Sense of Relief Ahead of the Weekend

The dollar is little changed against the major currencies, with a slightly heavier tone. It is poised to finish the week in a similar manner. 

Within the trading ranges, the dollar has weakened marginally against the major currencies over the past five sessions. Sterling is the main exception and it is only fractionally low (0.13%, according to Bloomberg). 

Softer economic data has encouraged some consolidation after an impressive run-up. On the other hand, the Swedish krona, which had been punished in the aftermath of the surprise 50 bp rate cut last week, bounced back, gaining a little more than 1.1% against the US dollar, helped by stronger than expected CPI report.

Even though the foreign exchange market activity is subdued today, the real signal is one of cautious relief. In recent days, the problem of Portugal’s Banco Espirito Santo has spooked investors. It has not only led to a sharp sell-off of Portuguese bonds and stocks, but has also had knock-on effects on other peripheral markets, amid heightened concerns about new systemic risk. Several banks have pulled planned bond auctions due to the market conditions. 

We suspect this reflects investors’ anxiety over the sharp decline in peripheral European bonds yields rather than systemic risk per se.  Reports today confirm that Banco Espirito Santo has a sufficient capital buffer to cover the parent’s liability and is also protected by the ban on short sales. Portugal’s bond and stock markets are rallying today. The 10-year benchmark bond yield is off 10 bp, recouping about a quarter of the week’s yield increase. Portugal’s bourse is up a little more than 2%, near midday, which is about a fifth of the week’s decline. More generally, the Dow Jones Stoxx 600 is posting modest gains today (~0.4%), snapping a five-day decline, led by financials which are up more than twice the index. 

The UK this week has reported softer than expected industrial and manufacturing output figures, easing in some house price indices, a wider trade deficit, and today a unexpected decline in construction output. It fell by 1.1% , whereas the market, encouraged by strong PMI readings, had forecast a 0.9% increase. This sector accounts for only 6% of GDP, but it is consistent the evidence suggesting that UK pace of growth is leveling off. 

Next week’s data, which includes inflation, employment and earnings. On balance, these are unlikely to encourage expectations of a rate hike this year. That said, dissents at the BOE are expected to begin either next month or September, in favor tighter policy. 

Yet in some ways, this is similar to what happened in the US yesterday. Kansas City Fed President George said there were many signs pointing to the need for a rate hike as early as this year. This view does not represent the majority of the Federal Reserve or FOMC. This is not the message from the FOMC statement or the minutes. 

Yellen testifies before congress next week. In either prepared remarks or in the Q&A, Yellen will likely discuss three issues key issues: the end of QE, dealing with of the Fed’s portfolio, and outlook for interest rates (timing and pace). In addition, we note there seems to be some push for a more rules-based decision making process at the Federal Reserve. Even though the recent crisis required innovation, the push against ad hocery is partly a push against this innovation. While it may heatedly be discussed, not much will likely come from it. 

US 10-year bond yields are off 9 bp this week that saw the US Treasury sell $61 bln of coupons. It is interesting to note that of this amount, only $5.1 bln was new cash. The rest was to replace maturing issues. The results of yesterday’s $13 bln 30-year bond sale seems under-appreciated. It saw the most demand from indirect bidders, which include large asset managers, like foreign central banks, in more than eight years (53.2%). Although there was no concession, with the yield at the lowest in a year, the bid-cover was on the recent average (2.4x). It is one auction, but it seems to point to strong demand for duration. 

There is much discussion about a point in the FOMC minutes that suggest some interest in possibly rejigging the Fed funds rate that the Fed policy has emphasized. The thought is that it could include more transactions that just Fed funds proper, such other types of loans and Eurodollars. The FOMC minutes make it appear that this is still a work in progress, and the Fed does not seem very close to making a decision about it. 

There is no US data of consequence, though a few Fed presidents speak. Plosser is seen as a hawk. He votes on the FOMC this year. Lockhart and Evans are not voting on the FOMC this year. 

Canada reports June employment figures today. The consensus calls for a 20k increase in employment after the nearly 26k in May. However, note that in May, 29k full-time jobs were lost. Barring a repeat of this, many expect the Bank of Canada to sound a little less dovish and more neutral when it meets next week. The US dollar is back testing the shelf created last week near CAD1.0620. Although we think the US dollar is bottoming against the Canadian dollar, the technical indicators, like the RSI and MACDs do not rule of a new low first.