Dollar Softens, Aussie Extends Recovery

The softer US dollar appears mostly consolidative in nature, except for the Australian dollar, where shifting interest rate expectations is prompting a short-covering rally, ahead of this weekend's election in which a change in government is expected, which could end, or at least reduce, the carbon and mining taxes. The other exception is sterling, where a strong service PMI, has pushed sterling to probe the $1.56 area and to 4-month highs against the euro. 

Australia reported Q2 GDP of 0.6%, in line with expectations and follows a 0.5% expansion in Q1.  Issues about the quality of the growth was of tertiary concern as the market takes aboard the less hawkish RBA statement and the data showing the Australian economy's resilience.  

The shift in interest rate expectations is profound.  For the first time in two years, the OIS implies a small bias toward an increase in the cash rate.  The 2-year note yield has risen 20 bp over the past six sessions to @.60%, a two-month high.   In that time, the Australian dollar has rallied about 3%.  Now through the $0.9130 resistance area, the next target is near $0.9175, but there has been interest reported in the $0.9200 and $0.9250 one-month calls.
 

The UK service PMI was impressive.  It rose to 60.5  from 60.2 in July.  This is the highest reading since at least December 2006.  It is the eighth consecutive reading above the 50 boom/bust level.  The consensus had been for some slippage.  However, given that the new orders component rose to a record 60.0 from 59.3 points to good momentum going forward.  

Today's report completes the trifecta of PMI reports and the take a way message is that the UK economy appears to have accelerated in Q3 from the 0.7% pace seen in Q2.   This in turn contributes to the general skepticism of the BOE's forward guidance and is reflecting in firmer UK interest rates and a stronger pound.  The BOE's broad trade weighted sterling index is at its highest level since mid-January and has appreciated 3.5% since the beginning of August, reinforcing the sense that financial conditions have tightened somewhat in the UK. 

The euro area service PMI was not as strong.  It slipped to 50.7 from the flash 51.0 reading, but its still well above the July reading of 48.9.  Of note, France., whose flash had shown a decline from the 48.6 July reading was revised to showed a gain to 48.9 and Spain moved above 50 (50.4 from 48.5).  However, it was Ireland's that was the most stunning at 61.6 (from 57.6) and marks a 6 year high.  Recall the manufacturing PMI released at the start of the week was at 52.0, a nine-month high.  New business and export orders were particularly strong, boding well for the coming months.  

The composite reading for the euro area slipped to 51.5 from 51.7, which, while slightly disappointing, is still the first back-to-back above-50 readings since July-August 2011 and new orders were above 50 (actually at 51.0) for the first time in two years.   The euro area confirmed Q2 GDP of 0.3% and Q3 growth looks similar), though as the disappointing July retail sales illustrates (0.1% vs consensus 0.2% and the June series marked down to -0.7% from -0.5%) domestic demand remains restrained. 

The North American session features the July US trade balance.  Recall that smaller than expected June deficit was behind part of the upward revision to Q2 GDP.  However, there is expected to be some "payback" in July in the form a larger shortfall (~$38.7 bln vs $34.2 bln).  The Fed's Beige Book will also attract attention, but ahead of Friday's employment report, tapering expectations are unlikely to change, though the period in which the report was prepared includes a sharp rise in US interest rates, including mortgage rates, in anticipation of the tapering.  

Meanwhile, US Senate is expected to vote today on tentative agreement on air strikes against Syria, apparently hammered out with the two Republican House leaders (Boehner and Cantor).    This may strengthen the US negotiating hand at the G20 meeting that begins tomorrow in St. Petersburg. 

Canada also reports its July trade figures.  It has been experiencing uninterrupted monthly trade deficits since the start of last year another small deficit is expected.  The Bank of Canada also concludes its rate meeting.  There is little doubt that rates remain on hold.  While the BOC has a modest and long-term tightening bias, interest rate spreads have moved US favor as the taping speculation outweighs Canada's stance.   We note that the previous CFTC reporting period saw a large rise in new Canadian dollar speculative shorts in the futures market.  These may be in weak hands.   A break of the CAD1.0470 area could confirm a near-term topping pattern in the US dollar, which would project to around CAD1.0370, potentially forcing some of the weak Canadian dollar shorts to cover.