Consolidation Continues into the Weekend

After large swings in the second half of last week, a generally consolidative tone emerged this week in the foreign market and continues now. The dollar fell against all the major currencies this week except the Japanese yen, against which it rose about 1%. The Scandis and antipodeans were the best performers, gaining 1.2-2.0% against the greenback this week; giving a sense risk-on.

Equities have been where the action is today. Following disappointing earnings from Google and Microsoft, the Asian equities were mostly lower, with the MSCI Asia Pacific Index off about 0.5%. The Nikkei itself snapped a five day advance and was down over 500 points at one. It managed to recover a bit, but still lost 1.5%, ahead of the weekend election. Still, a drop of a similar magnitude by the Shanghai Composite assured it to secure its place as the worst performing Asian bourse this week with a 2.3% decline (year-to-date -12.2%). European bourses are down as well, but losses are roughly half of what Japan and China experienced. However, technology is leading the downside.

Bond markets are narrowly mixed, though optimism that Portuguese political parties can reach an agreement this weekend is helping its bonds outperform. We note that the center-lefts indication in Italy that it will support the center-right Interior Minister on today's censure motion eases political anxiety and Italian bonds and stocks are outperforming today.  Net-net, US 10-year yields are off about 6 bp this week. It looks to be carving out a new range of 2.45%-2.75%.

Outside of Canada's CPI, the North American session has no main features and a quiet roll into the weekend is likely.  That said, there is a G20 finance ministers and central bankers gathering underway and could be a source of headline risk.   We suspect that US and Japanese policies will continue to draw support, while Europe could be subject to calls to do more ensure an economic recovery.  

The weekend also sees the Japanese elections.  There seems to be little doubt that the period of a divided Diet is over and that the LDP-led coalition will take control of the upper chamber through a solid majority.  While additional structural reforms under Abenomics will likely trickle out, the real contentious economic issue is the retail sales tax.  If the Abe government is successful in putting the economy on a sustainable growth track, then implementing the retail sales tax next April is likely.  

Over the last couple of weeks that have been a notable shift in the investment patterns of Japanese investors.  Last week was the second week in a row than Japanese investors bought foreign bonds.  Last week they bought JPY1.10 trillion, the most since last September, and this follows purchases of JPY974 bln the prior week.  Japanese investors also seem to have stepped up purchases of their own equity market, though foreign investors continued to buy as well (JPY398 bln). 

Two developments in Europe are worth noting.  First, Italy surprised by reporting its third consecutive increase in industrial orders.  The 3.2% month-over-month  increase in May follows an upward revision to the April series from 0.6% to 0.8%.    It is particularly revealing that foreign orders rose 9.4%, while domestic orders fell 7.9%.  The data shows the compression of domestic demand, while the foreign orders speak to exports.  

This is a theme throughout much of southern Europe.  There has been significant improvement in the external balances, which in turn is reflected in smaller Target2 imbalances.  It is not just a recession sapping the demand for imports, but it is also better exports.  

Second, on the same theme, Greece reported a 360 mln euro current account surplus in May.  This compares with a 1.23 bln euro deficit May 2012.  Separately, there was a 1 bln euro increase in deposits in June.   Yesterday German Finance Minister Schaeuble reiterated the carrot that is out there for Greece implementing the agreement and that is more debt relief.  It can take numerous forms, such a lengthening the duration of official loans.  The whole issue of an official sector haircut (OSI) seems like a taboo topic ahead of the German election (though it's not clear that the attitude will change afterwards).. 

Moody's decision late yesterday to lift the outlook for the US rating to stable from negative has little impact.  Given the rating agencies lack of private information, that decision is in effect mean one group of economists are somewhat less pessimistic about the US fiscal outlook.  Dog bits man.   News that Detroit became the largest municipal bankruptcy has been anticipated and is also having little impact on markets, leaving aside the city and state's bond markets.