Dollar Remains Soft

The US dollar remains on its back foot, where it has been since the disappointing employment report last Friday. It has slipped against all the major currencies this week, except the Canadian dollar. It is not so much the magnitude of the dollar's decline, which has been led by a 2% appreciation of the yen and a 1.8% short-covering gain of the Australian dollar. Rather, what is striking is the extent of the dollar's previous gains that have been unwound. The euro is at seven week highs. Sterling and the yen have set new 9-10 week highs.

Sterling has held on to the bulk of yesterday's sharp gains as the market continues to digest the real meaning of the new forward guidance and the conditionality. The debate over how much is a substantive change in policy and how much is simply a different communications style will no doubt continue.

In some ways, it confirms what we have suspected: Policy rates among the high income countries will remain low for the foreseeable future. It also seems to reaffirm the sense that a new phase of monetary policy is at hand. In response to the crisis, it has evolved from traditional rate cuts to unorthodox balance sheet expansion, and outside of Japan, appears to have moved to a new phase that focuses on investor expectations. The BOE confirmed another broad development and that is that the balance sheets of the major central banks will remain inflated for a long-time.

The BOJ concluded its two-day meeting without offering fresh initiatives of altering its assessment of the economy. As we noted previously, many observers continue to expect the BOJ to take additional measures to ensure reaching the inflation target. The tone remarks by BOJ Governor Kuroda at the press conference did not seem to suggest this was an imminent as some seem to believe. 

Separately, the MOF data showed Japanese investors bought foreign bonds for the fifth consecutive week.  Foreign investors sold Japanese shares for the second consecutive week. However, the equity sales have been small and over the past two weeks totaled JPY104 bln..  Each of the previous 4 weeks saw foreign buying  more than JPY345 bln.  

However, the Asian session was punctuated by the Chinese trade figures. Stronger than expected imports and exports, though producing a smaller surplus, was seen as consistent with the stabilization of the economy seemingly reflected in the recent official PMI surveys. Imports rose 10.9% and exports rose 5.1%. The Bloomberg consensus called for a 1.0% and 2.0% increase respectively. The trade surplus narrowed to $17.8 bln from $27.2 bln.

Base effects may have exaggerated the year-over-year rise in exports, as last July exports were unusually weak. Imports did not experience the same pattern, though we note that imports from Europe rose for the second consecutive month in July. On the other hand, there were some parts of the report that raised questions. 

First, given the reports about using copper to secure funding, it is notable that copper imports rose 8%. Second, given the use of fake trade documents to hide capital flows, it is notable that China's data has imports from Taiwan rising 16.6% year-over-year, up from 6.7% in June.  Taiwan reported a 1.1% increase in July imports from China year-over-year after an 8.6% pace in June. Of course, there are various reasons why two countries trade figures are not identical (this was true for years between the US and Canada, for example). 

News that China's imports from Australia increased helped the Australian dollar extend its recovery that began with an upside reversal on Monday.  Although the Aussie was pushed back in late Asia after approaching $0.9100, we suspect the market is not done yet.   If a band of resistance that extends to $0.9120 is overcome, the next target could $0.9280-$0.9300. 

That said, the Australian jobs data again disappointed.  Full time jobs were lost for the third consecutive month.  Unlike in June, part time jobs did not blunt the impact; they too fell (3.5k).  The unemployment rate slipped to 5.7%, but this reflected a drop in the participation rate.      The Aussie's advance, we think is largely technical and we expect the position squaring adjustment, perhaps encouraged by a recognition that the RBA is not likely to cut rates in Sept, will provide a new and better opportunity to get with the underlying declining trend. 

The European data stream has been light.  There are two developments to note.  First, Spain's June industrial output fell 1.9%, a third more than the market expected and the May decline was revised to -1.5% from -1.3%.  This points to weak momentum as Q3 begins.  It warns that some signs of economic stabilization may be seasonally related, perhaps driven by the tourist sector.  

Second, Germany reported a larger than expected trade and current account surplus.  Exports edged higher (0.6%) and the May decline was shaved (-2.0% from -2.4%).  Imports fell.  The better external account figures follows the stronger than expected industrial orders and output figures earlier this week.  Some economists may tweak higher Q2 GDP estimates.  The official report is due on August 14.  The German economy likely expanded faster than the US in Q2. 

Each day this week, the euro has recorded a higher low and a higher high.  The next objective is the mid-June highs just below $1.3420.  The technical pattern that the euro appears to have broken out of earlier this week suggests potential into the $1.3460-$1.3500 area.