Global Markets Calmer Ahead of the Weekend

After a difficult week, emerging markets appear to be stabilizing ahead of the weekend, with the MSCI Emerging Market equity index up about 0.65%. Most emerging Asian currencies, with the notable exception of the Indonesia's rupiah, are trading firmer. The stepped up efforts by officials, like the bond buying in India and Brazil's $60 bln intervention program, appear to deterring new selling, at least for the moment.

Against the majors, the US dollar is narrowly mixed, largely confined to yesterday's ranges. Of note, the Canadian and New Zealand dollars, along with the yen, are independently weak, trading below yesterday's lows. We suspect that market participants will be content to go into the weekend, (a extra long one for the UK, which has a bank holiday on Monday) near current levels.

The key issue remains the timing and pace of the Fed's tapering, for which the recent FOMC minutes showed broad support for schedule of reducing purchases toward the end of the year, with an eye toward ending purchases by the middle of next year. A Fed survey of primary dealers, reported yesterday showed the median expectations for a September announcement and the first tapering to be $15 bln ($10 bln less of Treasury purchases and $5 bln less MBS purchases).

 The next tapering move is expected in December and another $15 bln ($5 bln fewer Treasuries and $10 bln fewer MBS). This would mean that at the start of the 2014, the Federal Reserve will be buying $50 bln a month in long term assets, which, incidentally, is still larger than when QE3+ was initially announced a year ago (before being increased at the end of the year as Operation Twist's purchases were rolled into QE).

On the week, the US 10-year yield is little changed at 2.88%. Core and periphery European yields were up more with Germany's 10-year yield rising about 6 bp this week and Italy and Spain increased about 5 bp. The UK gilts were a touch firmer and the 10-year yield slipped a couple of basis points. Ten-year JGB yields are essentially unchanged on the week.

The news stream is light. The UK and Germany offered revisions to the preliminary Q2 GDP estimates. The string of favorable news from the UK continued as Q2 GDP was revised to 0.7% from 0.6%, following a 0.3% expansion in Q1. ONS cited net trade as a contributor, though all sectors contributed: industrial output rose 0.6% (the largest increase since Q4 2010), with manufacturing up 0.7%; services rose 0.6% and construction increased 1.6%. The more recent data suggests the UK economy enjoys good momentum into the first part of Q3.

Of note, and this is born out with the German data as well, the recovery has been helped by government spending. In the UK government spending rose 0.9% in Q2, up from 0.1% in Q1. In Germany, government spending rose 0.6% after a revised 0.1% rise in Q1 (initially it was reported to have contracted by 0.1%). For the record, German GDP was unrevised at 0.7%. This is the same pace as the UK. Given that the UK economy expanded faster than Germany in Q1, this means that in H1, the UK economy grew faster than Germany.

With the Federal Reserve having prepared the market for less QE, and the implication from the reflation in Europe, that rate cuts are over, it leaves Japan with both feet still on the monetary accelerator and suspicion that it may have to do more to achieve its 2% inflation target. The dollar briefly poked through the JPY99 level and has subsequently consolidated just below. The dollar has not traded above JPY100 for a month (July 25). Participants are watching the trend line drawn off the May and July highs and intersects today near JPY99.60. Support is seen near JPY98.50.

While the euro appears to have put in a short-term base near $1.3300, the $1.3380 area is preventing a return to above $1.34, where is was at mid-week. Sterling is a bit firmer and is trading above $1.56. The break of that yesterday has not seen follow through selling, though yesterday's highs near $1.5665 seem too far to be seriously challenged ahead of the weekend.

The dollar bloc is finishing the week poorly. The Aussie is straddling the $0.9000 area, after having begun the week above $0.9200. A move now above $0.9030-50 is needed to take some downside pressure off. 

 For its part, the Canadian dollar is among the poorest performers of the majors this week (after New Zealand and Norway) losing about 2.1% against the greenback. The disappointing retail sales report yesterday was only the latest in a string of disappointing data (which includes the sub-50 reading on the IVEY, poor employment data, unexpected large net portfolio capital outflows). The US dollar appears poised to test the year's high just above CAD1.06 and last year's high near CAD1.0660.