Dollar Mostly Firmer, Ahead ADP and FOMC Minutes

The US dollar is enjoying a firm bias; straddling the JPY105 after having dipped below JPY104 at the start of the week and new multi-year highs against the Canadian dollar.  Despite a sharp jump in November euro zone retail sales, at least partly telegraphed by yesterday's German report, the euro remains pinned near its recent lows.   There is some speculation that some of the pressure on the euro is emanating from Asian reserve managers. 

The Nikkei rallied almost 2%, led by industrials, consumer services and health care.  There may be a kernel of truth to talk of interest in Japanese shares on pullbacks, we are struck by official efforts.  In particular, as part of the BOJ's quantitative easing efforts it buys equity ETFs and reportedly bought about JPY33.5 bln in the first two days, to bring its holdings to almost JPY2.5 trillion.    The gains today saw the Topix gain the most in almost 4-months and close at its highest level since July 2008, while the Nikkei's gains helped neutralize the recent bearish technical developments.

We expect the weakness of the yen to become increasingly a cause of concern, with push back likely as soon as the next G20 meeting.  South Korea is increasingly frustrated and the government is reportedly considering as much as KRW1.9 trillion 'risk insurance' for Korean exporters, hurt by the yen's competitive devaluation.  In addition, China may also harangue against the reliance on the weak yen.  

The Canadian dollar is the weakest of the majors so far this week, losing about 1.5% against its US counterpart.  The greenback is extending its gains above CAD1.08 today, for the first time in three years.  The bears have come out in force following a triple-whammy:  yesterday's larger than expected trade deficit and deteriorating terms of trade, a much weaker than expected IVEY survey and comments by the central bank governor acknowledging that the inflation undershoot was his most significant concern.  

The speculative community was already bearish the Canadian dollar, as reflected in a large gross short position in the CME currency futures.  At the end of last year, the gross short speculative position was 86k contracts, the largest short position after the Japanese yen.  The next immediate upside target for the US dollar is near CAD1.0850, the 2010 high.  However, we are cautious and concerned that the short-term market is over-stretched.  Near-term consolidation may offer a better opportunity to get with what we expect to be the underlying trend, than chase the market here.  

Our strategic trade recommendation for 2014 is short the Canadian dollar and long the Mexican peso.  Here too we are cautious about chasing the market.  The Canadian dollar has slid from near MXN12.40 at the end of last week to almost MXN12.01 today.  Technically, this area should offer support and a bounce to MXN12.15-20 would offer a better new entry opportunity.  

US Treasury Secretary Lew is in Germany today apparently pressing the international case (IMF, EU and US) that is critical of the German trade and current account surpluses.  Germany's external surplus is the largest in the world, as a percentage of GDP.    Today German released its  November figures.  The trade surplus edged up to 18.1 bln euros from 17.9 bln, oin the back of a 0.3% increase in exports and a 1.1% decline in imports.  The current account surplus rose to 21.6 bln euros from 18.8 bln.    In a country where "debt" and "guilt" are the same word, Lew's admonishments are likely to fall on deaf ears. 

Separately, Germany reported a 2.1% rise in November factory orders, completely offsetting the October decline and pointing to potential upside tomorrow's industrial production report.  Neither this nor the 1.4% in euro area November retail sales managed to stem the erosion of the euro.   A break of this week's low just above $1.3570 could spur a quick move toward last month's lows near $1.3525.  The risk is that some speculative euro longs are pared ahead of Draghi's press conference tomorrow, where the risk is for dovish comments in lieu of more immediate action. 

The stronger than expected service PMI yesterday failed to lend much support to the Swedish krona.  It does not seem to stand in the way of another rate cut by the Riksbank.  While officials, including the central bank governor are concerned that low rates will aggravate household indebtedness, they recognize this is something that the government not the central bank ought to address.  The key going forward may not be the real sector per se, like the industrial production and orders data due at the end of the week, but inflation.  The December CPI report is due on January 14.  In November the year-over-year rate stood at 0.1% and 0.7% at the core.  The next immediate target for the euro is in the SEK8.9160-SEK8.9260 area. 

There are two highlights for the North American session today.  First, the ADP employment estimate for private sector employment.  It seems like the ADP methodology is purposely tweaked from time to time to ensure that it does dovetail with the non-farm payroll report.  The recent performance has been uncanny.  The average increase in ADP over the past 3 and 6 months is 195k and 181k respectively.  The private sector component of the non-farm payrolls has been 193k and 180k respectively.   The ADP estimate today will steal thunder from Friday's BLS jobs report.  Barring a significant disappointment, the Federal Reserve is widely expected to taper its long-term asset purchases by another $10 bln next month.  

Second, are the FOMC minutes from the December meeting in which its decided to taper and alter its forward guidance at what is likely to prove Bernanke's last FOMC meeting.   Since Yellen's appointment was confirmed, we expect Bernanke to resign shortly.  The minutes themselves are likely to shed some light on the discussions, but keep in mind that the minutes themselves are primarily a channel of Fed communication as opposed to an official verbatim record of the proceedings.