Month-end Consolidation Featured Ahead of Next Week's Key Events

The US dollar is consolidating, largely within yesterday's ranges.  Month-end and quarter-end hedge and portfolio adjustments are notoriously difficult to predict.  There is also large option expires today.  Given the EU Summit this weekend, a holiday in the US on Monday, and no fewer than five central bank meetings among the high-income countries next week, the broad consolidative, even in choppy, tone is likely to carry into the weekend.  

There are four new pieces of macro-economic puzzle that have been delivered today.   First, With the ECB being the most likely central bank to ease policy next week, and given the market's focus, the euro area data are the most important.   The preliminary August CPI was reported in line with expectations.  It rose 0.3% year-over-year, down from 0.4% in July.  The decline in the headline rate was largely a function of energy prices.  The core rate unexpectedly ticked up to 0.9% from 0.8%.   This is the highest since April. 

The euro recorded session highs in response, just shy of $1.32, around where there is around $1.5 bln option expiry today.  Although, the speculative market positioning is extended, participants continue to sell into even the most modest of euro upticks.  

Second, a key development in recent weeks has been the accumulation of evidence that the German economic engine has sputtered.   The economy contracted in Q2 (-0.2%), and survey data has generally disappointed.  Real data for Q3 has been minimal, but today Germany reported retail sales for July.  It was sorely disappointing.  Retail sales plunged 1.4% on a calendar and seasonally adjusted basis. This is the largest drop since January 2012.   The Dow Jones survey found a consensus for a flat report.  Adding insult to injury, the June increase of 1.3% was revised to 1.0%.  

It would be easy to simply blame geopolitics for this poor result and the derailing of the German economy.  However, the risk is that something more is happening.  German exports to Russia are no more than 1% of German GDP.  While geopolitics, of course, are a headwind, the more important German economic challenges are internal.  Interest rates are low, and the decline in the euro is also stimulative, but fiscal policy is arguably a larger drag on Germany than is Russia.   

It is fine for German officials to argue against French and Italian calls for changes in the Stability and Growth Pact on grounds that there is already flexibility built into the treaty.  However, Germany itself is reluctant to take advantage of that flexibility itself.  Although observers tended to focus on Draghi's comments at Jackson Hole about the progress on the ABS purchase scheme, more of his talk was encouraging countries to use that fiscal flexibility.    Draghi did not go as far as German Finance Minister Schaeuble, who said that the ECB's monetary tools to revive the region's economy have been exhausted, but he did make it clear that fiscal policy needed to compliment the monetary efforts. 

Third, UK's Nationwide reported a 0.8% rise in its August house price index.  The Bloomberg consensus was for a 0.1% increase.  The year-over-year rate rose to 11% from 10.2%.  This helped underpin sterling, and may help it snap a 7-week losing streak.  It finished the North American session last week near $1.6572, according to Bloomberg.   

The consensus continues to expect the BOE to hike rates before the Federal Reserve next year, but sterling had fallen out of favor, amid conflicting forward guidance signals and the general rebound in the US dollar. In addition, the UK economic momentum has slowed a bit, and this is expected to be evident in the next batch of PMI reports next week.   The Scottish referendum is drawing close, and although most do not expect the result to favor independence, it is, for many, a close call, with significant consequences possible.  

 Fourth, Japanese data was disappointing.  While the focus has been on inflation while the BOJ continues to buy the equivalent of $70 bln a month in securities, the real sector  has continued to struggle since the retail sales tax was hiked on April 1.  We had argued that Japanese officials seemed reluctantly to recognize that the May-June quarter was a lost cause, but had been cheering a recovery in Q3.  Today's data raises doubts about that, though the typhoons and poor weather may have exaggerated the weakness with today's reports.  

Household spending fell 5.9% year-over-year in July.  It had declined 3.0% in June.  The market had forecast a small uptick, meaning that the actual report was more than twice as weak as had been expected.   Industrial production did tick up, but the 0.2% increase was fell far shy of the 1% that was forecast, and pales compared with the 3.4% decline in June.  The producers expected a rebound in August and September (1.3% and 3.5% respectively, but have been over-optimistic in recent months). 

Separately, Japan reported inflation measures for July in line with expectations.  This meant an unchanged core rate (which excludes fresh food) of 3.3%.  When stripped of the tax increase, the core CPI, which the BOJ is targeting stood at 1.3%.  The Tokyo CPI, which is reported with a smaller lag, saw a slight dip in the core rate to 2.7% in August from 2.8% in July.  Japan also reported that unemployment rose to 3.8% in July from 3.7% in June, though the job-to-applicant ratio rose to a 22-year high.  

Meanwhile, the geopolitical situation in Ukraine remains very fluid.  Many investors seem bemused by the various words officials are using for Russian action:  incursion and intervention, with an effort to shy away from invasion.  Diplomacy is all about nuances.  A new round of sanctions seem increasingly likely, and some countries, especially the Baltics, want NATO to provide military assistance to Ukraine. NATO meets next week.  The uncertainty over possible weekend developments, however, could help deter the month-end bounce in the euro that many observers have called for.  

The North American session features US personal income and consumption data, which may be soft.  This, we suspect, reflects the shifting composition of growth rather than a signal of slower growth.  The Atlanta Fed's now-cast (as opposed to forecast) has the US economy tracking about 3.2% growth here in Q3.  The core PCE deflator is expected to be unchanged at 1.5%. Separately, the Chicago PMI will be reported, and a strong reading is expected (56.5 s 52..6).   

Canada reports Q2 GDP, and it is expected to have accelerated to 2.7% from 1.2% in Q1.  The Canadian dollar is the best performer among the G10 currencies this week, rising about 0.8% against the greenback.  The US dollar had fallen to CAD1.0830 at midweek, and has been consolidating since then.  A push through there is possibly if the data does not disappoint. 

Today is another big day ahead for Brazil.  It too will report Q2 GDP which, of course, matters for both economics and politics. Markets are expecting a sharp drop to -0.4% on the quarter and -0.6% year-over-year. This would represent the first negative year-over-year print since late-2009. The markets will also eagerly await the latest electoral poll we get another electoral poll (Datafolha). The other two polls this week showed that Marina Silva would beat President Dilma in the second round.