Dollar Soft, Federal Government Still Closed

The US dollar is mostly softer, weighed down by several factors, including the closure of the government for the third day,  new six month high in China's service PMI, the highest composite euro area PMI in more than two years, and the failure of ECB's Draghi to express increased concern about either the tightening of monetary conditions (stronger euro, higher rates, less excess liquidity, continued decline in lending) or the disinflationary pressures.  

While European bourses are mixed,  the MSCI Asia-Pacific Index was up 0.4%, while the near-midday in London, the MSCI Emerging Market index is up 1%.  Indian shares are leading with the biggest rise in 2 week (~2%), encouraged apparently by the recovery of the rupee (best level nearly 3 weeks).   Moody's upgraded its rating for the Philippines to investment grade, matching previous moves by the other two main rating agencies, but is unlike them, has a positive outlook too.  Japan was the main exception in Asia, though losses were minor (~0.1%).  We note that the dollar traded at five week lows yesterday against the yen.  It remains within yesterday's range today.  

Draghi's misquote yesterday is very instructive of the differences between Europe and the US.  The ECB President was trying to explain himself and he said that "As they say in America, there is only one way to skin a cat."  Of course, what Americans really say is that there are many ways to skin a cat.  This is meant to imply a certain flexibility in means for a desired end.  It is pragmatic and lends itself to innovation.  Draghi's turn of the phrase illustrates the more rules-based approach that European leaders pride themselves on.  

The Federal Reserve has three mandates:  financial stability, price stability and full employment.  The ECB has one:  price stability.  Draghi admitted that because it is the only goal, inflation needs a low target, and refused to be pulled questions about risks posed to what Draghi called the weak, uneven and fragile recovery of the tightening of monetary conditions and the sharp fall in price pressures.  

Meanwhile, Italian assets continue to outperform following the survival of the Letta government.  Berlusconi's volte face shows at one and the same time a political savvy and his vulnerabilities.  What has yet to be determined, it seems is if the breakaway faction of the PdL does indeed form its own party.  Recall that tomorrow the Senate panel resumes deliberations on whether to enforce the court-ruled ban on office for convicted felons.  Meanwhile, on Oct 15, Berlusconi is due to begin servicing his one-year term, most likely under house arrest. 

Letta's survival of the vote of confidence in the Senate yesterday was a function of a split in the center-right.  Ironically, Letta may find that the split in his own party is ultimately more dangerous.  The center-left face a leadership contest in early December.    Nevertheless,  Prime Minister Letta is having a good week indeed.  Today's service sector PMI rose above the 50 boom/bust level for the first time in more than two years.  The 52.7 reading in September compares with 48.8 in August and expectations for 49.1.  

In turns out that rather than repatriate funds into the fiscal half year end, Japanese investors bought foreign bonds last week, for the third consecutive week.  During the streak they have bought JPY1.7 trillion (~$17 bln) of foreign bonds.   They bought foreign equities for the fourth consecutive week (for a total of ~$9 bln). For their part, foreign investors continued to buy Japanese shares.  During the four-week buying spree, they have bought about $8.5 bln worth of shares, though more than three-quarters may have been offset by flows out of Japanese bonds.    

The rise in China's service PMI (55.4.from 53.9) helps blunt the impact of the soft manufacturing PMI earlier this week and new orders also increased.  Chinese markets remain closed for the national holiday.  Separately, we note that yesterday Australia (Bureau of Resources and Energy Economics) raised its price estimate for iron ore this year and next and cited stronger Chinese demand.  This year's price forecast was raised to $121 a metric ton  form $117 in June, while next year's average price was lifted to $119 from $112.  Its forecast for Chinese demand was raised by 8.3%.  

Euro area service PMI edged to 52.2 from 52.1.   Expected strength was seen in France and Italy, as noted above.  German came in a touch weaker than the flash and Spain slipped back below 50 to  49.4.   The euro had made session highs in early Asia near $1.3625.  

The UK service PMI eased to 60.3 from 60.5, but above the 60.0 consensus on Thomson Reuters.  Sterling traded higher in response, gaining about a third of a cent.  It remains inside yesterday's ranges, but the consolidative pattern looks bullish and buying on pullbacks continues to materialize.  The euro extended yesterday's recover against sterling and tested the GBP0.8400 level today where it appears to have run into new offers.  This area corresponds to a 50% retracement of the losses since Sept 23.  Look for another test on the highs and potentially a move to marginally new highs, but we look for sterling to begin to outperform again. 

The US data calendar features non-federal government reports, including weekly jobless claims, and the ISM non-manufacturing ISM.  The information investors want, which is when will the government re-open.  The longer it is closed of course the more it hurts the economy, let alone the hardships it causes for many households.  Remember that it is the federal government not a private sector business, that hires the most low wage workers. 

What many are worried about too is the looming debt ceiling.  The government shutdown is embarrassing and disruptive on many levels.  The debt ceiling brings the possibility of default, which could inflict longer-lasting pain.   We still think the most likely outcome will be a group of Republicans in the House, with an eye past the primaries where they may face opposition from the Tea Party wing, and toward the 2014 elections, join forces with the Democrats to pass a clean bill that will pass the Senate.  At the same time, to repair what they will recognize as the damage, they may also reach an agreement on the debt ceiling.  Ironically, the more damage that the leadership perceives is being inflicted the greater the chances of a larger deal.