Consolidative Tone Persists, Dollar Mixed

The consolidative tone that has been a general feature of the foreign exchange market continues today, leaving the US dollar broadly mixed.  Even though the Fed's new Labor Market Conditions Index improved more than expected, the performance of the Fed funds and Eurodollar futures indicate little impact on expectations for the first rate hike.   This is to highlight that the main drivers of the dollar at the moment are not developments in the US but Europe and Japan.  

Speculation that Abe was going postpone the implementation of next October's planned hike int he sales tax (to 10% from 8%) and call snap elections helped lift the dollar to JPY116 yesterday.  Today, denials of the same by the Cabinet Secretary pushed the Nikkei off its new 7-year highs and the greenback away from the JPY116 level.  Initial support for the dollar is seen near JPY114.80-JPY115.00.  However, it takes a break of the JPY114.00 level to be anything significant, from a technical point of view.   For its part, the Nikkei gapped higher and drifted lower on the new.  It settled on its lows without fully closing the opening gap.  

Although some officials are trying to link the ultimate decision to next week's Q3 GDP report, we suspect that the bar is too high, and that Q3 GDP will come in around 2.0%-2.2%, not the 3.8% some officials reportedly cited.   In addition, to the snap election and delay in the sales tax increase, we continue to expect a supplemental budget (JPY3-5 trillion), and  a reduction in the tax on corporate profits by 2-3 percentage points.  The corporate tax base, however, may widen, and this may be ultimately rather neutral for corporate tax revenue on the aggregate scale. 

Sterling is very much in focus today.  The UK first released a mixed employment report that saw average weekly earnings rise more the expected.  Earnings, which are reported with an additional month lag behind the claimant count and the unemployment rate, rose on a 3-month year-over-year basis to 1.0% from 0.7%.  Excluding bonuses, average weekly earnings rose 1.3% from 0.9%.    This is the first time since March both have a 1-handle.  To be sure earnings growth is still lagging inflation, but the direction, albeit in high-frequency report, is positive. 

Other details were more mixed.  In particular, the claimant count (-20.4k) was in line with expectations, the ILO unemployment rate stayed at 6%, defying expectations for a dip to 5.9%.   Sterling reacted positively to the earnings data, but the market was reluctant, for good reason, to take sterling above yesterday's high (~$1.5945) ahead of the BOE's quarterly inflation report (QIR).  As widely expected the QIR cut the central bank's forecast for both growth and inflation, sending sterling to new session lows near $1.5875.   Support in the $1.5840-60 area may stem the tide, for the time being.

In some ways, the QIR confirmed what many investors have suspected.  Rather than come before the Federal Reserve, the first rate hike by the Bank of England is likely to come after--toward the end of next year.  For the record, the BOE cuts its growth forecasts to 2.9% for 2015 and 2.6% for 2016, down from 3.1% and 2.8% respectively from the previous report in August.  It warned that inflation may slip below 1% in the coming months, and tended to focus on the downside risks emanating from the eurozone. 

There are a few developments elsewhere to note.  First, ahead of Q3 GDP estimates the euro area reported the region’s industrial output rose 0.6% in September, just below the Bloomberg consensus for a 0.7% increase.  However, the disappointment was checked by the upward revision to the August series, showing a decline of 1.4% rather than 1.8% as initially reported.   

Second, the Reserve Bank of New Zealand dashed market speculation by indicating that it was too early to lift the mortgage rules.  This helped lift the New Zealand dollar, which is the strongest of the majors today, up about 0.8%.   

Third, oil prices are lower.  The market is becoming more skeptical about OPEC output cuts later this month (Nov 27). 

Fourth, Hong Kong indicated it would lift the CNY20k limit for daily currency limit for Hong Kong residents.  This is likely aimed at ensuring a strong start to the HK-Shanghai equity link that will be launched early next week.