Geopolitics Takes Toll, Euro and Sterling Remain Resilient

The market's response  to the Russia invasion and occupation of Crimea has wobbled the foreign exchange market and sent bonds higher and equities lower.  Gold and oil are more than 1% higher. As one would expect both the Russian and Ukrainian currencies and equity markets have sold off.   Eastern and Central European markets have also been among the hardest hit. 

The Japanese yen, and to a much less extent, the Swiss franc, are the only major currencies to have gained against the dollar.  However, the Norwegian krone, which is also backed by a large net international investment position, has suffered not just against the dollar, but the euro as well.  All things considered the euro and sterling have held up fairly well.  Recall that after Russia invaded Georgia in 2008, the euro fell four cents. 

The G7 has suspended preparations for the G8 meeting in early June that was to be hosted in Russia.  NATO has, of course condemned Russian action.  Putin has agreed to setting up a contact group and allow a fact finding mission in response to Merkel's insistence.  The main anxiety does not appear to be stemming so much from Russia's hold on to Crimea.  The fact that Russia felt compelled to use military force to secure an area that it already dominated is, arguable, a sign of weakness not strength.  Rather, the underlying concern is that are Russia's intentions for the rest of Ukraine.  De-stabilize through political subterfuge and economic pressure the government in Kiev ?  What about other concentrations of ethnic Russians in neighboring countries ?  

There has been plenty of economic news, but this seems to be overshadowed by the Russia/Ukraine story.  The main economic news is the batch of PMI readings.  China reported official readings.  The manufacturing PMI was reported at 50.2, while the final HSBC versions was 48.5  from 48.3 in the flash reading and 49.5 in January.  The official service PMI rose to 55.0 from 53.4.   The Chinese yuan stabilized today after last week's (relatively) sharp decline.  The dollar finished the local session just below CNY6.1460, having been confined to a CNY6.1439-CNY6.1569 range.   The Shanghai Composite rose almost 1%, while the small cap Shenzhen gains 1.7%.  The key 7-day repo rate eased a little more than 1% to 2.5%.  

The euro area manufacturing PMI rose to 53.2 from the 53.0 flash reading, compared with 54 in January.  That it is consolidating just below the 2 1/2 year highs should not be seen as disappointing.  However, the decline in prices paid (49.8, the lowest since last August) warns of the deflation/disinflation threat.  While Germany's preliminary 54.7 reading was tweaked up to 54.8, it is really the French report that made is truly notable.  It rose to 49.7 in the final reading, up from 48.5 in the flash and even up from the 49.3 reading in January.  

Elsewhere of note, Spain increased to 52.5 from 52.2 and is at its best level since April 2010.  The employment sub-index rose to 52.4 from 50.8 and is the highest since July 07.  On the other hand, Italy disappointed with a 52.3 reading; lower than the 52.8 consensus forecast and 53.1 in January. 

Norway and Sweden disappointed.  Norway's manufacturing PMI slipped to 51.0 from 52.8.  The consensus expected 52.5.  Sweden's fell to 54.6 from 56.4.    The market had expected a pullback to 55.0.  The euro had broken below support at NOK8.30 last week and seemed to run out of steam near NOK8.26.  Although we favor a break in the medium term, we thought last week's break was premature and not sustainable.  We anticipate near-term potential toward NOK8.35.   The Swedish krona was driven higher by the strong Q4 GDP report before the weekend (1.7% on the quarter, nearly 3-times greater than the market expected) and it is consolidating those gains today.    The euro has largely held below SEK8.87. 

The resilience of the UK economy continues with the Feb manufacturing CIPS/PMI.  It rose to 56.9 from a downwardly revised 56.6 (from 56.7) reading in January.  While new orders slipped, the employment sub-index rose to 55.4 from 54.1, which is new 3-year high.  Separately, consumer credit rose GBP0.7 bln, in line with expectations and mortgage approvals were stronger than expected (Jan 76.9k vs 74.5k consensus), which is the highest since November 2007,  and the back month was revised up (Dec to 72.8 k from 71.6k). 

Sterling and the euro are trading well within the pre-weekend ranges, though slightly heavier from the North American pre-weekend close.  For the most part, after the move in pre-Asian trading the euro has largely been confined to a 30 tick range $1.3760-$1.3790.  Sterling has been in a slightly wider range $1.6700-$1.6750.  The intra-day technical studies of both are not generating strong signals and the consolidative tone may persist, pending more developments.  

Japan's MOF reported its capex survey for Q4.  It came in at 4.0%, which is more than twice the increase in Q3 (1.5%), but still below consensus (4.9%).  It may not be sufficient to prompt revisions to the final Q4 GDP print due out early in Japan on March 10.  The dollar's low against the yen was set in late morning turnover in the Euro near JPY101.20.   It is the sixth consecutive session that the dollar has recorded lower highs.  The lows from early February were set near JPY100.75 and is the next obvious target.  Separately, we note that the Nikkei gapped lower and, although it lost almost 1.3% today, it closed near its highs.   The gap, which has been entered, but not closed, is found between the pre-weekend low 14735 and today's high 14684. 

The North American session will be dominated by geopolitical themes and another winter storm in the Northeast.  The US reports personal income and spending data for January and the core PCE deflator (expected to tick down to 1.1% from 1.2%).  The ISM manufacturing index is expected to rise to 52.0 from 51.3.  Auto sales, which typically do not move the foreign exchange market, could, nonetheless, be informative.  It has been one of the strong parts of the economy, with knock-on effects on production and inventories.  While total vehicle sales are expected to have ticked up (15.4 mln unit pace form 15.16 mln), the sales of domestic vehicle brands may have slipped.  

Separately, January construction spending is expected to have fallen.  Expectations for Q1 GDP have been shaved and although the Bloomberg consensus still shows expectations for a 2.1% pace, we suspect the real expectation is now closer to 1.5%-1.75%