The Dollar Comes Back Bid

After yielding ground yesterday, the US dollar comes back bid today.  The main driver is the divergence that favors the US.  Specifically, yesterday two people we have identified as part of the troika at the Federal Reserve, from where policy signals emanate,  played down the disinflationary threat of the fall in oil, saying it would likely be temporary. 

Instead both Fischer and Dudley discussed the stimulative aspects of drop in energy prices.  At the same time, Dudley explicitly reaffirmed his belief that the pricing in of a rate hike in mid-2015 is reasonable.  For his part Fischer also seemed to indicate that it was undesirable for interest rates to stay near zero for any longer than necessary.  

This stands in stark contrast to Asia and Europe.  The PBOC refrained from draining funds from the banking system today.  This served to heighten speculation that a cut in reserve requirements is likely shortly.  The ECB meets Thursday.  Following last week's lower flash CPI, the weakness in Germany's PMI (below the 50 boom/bust level), and a continued decline in market measures of inflation expectations, many expect some sort of policy response.  

The market has all but ignored Moody's downgrade of Japan that was announced yesterday.   The generic 2 and 5 year bond yields fell to record lows today.  The 10-year yields was a more volatile, but also finished lower on the day, despite the poor reception to the new 10-year bond sale.  The bond auction saw a weak bid-cover  (3:1 which is the lowest in nearly 1.5 years) and a large tail. Moody's also downgrade five Japanese banks, but the financial component of the Nikkei gained slightly, but sufficient to outperform telecoms and consumer staples.  

Prime Minister Abe cannot be happy with today's day, which underscore why the LDP is likely to lose seats at the December 14 election.  Wage growth remains miserly.  Wages, when adjusted for inflation, have been falling for 16 months through October, when they were 2.8% below year-ago levels.  Total cash earnings are up 0.5% year-over-year.   It is the third consecutive month that the pace of increase as slowed.  In July it stood at 2.4%, which marked a peak.  In September, it was 0.7%.  The consensus expected a small improvement. 

The Reserve Bank of Australia was the first of four major central banks that meet this week.  The Bank of Canada meets tomorrow, followed by the BOE and ECB on Thursday.   There are two elements of its statement that are important for investors.  First, it continued with its forward guidance for a period of stability on rates.  This is important because the market had been feeling more confident about a rate cut next year.  After today’s statement, market expectations eased, which means interest rates backed up sharply (7.5 bp in the 2-year yield and 11 bp rise in the 10-year yield.  Second, the RBA stepped up its rhetoric about the exchange rate, saying that a lower exchange rate may be necessary for the adjustment process.  

Today’s data suggests maybe the RBA is putting too much emphasis in the need for a weaker currency.  It reported today a smaller Q3 current account deficit.  It was A$12.5 bln, down from A$13.9 in Q2 and expectations for a A$13.5 bln shortfall in Q3.  In terms of Q3 GDP, which will be reported tomorrow, net exports increased to 0.8% from -0.9% in Q2.  Separately, Australia reported October building approvals rose 11.4%, more than twice the consensus forecast and offset in full the September decline.   

The Aussie initially rose just above $0.8540.  It stopped shy of last Friday’s high before reversing lower.  A break of $0.8450 would likely target $0.8400. 

The UK’s construction PMI was disappointing.  It slipped to a still strong 59.4 from 61.4 in October.  The consensus was for 61.0.  Of the three PMIs, this is the least important as it represents the smallest sector.  Tomorrow’s service PMI is the most important of the PMI reports.   It is expected to rise to 56.5 from 56.2.  Sterling is trading in the upper end of yesterday’s range.  In the second half of last week, sterling had frayed the 20-day moving average, but yesterday and today it contained the upticks.  It comes in today near $1.5745.  It has not closed above the 20-day moving average since October 28.

News from the euro area is light.  The only economic data was the October PPI report.  PPI was off 1.3% year-over-year, in line with expectations and a small improvement from September’s     -1.4% reading.    Meanwhile, Dow Jones Stoxx 600 is up 0.3% near midday in London, having trading at new two-month highs.  The energy sector is leading the way, snapping a six session losing streak to rise almost 2% today.  This benchmark has rallied 12% since the mid-October low, partly in anticipation of further easing by the ECB. 

The economic calendar for North America is light too.  October construction spending is expected to rise 0.6%, offsetting the 0.4% decline in September.  It tends not to be a market mover.  The US will also report auto sales.  Spurred by auto loans and cheaper fuel, auto sales ar expected to have risen.  It is noteworthy that the increase in vehicle sales this year has been led by light truck and SUVs.  That said, on a sales-weighted basis, the average miles per gallon of gasoline has risen from 20.8 in 2008 to 25.3 last year.  In terms of Fedspeak we note that Yellen and Fischer speak in the North American morning and Brainard (on paperwork reduction) near midday.