Dollar is Firm but Loses Momentum Against the Yen

The capital markets are mostly quiet, amid a light news stream, and ahead of three key events in the coming days, with US markets closed tomorrow and light participation expected on Friday.  These events are tomorrow's OPEC meeting, the flash euro area inflation reading on Friday, and month-end portfolio and hedge adjustments.  

The odds of a substantial output cut from OPEC appears to have slipped. The Saudi oil minister continues to play down the need for output cuts, apparently on grounds that to stabilize the market; more than OPEC cuts are necessary.  Although there were some, suggestions that Russia could cut output to help facilitate on   OPEC cut were not seen as particularly credible.  Rosneft official was quoted on the newswires indicating Russia does not plan on reducing its output.  

Simply put, as a cartel, OPEC ostensibly is interested in keeping prices higher than they would otherwise be.  However, for numerous reasons, OPEC is not the price setter it once was.  Especially with the rise of US output, there has been a significant shift in the underlying fundamentals, and this requires a new strategy.  Essentially, prices may have to fall to levels that begin curtailing production in a significant way.  This is seen as closer to $70 for Brent and $60-$65 for WTI.  

Part of the challenge is that in industries that have high fixed costs, which in this case may be more a function of fiscal need than the cost of production, there are

 incentives to produce even at a loss. Or worse, increase production in the face of falling prices to try to preserve revenue levels.  Of course, this serves to exacerbate the problem.   

The failure of OPEC to indicate a serious cut in output will likely encourage fresh selling of oil.  This would likely support sovereign bond markets and could support equity markets, outside of energy.   It may mean little relief for high yield bond market indices for which energy sector bonds account for a significant part.  

The continued fall in oil prices won't do the ECB any favors in its battle to arrest disinflationary forces.  It will report the flash November CPI on Friday, ahead of next week's ECB meeting. Although some economists/analysts are predicting a sovereign bond purchase plan will be unveiled, we are less sanguine.  We understand recent comments as indicating that a consensus favors waiting until next year to see the second takedown of the TLTRO, which is expected to be substantially more than the first, and the covered bond and ABS purchases.   

We continue to be impressed with the legal, political and operation challenges of a sovereign bond purchase program in the EMU.   Moreover, we can't help but wonder if all this speculation of sovereign purchases distracts from 1) the existing extremely accommodative stance--negative deposit rate, full allotment of refi operations at a fixed rate just above zero, and 2) the need for structural reforms to boost growth potential and support aggregate demand.  

The main economic news today has been the second look at UK Q3 GDP.  Although the 0.7% quarter-over-quarter growth was left unchanged, the details were disappointing.  Although private consumption edged up (0.8% from 0.6%), it was government spending that really was the standout.  Despite the talk about Tory austerity, government spending rose 1.1%.  The market expected a 0.2% increase.  Business investment fell 0.7% (a 2.3% increase was expected after a 3.3% rise in Q2).  Exports fell 0.4%, while the market had expected a 0.1% decline.  Imports jumped 1.4% after having fallen 0.3% in Q2. 

Sterling looks to be tracking short-sterling futures.  The Dec  2015 contract initially ticked up to new highs, but then reversed.  This coincided with sterling falling on the news, but then recovering to back to session highs.  The key is $1.5740 on the upside.  A move through there could see a quick move toward $1.58, were sellers likely lurking. 

The dollar has lost some momentum against the yen.  Initial support is being tested near JPY117.70-80.  A break could force a bigger short squeeze in the yen and push the dollar toward JPY117.00.  Former MOF official, Sakakibara has opined that the 14% fall in the yen since mid-year has largely run its course.  This echoes comments by some current officials, like Finance Minister Aso.   Separately, we note that Sakakibara warned that the LDP will likely lose more seats in the December 14 snap-election than many anticipate.  According to newswires he has intimated that a loss of 100 or more seats could force Abe to step down.   This would indeed be a shock to investors.   

Due to the holiday tomorrow, the US economic diary is chock-full today.  The initial focus will be on the volatile durable goods orders for insight into business investment.  Personal consumption and expenditure data will be helpful for economists to firm up Q4 GDP forecasts.  Note that the core PCE deflator is expected to be unchanged at 1.5%.  

Later in the US morning, the Chicago PMI and University of Michigan consumer sentiment, and pending and new home sales will be reported.  The Chicago PMI is often correlated with the national figures while the Univ of Michigan’s measure of consumer confidence is highly correlated with the equity market.  The drop in gasoline prices and improvement in the labor market may help as well to lift the measure toward 90 in its final read.  Small improvement is expected in the housing data.   The bottom line is that the slew of data is unlikely to distract from the US-friendly divergence theme.