Dollar-Boc Slumps with Commodities, Greenback Remains Bid

The dollar-bloc currencies and the Norwegian krone were the strongest major currencies last week but are leading the downside today. The slump in commodity prices is taking a toll. WTI is off by nearly 3%. Copper is off about half as much, and gold is off about half as much as copper. More broadly, the US dollar is firm across the board.

Large euro bids had been rumored to have been stacked near $1.06. The euro got as near it as possible without going through (according to Bloomberg the low was $1.0601 in a Tokyo-less Asian session) to a new seven-month low. A somewhat better than expected flash eurozone PMI may have helped the euro recover, but it ran out of steam near $1.0650.

German industrial order and output data, amid a slowdown in China (and Russian sanctions), gave rise to some concern about the strength of the European locomotive. However, today's flash PMI reading is considerably more upbeat. The manufacturing PMI rose to 52.6 from 52.1. The Bloomberg consensus had expected a small decline. This is the best reading since August. The service PMI rose to 55.6 from 54.5. Here too the market expected a small decline. It is the highest since September 2014. The composite reading rose to 54.9 from 54.2.

France was not nearly as robust. The manufacturing PMI did tick up (50.8 from 50.6, matching expectations), but the service PMI slipped to 51.3 from 52.7. The market had not expected such a deep pullback. This forced the composite reading down to 51.3 from 52.6.

The strength of the German reading, however, lifted the eurozone readings. The eurozone composite of 54.4 (up from 53.9) represents a new cyclical high. This drives home a point we have made before. The economic data does not appear to justify the sense of urgency that Draghi and many others at the ECB have expressed. The case for more action is predicated on the ECB staff revising down its forecasts for growth and inflation.

Sterling reversed lower before the weekend and experienced follow through sales today. At the end of last week, sterling held the 50% retracement of the rally from Nov 6 (~$1.5030) to Nov 19 (~$1.5335) at around $1.5220. Today it extended the correction to nearly $1.5140, the 61.8% retracement target. A break could signal a return to the $1.50 area. There might be some positioning ahead of tomorrow's testimony by senior BOE officials (including Carney and Haldane) before the Treasury Select Committee to discuss the November inflation report.

Tokyo markets were closed for the Labor Day holiday. The dollar is consolidating even if not in quite as narrow of a range as was seen before the weekend (a little more than a quarter yen). However, last Thursday's range (~JPY122.60-JPY123.65) remains the key. We anticipate a retest of the highs.

The Australian dollar retested the pre-weekend high near $0.7250, but the pull of commodity prices proved too much. It shed nearly a cent before buyers were found. The $0.7160 low corresponds to a 50% retracement of the gains from the middle of last week. Initial resistance is seen near $0.7185 and a move back above $0.7200 signals another run at $0.7250.

The US dollar is poking through CAD1.3400 for the first time since the end of September. The multi-year high was set on September 29 just below CAD1.3460. Initial support now is seen near CAD1.3380. Oil prices are under pressure, and the US premium over Canada on two-year money continues to widen. It rose from about 3 bp in mid-October to more than 32 bp now, a fraction of a basis point from the August multi-year high.

The divergence theme that is often discussed in the context of the Fed and ECB is also evident between the US and Canada. This year, the Canadian two-year yield has fallen almost 40 bp (BOC cut rates twice earlier this year) and the US two-year has risen by nearly 28 bp.

In the US today, Markit’s preliminary manufacturing PMI (November) and existing homes sales (October) may attract some attention, but it is the Federal Reserve discount rate meeting that is the subject of speculation. Our analysis initially focused on the results of the August meeting, when a minority of regional Federal Reserve Presidents favored lifting the discount rate. In September, a majority did, but the Board of Governors refused. We suspect that an agreement to lift the discount rate will be announced when the Fed funds target is lifted. To do so before would needlessly risk 1) risk disrupting the market and 2) minimize the Fed's options next month, and 3) preempt the Fed funds hike.