Dollar Mostly Firmer, but Euro Recovers, Yuan Tumbles

The US dollar is firmer to start the week against most of the major currencies.  The euro zone reported less deflation than expected, and Germany and Italy reported better manufacturing PMIs.  This helped the euro recover from the initial slide in Asia that had taken it down to $1.1160.   Disappointing capex figures from Japan coupled with US 10-year yields firming back above 2.0%, helped lift the dollar toward JPY120, but offers there capped a stronger advance.  Modest corrective pressure against the euro appeared to limit sterling's reaction to the stronger than expected manufacturing PMI.  It has been largely limited to Friday's trading range against the dollar.  

The Chinese rate cut over the weekend helped lift dollar against the yuan to around CNY6.2780, its highest level since 2012.  It did not have a positive knock-on effect on the dollar-bloc currencies or emerging market currencies, though it helped lift small cap stocks in China (Shenzhen Composite gained 2% while the Shanghai Composite rose 0.8%).  

Japan's Q4 capex rose 2.8%, while the consensus was for a 4.0% increase after 5.5% in Q3.  Profits rose 11.6% after a 7.6% gain in Q3, on the back of a 2.4% increase in sales (2.9% in Q3).    Due to a a somewhat firmer than expected build in inventories (0.4%), there is risk that fourth quarter growth of 2.2% is revised up

At the end of last week, Germany, Italy and Spain reported less deflation or, in the former two cases, inflation instead of deflation,  This was translated into a flash eurozone February CPI reading of a -0.33% from -0.61%.  The core rate firmed to 0.62% from 0.57%.   Unemployment fell to 11.2% in January from 11.3% in December (which was revised from 11.4%) 

The eurozone manufacturing PMI was in line with the flash reading of 51.0.  However, the country breakdown was mixed.  Germany stands at 51.1 from the 50.9 preliminary reading, but France ticked down to 47.6 from 47.7.  Spain slipped to 54.2 from 54.7.  The consensus had expected a 55.1 reading.  Italy offered a pleasant surprise, with a 51.9 reading up from 49.9 in January.  

Broadly speaking the eurozone data is consistent with the the modest cyclical recovery that appeared to have begun at the end of last year.  Italy is participating, but France remains the apparent laggard.  The improvement extends from money supply and credit improvement, through a moderate improvement in the real sector reports.   The positive growth impulses have positive impact on balance sheets and confidence.  

The combination of better growth and lower interest rates should help produce smaller deficits. However, it does not deter the ECB from launching its bond buying program later this month.  The ECB staff is expected to raise is GDP forecasts later this week at the same time that it may shave its inflation forecasts.  

At the same time, the better growth prospects in Europe and Japan, and new action by the PBOC may help reduce the international headwinds on the US economy, which Yellen argued last week were largely balanced.  We note that Q4 GDP was not revised down as much as economists had feared, and wages and salaries were revised higher in Q3 and Q4.   Continued improvement in the US labor market is the key the outlook for Fed policy, as officials continue to expect inflation to rise (after near-term weakness) toward the 2% objective.  

The US reports personal income and consumption data for January.  Income is expected to have risen more than consumption.  This would lend credence to ideas that after stepping up consumption in Q4 (4.2%), that American households boosted savings at the start of the new year.  The core PCE deflation, which is the policy target is expected to be unchanged at 1.3%.  Separately, the US manufacturing ISM is expected to continue ease (53.0 in February from 53.5 in January).  The manufacturing activity has moderated since 57.9 in October.  

The UK reports three PMIs this week.  Today's manufacturing PMI rose to 54.1 from 53.1.  It is the highest since last July. The construction PMI is to be released tomorrow, but it is the service sector PMI on Wednesday that reflects the largest sector.  While the soft patch hit in H2 14 appears to have ended, the decline in M4 today (-2.2% year-over-year) keeps the downtrend since the end of 2013 intact.  This may become a greater cause of concern if it does not improve in the coming months.  It may signal softness in retail sales. 

Lastly, we note that the JPY120 level houses a large option expiry today ($1.5 bln). Above JPY120, is the JPY120.50 high neared in mid-February.  Initial support looks to be around JPY119.30.  The euro can move into the $1.1250-75 band before the bears try to make another stand. Sterling looks constructive, though it is lower on the day as North American dealers take to their desks.  Initial support is pegged near $1.5410.  The session high is near $1.5450.  Canada is faring the best of the dollar-bloc, with CAD being the only one that is higher.  The Scandis are seeing recent gains pared in response to their disappointing PMIs.