EZ PMI Lifts Euro, Soft CPI Kicks Aussie

There are two important drivers in the foreign exchange market today.

First the euro area flash PMI was stronger than expected, and this helped lift the euro about half a cent and further cement its recovery from the dip to seven day lows yesterday. We did not think May was a particularly likely time frame for a new ECB initiative for several reasons, including awaiting for a cleaner inflation read after the Easter distortions and new staff forecasts. Today’s report strengthens this conviction.

The EMU composite PMI rose to 54.0 from 53.1. This is the best since May 2011. The market had expected a small decline. And indeed, a small decline there might have been but for the strength of the German readings. Its manufacturing survey rose to 54.2 from 53.8, twice the gain the market expected. The service sector was even more stronger, rising to 55.0 from 54.0. Here the market had expected a small decline. The strength of the service sector can be understood as a reflection of the domestic economy and, therefore, is particularly encouraging.

France, however, remains the laggard. Its manufacturing PMI slipped to 50.9 from 51.9,and the service sector PMI fell to 50.3 from 51.4. Before the report, some economists had expected France to fare better than Germany, thinking that the recovery was finally gaining traction, and other surveys warned of the risk of softer German data.

Later today France is expected to unveil its 2014-2017 fiscal program. It has already been reported that it will project a 3.8% budget deficit this year, up from 3.6% and 3% in 2015 from 2.8%. The government will estimate 1% rise in GDP this year followed by 2.25% for the next two years. These seem somewhat optimistic, and optimistic growth forecasts translate into disappointing expectations and higher deficits.

The second important development is softer than expected Australian CPI data that stole the wind from the bulls’ sails. The market, including ourselves, we caught leaning the other way. The price action yesterday suggested the year’s uptrend was resuming.

Instead, the Aussie has reversed lower is trading well below its 20-day moving average for the first time in a month. Further losing are likely as the short-term speculators, who in the futures market had gotten net long earlier this month for the first time in a year, will get out of longs and likely re-establish shorts. Initial targets are near $0.9155 and perhaps toward $0.9000 over the slightly longer term.

Headline CPI rose 0.6% in Q1 for a 2.9% year-over-year rate. The market had expected a 0.8% quarterly increase and a 3.2% year-over-year rate. The more policy significant measures, the trimmed and weighted mean were also 0.2-0.3% lower than expected. The price of tradable goods rose 0.4% in the quarter, down from 0.7%. This likely reflects the appreciation of the Australian dollar over the quarter. Prices in the non-tradable sector rose 0.7%, slightly less than the previous quarter.

In addition to the euro area PMI, that reflects German strength, and the Australian CPI, which suggest rate hike speculation is well premature, there are a few other developments that are noteworthy.

HSBC’s flash manufacturing PMI for China was spot on expectations at 48.3, up from 48.0. The details were somewhat less encouraging. The export orders’ component slipped 2 index points,and the employment component fell almost 1 point. There was a rise in new domestic orders (1.2 points), but at 47.7,it continues to contract. This news weighed on stocks and the yuan. The dollar rose to almost CNY6.25 a new two year high.

Minutes from the BOE meeting earlier this month showed an active debate about the extent of slack in the labor market and how long inflation can be expected to stay low. Although there may have been a tendency among the early press coverage to have a hawkish spin, the implied yields on the short sterling futures strip are all lower. Starting with next June’s contract, yields are 3-4 bp lower. Separately, the monthly public finance reports (budget) were better than expected, and there is still some speculation that will be scope for some electioneering.

In Europe, we note that although Italian 10-year bond yields are at their lowest level since 1993, and premium over Germany is nearing 100 bp, and Spain yields continue to edge lower, and a move below the 3% threshold is likely before the weekend, Portugal is quickly moving to catch up. In the past month, Portugal’s 10-year yield has plunged 62 bp, roughly double the decline seen in Spain and Italy. When spreads and yields were at these levels previously, officials were warning that the markets were mispricing risk. Debt levels are higher now.

The North American session features the Markit PMI flash manufacturing report and new home sales. Both are expected to have improved. Estimates of US oil inventories may draw more attention than usual. US inventories are rising and are at their highest since last June. Output last month was 8.3 mln barrels a day, which is the most since April 1988. Canada reports February retail sales. The consensus calls for a 0.5% increase on both the headline and excluding auto measures. The data is unlikely to lend much support to the Canadian dollar, which is at new 3-week lows today. The initial target is near CAD1.1070 and then CAD1.1120.