Strong European Data Weighs on Dollar

There is one story today. It is stronger European service sector PMIs. This has pushed lower in the US dollar against all the major currencies and most of the actively traded emerging market currencies.

Sterling is trading at new multi-year highs to edge closer to the psychologically important $1.70 level, while the euro has moved within spitting distance of the year's high set just above $1.3965. The Dollar Index is at new lows for the year.

Growth in Europe appears to be accelerating into early Q2 despite the ongoing fears that the sanctions on Russia and the fallout from the Ukrainian conflict will sap the fragile recoveries. That is still to be seen. The composite PMI reading for the euro area stands at 55.1, which is the highest since May 2011, and is consistent with our warning of risks that the ECB staff forecasts next month revise high its GDP forecasts.

Indeed, it is the stronger growth performance in the face of lowflation that can act as a prophylactic against unorthodox action like asset purchases or a negative deposit rate by the ECB. Moreover, while Germany is still the undisputed locomotive, the real news today lies with the robust reports from Italy and Spain.

Italy's service PMI rose to 51.1 from 49.5. The consensus expected 50.4. The forward-looking new business component rose to 51.5 from 51.0. Spain' was even more impressive at 56.5 from 54.0. This is a seven year high. Separately, Spain also reported a decline in unemployment (111.6k) which was twice as large as the market expected And rather than sell-off, the both the Italian and Spanish bond markets have rallied on the new. Spain's 10-year yield is pushing further through the 3% threshold, and Italy is just above there.

France continues to be a laggard. The French service PMI edges higher to 50.4 from the flash reading of 50.3; the real comparison is with the March reading of 51.5. Separately, investors will take on-board the French government's push against GE's bid for Alstom and the Economics Minister called for a change in monetary policy to weaken the euro, which elicited a Bundesbank response.

We note that the ECB's 7-day refinancing operation generated a net drain of 43.5 bln euros. Recall that through this facility, last week injected 60 bln euros. The results of the operation to sterilize the SMP purchases is still awaited. The dramatic decline in EONIA from the month end surge shows money market conditions have eased.

The UK reported a strong service report. The PMI rose to 58.7 from 57.6. The consensus was for little changed. Notably employment jumped to 56.0 from 53.5. There is an ongoing debate over the extent of the spare capacity in the UK economy. News that output prices increased from the 11th consecutive month (input costs fell to the lowest level in a year) supports ideas that it is quickly exhausted, especially as many companies attributed higher operating costs to higher wages.

The March 15 short sterling futures contract implied yield of 1% is the highest since mid-February and warns that investors may begin to fear an earlier rate hike. The Bank of England's Quarterly Inflation Report is due next week(May 14) and there is a risk of more hawkish commentary in the run-up to it. The UK's 10-year yield premium in the G7 is increasing.

The Reserve Bank of Australia left rates on hold as widely anticipated and the tenor of the push against the strength of the Australian dollar remained the same. The currency remains firm, near the recent highs, above $0.9300. Nearby resistance is pegged near $0.9325-35. Australia reports retail sales first in early Sydney on Wednesday. The Bloomberg consensus is for a 0.4% increase after a 0.2% rise in February.

Japan's markets were closed yesterday as well as today and re-open tomorrow. Activity remains quiet, and the dollar remains within yesterday's trading ranges against the yen. It is once again straddling the JPY102 area. The market may be reluctant to push it too far away ahead of the return of the Japanese market.

The US and Canada report March trade balance figures today. The data will be a factor in economists' forecasts of Q1 GDP revisions, but is unlikely to matter much to the market that is focusing on Q2 and beyond. Canada may report its second consecutive monthly trade surplus, a feat that has not been since late 2011. The IVEY index is expected to soften a bit from the 55.2 reading in March (when expectations were for a 59.0 reading). The Bloomberg consensus forecasts a 54.5, which would be the lowest of the year, so far.