Dollar, Yen Firmer, Overall, Several Developments, Little Movement

The US dollar and yen are generally firm in what appears to be mostly a light bout of position squaring after a loss of downside momentum.   This is true across the board, major and emerging market currencies. 

It may be tempting to attribute the firmer dollar tone to heightened chances of tapering given the signs of a budget agreement.  However, US 10- year bond yields are essentially unchanged on the news.  Moreover, the budget still needs to be approved, and it is very likely to be modified in the process.  In any event, the deal is not that far from what many economists had anticipated and there have been reports from Washington, suggesting a budget agreement was in the works.  

Like other agreements seen in recent days, like at the WTO or on the resolution mechanism in Europe, the budget agreement is forged in compromise.  The Republicans managed avoid new taxes, though "fees" on airplane tickets will rise (as will contributions by federal workers to their pension plans).  Democrats managed to protect Medicare and Social Security.  

Overall, spending in 2014 now appears to be about $45 bln higher than previously was the case.    This does not sit well with parts of the Republican leadership.  At the same time, the agreement does not include an extension of unemployment insurance, which is set to expire Jan 1, affecting around 1.3 mln people. 

At the same time, the agreement would reduce the projected deficit by around $20 bln.  The agreement does not, though address the structural problems looming in toward the end of the decade, when the cost of the basket of goods that citizens receive consumes all of the anticipated tax revenues, before one gets into discretionary spending and security.  It is a two-year agreement, which would allow both parties to blunt the sour taste of the government closure in October. 

Meanwhile, reports indicate that the entire Senate vote on Yellen's nomination is likely to be held next week.  This may not be in time for the FOMC meeting, but it does strengthen our base scenario that Bernanke steps down early and Yellen chairs the late Jan FOMC meeting.     

The case against tapering next week remains.  The fact that a third of participants (in a Bloomberg poll after the employment data) suggests that there is risk of a market reaction.   The Fed's decision is not simply about the jobs market.  Yes, it appears to have strengthened, but there is much noise around the trend.  However, this is only one element of the policy making equation.  Inflation is low and has not moved back toward the Fed's target as it anticipated.  This does not make for a strong case for tapering.  In addition, if tapering will be replaced by forward guidance, a key issue to making it credible is allowing the new Fed, who will be there to execute, provide the forward guidance.  

European news has been limited to the confirmation of the German Nov CPI at 0.2% on the month and 1.3% year-over-year.    We recognize that Spain's 5-year yields has fallen to new multi-year lows.  Although Spain and Italy's 10-year yields are a bit lower, the bigger move it in the belly of the curve.   Over the past 3-months Italy and Spain's 5-year yields have fallen 82 and 87 bp respectively.  The 10-year yields are off 48 bp.   Separately, Letta-Alfano government is have a vote of confidence today and it is widely expected to pass.  The court ruling disallowing the current electoral law may enhance political stability by limiting the new PD leader Renzi's room to maneuver, until a new electoral rules are in place.  A French-type model seems like the early favorite.  

China continued to report November economic readings.  While retail sales (13.0% same as Oct) and industrial output (10% vs 10.3% in Oct) were in line with expectations, lending was surprisingly strong.  New yuan loans rose to CNY624.6 bln.  The Bloomberg consensus called for an increase to CNY580 bln from 506.1 bln in Oct.  However, financing jumped even more outside of the traditional banking channels.  Aggregate financing rose by CNY1.23 trillion.  The market had expected only about a CNY64 bln increase from the CNY856.4 reported in Oct.  The gap between the new yuan loans and aggregate financing is a proxy for China's shadow banking sector. 

Japan reported Oct machine orders rose 0.6% rather than 0.7% as the consensus expected, after the 2.1% decline in September.  The year-over-year rate, however, rose to an impressive 17.8% from 11.4%.  Some improved domestic demand and offshore auto-related orders were thought to be the drivers.    The dollar lost momentum against the yen yesterday and yen purchases for dollars and sterling were reported out of Tokyo.  Support for the dollar is seen in the JPY102.20-30 area.  

Lastly, we note that the Nikkei, which has been particularly interesting lately, saw intra-session selling that did not quite bring it down to Friday;s highs (above which it had gapped on Monday).  It managed to retrace more than half the loss (finished off 0.6%), above opening levels and near the session highs.