the government surprised many by scrapping the 6% IOF tax on foreign purchases of local bonds. The main exceptions to the dollar's strength are the Japanese yen, as Prime Minister Abe failed to rebuild the confidence in his program, and sterling which reacted positively to the stronger than expected service PMI, rounding out the trifecta of improving PMI surveys.  

There was much anticipation for details of what Abe indicated was the third arrow of his program.  To compliment the fiscal and monetary efforts was to be structural reforms.  This was always seen to be the weakest of the three, but in some ways the most important.  Abe's pledge to "slay the deflation monster" may make for colorful headlines, but investors were disappointed with the substance.  

The third arrow consists largely of new investment in power generation and infra-structure, as well as increased foreign investment.  However, the goal of boosting national income by 3% a year for the next decade seems like pie-in-the-sky given the unfavorable demographics and without specifics on labor and capital market reforms.   In addition, in terms of marketing, waiting for next week's unveiling of the "growth strategy" seems to be diluting whatever effort there is to shock and awe.

The Nikkei was trounced, declining by almost 4% to new lows for the move and now off about 18.8% from the peak on May 23.  The dollar was pushed back below JPY100, though Monday's low just below JPY99.00 was not challenged (yet?).  

The disappointing Japanese news was, however, part of the larger disappointment from the Asia-Pacific area.  This included HSBC's service PMI for China which ticked up insignificantly to 51.2 from 51.1 in April.  It stood at 54.3 in March.   Australia also contributed to the theme by reporting a disappointing Q1 GDP of 2.5% year-over-year, down from 3.1% in Q4 and below the consensus of 2.7%.  This weighed on local shares, which tumbled 1.3% to their lowest level since late January.  This brings the decline since May 20 to a little more than 8%.  The market, which seemed agnostic between a pre-election rate cut in August or September is moving toward August.  

The euro zone continued the disappointing theme of the day.   The better than expected manufacturing PMI reports was not repeated in the service sector.  The pan-EMU service PMI came in a 47.2 compared with the 47.5 flash reading, which the Markit compilers points to a 0.2% GDP contraction here in Q2.  Germany's final reading was a touch below the flash reading at 49.7 from 49.8.   France was steady at 44.3.  Italy reported an unexpected decline to 46.5 from 47.0 and, of note, new business was at its lowest level for the year.  

Spain was the notable exception, with the service PMI rising to 47.3 from 44.4 in April and amid expectations for 45.0.  Although still below the 50 boom/bust level, it is at a 23-month high.  The employment index reached a 20-month.  This follows the larger than expected decline in unemployment reported yesterday. Although unemployment has fallen for three months, we cast a jaundiced eye toward it as it looks largely seasonal and the vast majority of labor contracts signed are temporary in nature.  There was not improvement to speak of after seasonal adjustments.  

Separately, the euro area reported a 0.5% decline in April retail sales.  This is twice the decline the consensus expected and the third consecutive decline.  Nevertheless, we do not expect an ECB response tomorrow in terms of a change in policy.   For its part, the euro is trading mostly within yesterday's range which is within the range seen on Monday.   The $1.3100-10 offers the nearby cap (and coincidentally the 100-day moving average).  Initial support is seen near $1.3050 and a break would signal a move back toward Monday's low near $1.2950.

Sterling is trading near 3-week highs against the euro and remains within spitting distance of the 3-week high set against the dollar on Monday near $1.5375.  A move above $1.5400 is needed to lift the outlook.  The spur for sterling today comes from the third PMI reading this week to better expectations.  Today was the important service sector.  It rose to 54.9 from 52.9 and is the strongest since March 2012.  Of note, new business rose to a 3-year high (57.2 vs 54.2).  The BOE was not expected to alter rates or renew gilt purchases at the conclusion of the 2-day MPC meeting tomorrow, which is Governor King's last meeting.  He is leaving as a nascent recovery seems to be taking hold. 

The North American session sees the US service ISM and the Fed's Beige Book, and, perhaps, most importantly, the ADP employment estimate.  It is not that the ADP report is particularly accurate on a month-to-month basis, but it does appear to steal some of the thunder of the US non-farm payroll report.  Moreover, this is particularly important given the speculation around the Fed's tapering.  Last month, the ADP under-estimated the private sector rise in non-farm payrolls by 57k, or nearly 30%.  The Bloomberg consensus is for 165k increase.