Dollar Mostly Softer, but still Muted Reaction to Developments

The global capital markets have continued to stabilize, but the response to recent developments has been muted. Yesterday's much sharper than expected downward revision to US Q1 GDP (1.8% vs 2.4%), owing mostly to weaker consumption and corporate spending, reassuring talk by several Fed officials, include some for the most hawkish camp, coupled with continued easing of China's liquidity squeeze and an EU agreement on how banks losses will be distributed, has barely spurred a reaction in the capital markets. Month and quarter-end portfolio adjustments may be an explanatory factor, though it is not very satisfying. Many participants appear to lack near-term conviction.

The launch of new Toshin funds in Japan may have weighed on the yen, but the greenback remained shy of the JPY98.70 high seen Monday and is little changed on the week. There is talk of Japan-based offers in the JPY98.40-50 area. The Nikkei gained almost 3%, the first gain of the week, led by a 6% rally in the financials. Japanese government bonds were also firm and yields eased 3 bp to approach the lower end of the 0.80%-0.90% range that has largely dominated for the past several weeks.

China stands out as a main exception to the 2% rise in the MSCI Asia-Pacific Index. The Shanghai Composite ended marginally lower, extending the losing streak to the seventh sessions. The continued easing of money market conditions failed to lift sentiment and Fitch, following similar moves by a number of banks, cut its growth forecast for the world's second largest economy. It cited the jump in interbank rates in recent weeks. Those rates have eased, but remain elevated. The 7-day repo rate stands near 6.75% today, compared with this year's average of 3.85%.

While there was a muted response to the downward revision of US GDP yesterday, the revision to UK GDP today gave the market fresh excuses to sell sterling, which seems to also under month-end pressures. While the quarterly growth estimate of 0.3% was left untouched, the year-over-year rate was halved to 0.3%. Sterling's recent losses were extended and it is trading at its lowest level since June 3. The market seems to have gotten ahead of itself and there is a reasonable chance that the session's low for sterling is in place near $1.5265. That said the $1.5330-50 area may offer a stiff near-term cap.

The euro recovered from the first dip below the $1.30 level in more than three weeks, but the upticks appear half hearted. Buying interest ran out of steam near $1.3040. The EU agreement on dealing with losses of insolvent banks (the so-called "bail-in, whereby the bank itself, its creditors and shareholders bear the burden before large depositors--over 100k euros--and tax payers) is a step in the right direction, but a banking union still seems more than a year off.  The two-day EU Summit begins today and the agreement will help the atmosphere.  The key issue at the Summit will be employment. 

The ECB's assurances to keep monetary policy exceptionally accommodative for the foreseeable future is not really new and investors knew, or at least learned over the past week or so, that a rise in US yields can have serious and substantial knock-on effects on European interest rates regardless of the ECB's stance. The real issue is will the ECB take new steps to offset the apparent tightening in euro area financial condition at next week's meeting. And it seems unlikely.

Europe reported an uptick in the Sentix sentiment surveys, but it appears that the real sector data has not been quite as dismal as the sentiment readings have suggested and this appears to be a little catch-up. Although Germany reported a somewhat better than expected employment report (unemployment fell by 12k instead of rising by 8k), the most important news was that one of the pillars of the ECB's monetary policy continues to flag. M3 slowed to 2.9% from 3.2%. Most troubling is that loans to the private sector continue to fall. The 1.1% decline in May follows a 0.9% decline in April. 

The North American  session has two features.  The first is the May personal income and consumption data, which will help economists fine tune Q2 GDP estimates.  The Bloomberg consensus is for 1.7%, growth in Q2, though this was before yesterday's revisions to Q1 GDP .   Personal income is expected to have risen 0.2% in May from a flat reading in April, while spending is expected to have fully recovered the 0.2% decline seen in April.    Given the dovish dissent at the recent FOMC meeting and the fact that April core PCE deflator was at a record low of 1.05% (rounded up to 1.1%), the market is more vulnerable to a downside surprise than upside.  Recall that the FOMC statement suggested that the decline in inflation was likely transitory.  

The other feature of today's session is the continued flurry of post-FOMC Fed speeches.  Today is Dudley in NY about the labor markets (10:00 am ET), Powell in Washington on monetary policy (10:30) and Lockhart in Georgia on the economy (12:30).