Dollar Mixed in Quiet Market

The US dollar has begun the new week in a way that reflects the recent underlying theme in terms of the price action.  It is a bit softer against the euro and sterling, while faring better against the dollar bloc and many emerging market currencies.  

There have been three main developments today, but it is difficult to say that it explains the price action.  First, Japan's Tankan survey showed increased business confidence that is also broadening in the sense of lifting sentiment at small businesses too.  However, there are two elements that detract.  Capex plans have been cut by large corporations to 4.6% from 5.1% in Q3 and expectations for improvement.  

Although we think Japan's main obstacles to stronger growth potential is not the lack of investment (indeed there are still signs of excess capacity and redundant investment) and therefore think this goal of Abenomics is misguided, the lack of big business participation seems to undermine the government's program.  In addition, the businesses' forecast for next survey show apprehension over the retail sales tax hike planned for April 1.  

Separately, we note that small businesses will increase capex (7.9% from -0.7% in September).  In terms of the yen, the large manufacturers have an average of almost JPY96.80 from JPY94.45 in Q3.  The average thus far in the fiscal year is about JPY99.10.  

Second,the preliminary HSBC's China manufacturing PMI unexpectedly fell to 50.5 from 50.8 in November.  This represents a three-month low.  A silver lining amid the disappointment is the resilience of the orders sub-index.  There was a pick-up in both new orders and export orders--the latter is at a 10-month high.  In addition, that the results are above the Q3 average, which suggests the implication for GDP may be minimal. 

Chinese stocks fell, extending their losing streak into the fifth consecutive session.  The 1.6% decline in the Shanghai Index is the largest in a month.  Auto-related names and resource companies were among the hardest hit, following new that the city of Tianjin would limit the number of car  license plates.  Meanwhile, year-end pressure in China's money markets has seen a surge in interest rates, the with pressure most acute into the turn of the year.  Recall too that starting in Jan, the IPO market will re-open after a 15-month closure.  There appears to be pent-up supply that is weighing on sentiment as well.  

Third, the euro zone flash PMI was reported and the main take away is that German strength is offsetting French weakness on the aggregate level, but that the euro area's second largest economy appears to have really escaped the recession.   The pan-EMU manufacturing PMI rose to 52.7 from 51.6 in Nov and is the best since May 2011.  This reflects the German reading of 54.2, up from  52.7.  France reported a decline to 47.1 from 48.4.  The consensus had anticipated an increase.  The service performance was less encouraging.  It slipped to 51.0 from 51.2, with both the German and French national numbers results softening.  Germany, however, remains in expansion mode at 54.0 (from 55.7), but the contraction in France deepens to 47.4 from 48.0 (and here again the consensus expected a gain). 

New orders for German are the highest since April 2011.  In France, they have declined for three consecutive months.  It manufacturing index is at a 7-month low, while the service PMI is at a 6-month low.   Investors still seem to be paying little mind to this growing divergence.  

Over the past three months, the French premium (over Germany) has narrowed 9 bp on two-year money and has widened 6 bp on 10-year borrowings.  On the other hand, the CAC has under-performed with less than a 1.4% decline (in euro terms) against a nearly 6% increase of the DAX and a 0.5% decline of the Dow Jones Stoxx 600 over the past three months. 

The coalition government in Germany is in place.  While we had anticipated Asmussen being called back to Berlin for a cabinet position, we had thought the finance ministry was the play.  However, Schaeuble has held on to the post and Asmussen will be the new Deputy Labor Minister, opening his seat on the Executive Board of the ECB.  Schaeuble loss no time to suggest the BBK's VP Lautenschlaeger could be a good candidate as her background in bank supervision. 

Turning to the US, there are several economic reports, all of which will be overshadowed by the thinner trading condition and the midweek conclusion of the FOMC meeting.  For the record, the industrial production figures and the Empire Manufacturing survey (for Dec) are the most interesting.  The Markit Flash PMI is too new of a series and the TIC data (Oct) is too old and subject to revisions to show anything but broad flow patterns to impact the market.  

We have argued that it is not the growth variables of the policy making equation that are the most problematic at the moment, but rather the disinflation that is most worrisome. Given the strong rise in Nov-Dec last year will drop out of the measurement, a further sharp decline can be expected.  

The recently announced budget agreement was also seen by many as removing another obstacle to a tapering decision this week.  However, it became clear over the weekend it is not smooth sailing.  Specifically, the current agreement, approved by the House of Representatives, will be more hotly debated in the Senate, where the civil war between the Northern and Southern Republicans is most acute.  In addition, Republican leadership has indicated that it will seek more spending concessions in exchange for raising the debt ceiling early next year.