Dollar Recovers, But Remains Vulnerable

There has been no follow through US dollar selling against the major currencies after yesterday's disappointing ISM manufacturing report. In fact the dollar's resilience today comes in the face of constructive developments in Japan and Europe.

Japan reported the first increase in wage earnings in three months. Spanish unemployment fell by 98.3k, nearly twice what the market expected. UK construction PMI rose to 50.8, the first reading above the 50 boom /bust level since last October.

Yet the dollar, which had briefly dipped below JPY99.00 yesterday approached yesterday high today (JPY100.40 today, JPY100.70 yesterday). The Nikkei recovered early losses to finish 2% higher, led by a 6% recovery in financials. Japanese government bonds sold off and the 10-year yield rose 6 bp to 0.88%. Technically, we suspect if the dollar is not able to move above JPY100.70, the downside correction may not be over.

In addition, below the headline, the wage data points to another area in which Abenomics has seen limited results. The main factor driving the increase in wages earnings was special payments, such as commuting expenses, which rose almost 10% year-over-year. Base wages themselves were flat in April after a 0.9% fall in March.

European news was less ambiguously good, but the euro and sterling are unimpressed. Spain's unemployment fell for the third consecutive month. Prime Minister Rajoy had suggested over the weekend that the data would be encouraging. Peripheral bond yields are lower (~4-6 bp in Spain and Italy and ~12 bp in Portugal). 

Equity markets are higher, with the Dow Jones Stoxx 600 up almost 0.5% near midday in London, led by consumer good and services and financials. We also note that Turkey's capital markets have also stabilized. The stock market has recouped almost half of yesterday's losses and 10-year benchmark bond yield has fallen about 20 bp after rising 30 bp yesterday.

Following yesterday's better than expected manufacturing PMI, the UK construction PMI also offered an upside surprise. We are struck by the rebound that has been recorded since the 46.8 reading in February (to 50.8 in May). On top of that the BRC sales figures (1.8% in May vs consensus of 1.3%) suggests that perhaps the CBI distributive trades survey was too pessimistic. 

Sterling is trading with a heavier bias, straddling the $1.53 level through the London morning. The 5-day moving average is crossing above the 20-day average for the first time since mid-May, a constructive technical development and provided the $.5240 area holds, sterling can retest the $1.5400 area. 

The Reserve Bank of Australia left rates on hold as widely anticipated and the statement, little changed from last time, continues to see scope for additional rate cuts if necessary.  Separately, the Q1 current account deficit was smaller than expected at A$8.5 bln, down from A$14.7 bln in Q4 12. Tomorrow Australia reports Q1 GDP figures.  A 0.7% expansion is expected and given the stronger exports, there could be a small upside surprise (investment and inventories are expected to be drags).  The Australian dollar is the weakest of the majors today.  It has been pushed back into the upper part of last week's range (~$0.9650) after testing $0.9800 yesterday. 

The US and Canada report April trade figures today.  Canada, which before 2008-2009 would run trade surpluses has more consistently been recording trade deficits. for the last couple of years.   It is expected to have recorded a C$500 mln deficit in April after an average monthly shortfall of C$373 mln in Q1. 

In the US the Department of Commerce will be announcing annual revisions along side the April balance which is expected to be in deficit of about $41 bln, which would be slightly wider than the $38.8 bln in March.  The March shortfall was the second smallest since January 2010.  Net exports took half a percentage point off US growth in Q1.  In March US exports to recessionary Europe rose 14.4%, though were still off 8.0% year-over year.  

In addition to the Chinese yuan's appreciation, where it is trading near 19-year highs against the dollar and is the strongest Asian currency thus far this year, another factor that may be easing the US rhetoric about the yuan, is that the bilateral trade imbalance has shrunk.  The March US deficit of $17.9 bln was the smallest in three years.  Lastly, in late May, the USDA revised down its estimate for US agricultural exports this year, but continues to anticipate a nominal record.  A reduction of corn exports accounts for the lion's share of the adjustment.