Sterling and Yen Slip Lower, Euro Stuck in Week's Narrow Range

The main theme this week has been the heavy tone of both sterling and the yen.  The yen's weakness stems from the aggressive easing by the BOJ and the stepped up buying of foreign assets by Japanese investors.  The story that has emerged this week is that Prime Minister Abe is expected to decide shortly after Q3 GDP is reported at the start of next week that the economy is too weak to sustain the planned hike in the sales tax next year.  Such a decision may help bolster Abe's public support, and he is expected to use to dissolve the lower house and call for snap elections that will likely be held next month.  

A postponement of the sales tax increase for around 18 months is understood by investors to be another fillip for equities.   The Nikkei advanced 3.6% this week, easily the best performer among the major markets.  That said, it is noteworthy that the US S&P 500 has outperformed the Nikkei so far this year 10.3% to 7.3%.   Nevertheless, the rise in the Nikkei is associated with a weaker yen.  The yen lost 1.5% this week, coming into the North American session, which brings the year-to-date loss to 9.5%.  The dollar is posting new multi-year highs against the yen, near JPY116.40.  A weekly close above JPY116 will likely encourage a move to JPY118 on the way to JPY120, likely to be seen before the end of the year.  

Sterling has been trending lower since peaking four months ago.  We have noted how well sterling has been tracking the shift in interest rate expectations.  This was driven home this week by the Bank of England's Quarterly Inflation Report, which warned of the risk that UK inflation falls below 1% in the next six months.  Even though the BOE's longer-term inflation outlook was largely unchanged, the market was guided into pushing out rate hike expectations into late 2015.   The implied yield of the December 2015 short-sterling futures contract has slipped 12 bp this week to below 1.00%.  

Today's slippage was encouraged by a softer than expected September construction spending report.  Economists had expected the 3.0% decline in August to have been completely offset by the rise in September.  However, the report showed September only managed to recoup about half the loss (1.8% vs. -3.0%).  Sterling has fallen to new 14-month lows today and tested the $1.5650 level. The next immediate target is $1.55.  

For its part, the euro has traded quietly this week, stuck in a little more than a one cent range ($1.2395-$1.2510).  Today's preliminary release of Q3 GDP figures have contained some minor surprises but provided little in the way of fresh trading incentives.  The eurozone economy expanded by 0.2% in Q3.  To say this was double the pace the consensus forecast does not do it justice.  Second quarter growth was revised to 0.1% from a flat report initially.   This lifted the year-over-year pace to 0.8%, where it remained in Q3.  

German and Italian GDP was in line with expectations.  The German economy grow 0.1% for a 1.0% year--over-year pace.  Italy contracted by 0.1% on the quarter and 0.4% on the year.  The Dutch economy disappointed with a 0.2% expansion, which was a step down from the 0.5% Q2 GDP. 

It was the French report that offered the best surprise.  The economy grew by 0.3%.  The consensus had forecast a 0.1% expansion.  The positive news was tempered by the downward revision to Q2 from flat to -0.1%.  Still, the year-over-year rate rose to 0.4% from flat. 

Expectations that the ECB will be taking new initiatives to combat the risk of deflation and spur lending in the regions, coupled with the Swiss gold referendum later this month has seen the euro edge toward the SNB’s floor near CHF1.20.  The SNB has reiterated its commitment to defending it. 

After a dearth of top tier data, the US finishes the week with October retail sales.   A bounce back is expected (~0.2%) after a weak September report (-0.3%).  From a GDP perspective, the most important part of the report excludes autos, gasoline and building materials.  This core measure is expected to rise 0.4% after falling by 0.2%.  Yet it is remarkable how steady this measure has been, leaving aside this apparent volatility.  The 6-, 12- and 24-month average is 0.26%-0.27%.  The other important element here is that American consumption is not being fueled by credit.  Revolving credit (credit cards) has been mostly flat this year.  The increase in household credit has been for auto and student loans. 

The US also report import prices, which will be dragged down by the slide in oil prices.  That drop in oil prices translates into falling gasoline prices, and that coupled with a rising stock market can be expected to buoy consumer sentiment.  The University of Michigan consumer confidence survey also contains inflation expectations, which appear to be holding up better than some market-based measures like the breakevens (TIPS vs. conventional Treasuries).   Today’s session also features St. Louis Fed’s Bullard speaking on the US economy, and a Fed/ECB conference in Washington that includes Fischer, Powell and Coeure.