Yesterday's Euro-Phoria Eases, Market Awaits ADP and Oil Supply Figures

The powerful bout of long dollar liquidation, spurred by optimism that the new Greek government had moved away from its posturing about debt forgiveness, has largely faded today. The ECB is reportedly rejecting Greece's request to be allowed to expand its T-bill offering to replace the formal assistance program that runs out at the end of the month.

The greenback is consolidating yesterday's losses as the market awaits fresh cues. Dollar bullishness has not been broken, but short-term participants are looking for fresh incentives. Doubts about the timing of the Fed's lift off crystallized around two data points. The first was the weakness in hourly earnings in the December employment. The second was the weakness in December retail sales, especially when excluding autos, gasoline, and building material.

As we anticipated, the decline in retail sales was not an accurate reflection of US consumption. The Q4 GDP report showed the biggest rise in consumption in several years. The offset to the decline in average hourly earnings needs the next jobs report, which is due Friday. Earnings are expected to rebound by 0.3% after falling 0.2%. Today's focus will is on the ADP employment estimate, service ISM, and the latest oil inventory figures.

There are four developments earlier today that are noteworthy. First, in late morning in Europe, the PBOC announced a 0.5% cut in the required reserves. The move was not totally unexpected, and liquidity conditions were tightening ahead of the Lunar New Year holiday. The PMIs confirmed the economy has weakened further. The immediate reaction was taking the Australian and New Zealand dollars higher, and many of the commodity-linked emerging market currencies caught a bid.

Second, despite a tight labor market, Japanese wage growth remains a key aspect of Abenomics that remains "missing in action." Real cash earnings fell 1.4% in December year-over-year. Separately, reports suggest that the government is poised to appoint Harada to the BOJ to replace Miyao. Harada is perceived to be a dove and sympathetic to the reflation efforts. This reinforces market ideas that the BOJ will have to expand its QQE program again if it is to reach its inflation target. Japanese government bonds have turned more volatile. The benchmark 10-year yield rose to 40 bp today, doubling since January 20 and its highest yield since mid-December. A week or so ago, roughly $1.5 trillion of JGBs had a negative yield. Now only the bill sector does.

A rise in the Nikkei (2%) and the sharp rise in US Treasury yields yesterday encouraged some dollar buying against the yen. However, it stalled at JPY118. The JPY117.20-JPY117.80 range is likely to dominate the North American session.

Third, eurozone service PMI lends support to our contention that a cyclical low is being carved out. This generalization holds for Germany and Italy while Spain's expansion remains intact. France is the odd-man out. Germany's service PMI rose to 54.0 from the 52.7 flash reading and 52.1 in December. Italy's rose to 51.2 from 49.4. The market expected 50. Spain's service PMI rose to 56.7 from 54.3. France disappointed. It slipped to 49.4 from 49.5 in the flash and 50.6 in December.

The composite PMI stands at 52.6. It is the highest since last July. Separately, eurozone retail sales rose 0.3% in December after the November series was revised to 0.7% from 0.6%. The year-over-year increase of 2.8% is the highest since 2007. Contrary to worries, the deepening of headline inflation in the euro area has not resulted in consumers deferring purchases.

From a technical perspective, we had been anticipating the euro to test the $1.1460 area. As stops were triggered yesterday, the euro pushed to $1.1535, just beyond the 20-day moving average (for the first time since December 17). The short-term technical indicators warn of the risk of an other test on the highs, despite the modest pullback in Asia and Europe.

Fourth, the UK made in three in a row--of PMIs that beat expectations. The service PMI rose to 57.3 from 55.8 in December. The consensus was for 56.3. The composite PMI stands at 56.7. Short-sterling eased, and the implied yield is at a two week high of 77 bp. Sterling marginally extended yesterday's gains to poke through the $1.5200 level briefly. A band of resistance found between $1.5220 and $1.5270 is likely to remain intact, pending the US employment data at the end of the week.