Fed Tapering Ideas Trump European Data

Bolstered by recent US data and official comments, speculation that the Fed will begin tapering as early as a month from now has negated the impact of the positive surprises from Europe today, leaving the dollar with a firmer bias. 

The debate among is not so much whether the Fed tapers as is it already discounted. Noted dove and voting FOMC member Bullard speaks later today (and again tomorrow). Recall Bullard previously dissented in June due to the under-appreciated risks posed by the low inflation. He was brought back to the majority last month by an FOMC statement that seemed to give the low inflation readings greater significance.

Both the UK and the euro area provided positive surprises today. In the UK, there were two surprises. First, the minutes of the recent MPC meeting revealed that Weale dissented, preferring a shorter period of guidance. The BOE signaled that it did not expect the unemployment rate to fall below 7% until Q1 2016. Weale forward guidance of 17-24 months. Ironically, and as a reminder of how contextual such measures are, many observers see that as a hawkish stance.

The other surprise seemed more significant, but after a quick spike higher, sterling settled back to where it started from. The unemployment queue in the UK fell twice as fast as the market expected in July. That claimant count fell 29.2k and the June decline was revised to 29.4k, from 21.2k.

In addition, average weekly earnings, which are reported with an additional month lag, rose 2.1% the commonly used 3-month, year-over-year measure in June. This matches the fastest pace since late 2011 and is a marked increase from the 0.6% pace reported in March. On the other hand, the BOE's forward guidance emphasized the ILO measures of unemployment and that was unchanged at 7.8%.

In the UK employment has generally held up better than in most other high income economies. The price has been lower productivity. In contrast, the US saw greater contraction in the labor market, while productivity has fared better. Consider that the US economy is producing more goods and services than ever before (GDP above pre-crisis levels), with a couple million fewer workers.

The euro area surprised by expanding 0.3% in Q2, ending a six quarter contraction. This was slightly better than expected. Germany's 0.7% growth was, however, in line with what the Economic Ministry hinted last week, but it does make it the fastest growing economy in the G7 in Q2. Details will be released with the final report on August 23. France surprised with a 0.5% expansion, more than twice what the consensus expected. Household consumption and public spending were the biggest contributors, while investment contracted. Portugal also surprised, with a 1.0% quarter-over-quarter increase. The consensus anticipated a 0.1% expansion. The Dutch reported a 0.2% contraction, in line with expectations, but joins Spain and Italy, which had previously reported contractions (0.1% and 0.2% respectively.

The euro initially ticked higher was turned back from $1.3280 and eased back toward yesterday's lows. The euro's recent losses are coming despite the US-German 2-year interest rate differential continuing to trend in the euro's favor. This interest rate spread, which tracks the euro-dollar exchange rate has been trending down since hitting a mutli-year high in early July near 29 bp. It fell to almost 10 bp yesterday, which is the lowest since June 21. 

Meanwhile the dollar extended its advance against the Japanese yen for the third session rising to almost JPY98.45, where the 20-day moving average is found.  The dollar ran out of steam, but continues to trade in tight ranges just below the highs.    While the US-German 2-year spread has moved against the greenback, the US-Japanese 10-year spread is consolidating yesterday's gains that pushed the spread to 198 bp, new 2-year highs.  

We note that stronger than expected Q2 retail sales in New Zealand (1.7% and Q1 was revised to 0.9% from 0.5%.  This has lifted the New Zealand dollar and fanned speculation of a rate hike by March, which the OIS has fully priced in and looking for more aggressive rate hikes than seems likely over the next twelve months.  The risks of RBNZ comments aimed to pushing the New Zealand dollar lower appears to be increase.  

Lastly, we note that  emerging market stocks are edging higher.   Of particular interest are Indian shares which extended their rally for the fourth session, despite the stronger rise in wholesale prices (5.79% in July vs consensus 5.0%).  Tata Steel reported profits more than three times greater than consensus.