Market Catches Breath after Yesterday's OPEC-Induced Moves

OPEC decision to roll-over existing quotas sent oil prices sharply lower, pushed European bonds and stocks higher, and generally gave the US dollar a boost.  Today's theme is more consolidative in nature.    At the same time, the dollar's firmer tone against the yen helped lift the Nikkei while European stocks and bonds are struggling to extend yesterday's advance.  

There is much data for investors to digest today, but the key takeaway is that Japan's economy continues to absorb the fiscal shock of the sales tax hike back in April, while euro area flash November CPI slipped lower.  In Japan, part of the monetary policy response has already been taken.  The data may encourage a larger fiscal response in the form of a supplemental budget.  In the euro zone,  the low inflation fans speculation that the ECB could announce a sovereign bond purchase program as early as next week (though we remain skeptical).  

Japanese data can be summarized as low inflation, weak household spending, better than expected industrial output, and relatively tight labor market.  Core October CPI slipped to 2.9% from 3.0%, but when adjusted for sales tax increase (BOJ estimates it boost CPI by two percentage points), it eased below 1.0%.  The core November measure for Tokyo also ticked down further to 2.4% from 2.5%.   The 5% decline in the yen this month is expected to help renew the upward pressure on prices. 

Overall  household spending rose 0.9% in October after a 1.5% increase in September.  It still leaves the year-over-year rate 4% lower than a year ago.  Retail sales dropped 1.4% in October, after rising 2.8% in September. Separately, Japan reported industrial production rose 0.2% in October.  The consensus had expected a 0.6% decline after September 2.9% rise.  The year-over-year rate was -1.0%.  The consensus expected -1.7%.  The unemployment rate slipped to 3.5% from 3.6% and the job-to-applicant ratio rose to 1.10 from 1.09. 

The dollar had eased to JPY117.25 yesterday, but recovered after the OPEC decision to JPY117.80, and has built on those gains today.  The greenback has approached JPY118.25, but with US 10-year Treasury yields back at 2.20% (from 2.33% on Monday), there seems to be a reluctance to push the dollar much higher now.   

After soft German and Spanish flash CPI reading yesterday, it is not so surprising that the flash euro area measure slips to 0.3% from 0.4% in October.  The core rate was unchanged at 0.7%.   The key issue is whether this is sufficient to spur the ECB into action next week.  We are not convinced it is ready to surmount the legal, political and operational hurdles associated with a sovereign bond purchases program, though speculation is running high.  European bond yields, periphery, and core fell to new record lows yesterday and are consolidating today. 

Separately, we note that there has been an uptick in German consumption, which many critics have called for by the traditional export machine.  This was evident in the Q3 GDP report earlier this week and again in today’s October retail sales report.  Retail sales jumped 1.9% in October, after a 2.8% decline in September.  The consensus had anticipated a smaller bounce-back. 

The German consumption contrasts with the French consumer strike.  Consumer spending fell 0.9% in October.  The consensus had forecast a 0.3% increase.  French consumption has fallen in three of the past four months, and the year-over-year rate has fallen to a mere 0.2%, not the 1.0% the consensus expected. 

Meanwhile, EC President Juncker, who easily survived the censure vote yesterday, has indicated that fining Italy and France for fiscal excesses would be the easy thing to do.  Instead, he intends to give both countries three more months to get their fiscal house in order.  How bold and brave.  He is asking for a detailed schedule of economic reforms.  Specifically when the government cabinets will adopt the reforms and when they will be approved by parliament, as if either Hollande or Renzi can do so confidently.   

Europe prides itself on being rule-based.  It makes rules for itself that it either ignores or modifies when it suits.  This practice cannot help but undermine the institutional credibility, and put more pressure on monetary policy to do things it is not really equipped to do.   As we have pointed out before, Merkel is often praised for being a great political tactician.  She is playing with a strong hand.  

When everything is said and done (more is said than done), France has played extremely well with a weak hand.  The economy is in poor shape, even though it expanded more than Germany in Q3.  The government is terribly unpopular.  Yet the ECB has talked the euro down and is expanding its balance sheet, like France has advocated.  It has been given more time to reach EC budget targets, and even then has taken unilateral action to delay it even further, with little cost in terms of yield or political push back. 

The euro itself is about half a cent lower than where the North American session left it on Wednesday, which was a little above $1.2500.   Without fresh impetus from North America today, where there are no US economic reports, the euro is likely to consolidate ahead of the weekend.  Canada reported Q3 GDP.  It is expected to be around 2.1%, down from 3.1% in Q2.  The drop in oil prices weighs on sentiment for the Canadian dollar.  The Bank of Canada meets next week, but is widely anticipated to be on hold.