Dollar is on the Defensive, though Yields Rise

The US dollar is trading heavily against most of the major currencies, but the general tone appears consolidative in nature.  Despite a disappointing UK manufacturing PMI (53.4, a four-month low), sterling is near a three-week high above $1.2600. 

The consolidative tone for the dollar that began last week continues.  It has been unable to make much headway this week, except against the yen, despite stronger data and higher yields.  Sterling is leading the move with nearly a cent gain against the greenback.  The euro is firm with around a 0.3% gain that puts it close to $1.0625.  In the emerging market space, Russia and South Africa are ahead of the pack, while eastern and central European currencies benefit from the steady to firmer euro.  As expected Brazil cut the Selic rate yesterday and the real is expected to open steady to firmer.  

Asian equities advanced, led by the1.1% rally in the Nikkei.    European shares are heavier and the Dow Jones Stoxx 600 is off 0.5%.  Energy is the only sector that is higher.  MSCI Emerging Market equity index is up 0.2%, fourth gain in five sessions.  Bond yields are higher, with European 10-year yields up 2-4 bp, while the 10-year US yield is above 2.40%. 

Oil prices are firm after yesterday's OPEC agreement.  Many seem prepared to respect the price action and not resist the higher oil prices, but many are skeptical of the implementation, which does not begin for another month. Saudi Arabia is perceived to have blinked.  It agreed to cut its output by almost 500k barrels a day, while its rival Iran was allowed to boost output slightly (90k barrels a day).  That would bring Saudi output to 10.1 mln barrels a day, which incidentally is its average output from the end of last year through April of this year.  Iraq failed to resist pressure for output cuts despite claiming it should be exempt due to its battle against ISIS.  

If OPEC agreed to almost a 1.2 mln barrel a day cut, most driven by about a 4.5% cut in member's output, non-OPEC is supposed to deliver a 600k barrel cut.  Next week there will be meetings with OPEC and non-OPEC countries.  Conflicting reports suggest Russia could phase in 200k-300k barrel cut over the course of the first several months of next year.   Getting many other non-OPEC countries to participate actively may be difficult.  Mexico, for example, quickly indicated it would not cut output.  

The US has reported a string of stronger than expected economic data, including yesterday 216k increase in the ADP employment estimate.  US interest rate premium is historically wide and getting wider.  Europe has two political risk events this weekend with the Austrian presidential election and the Italian referendum on tap, before the ECB meeting next week which is expected to 1) extend QE, 2) tweak the rules to minimize scarcity of securities, and 3) enhance the securities lending to ease pressure in the repo market.  The dollar is not making a move upside headway, though it did reach an eight-month high against the yen in Asia before pulling back in Europe.  

The absence of further dollar gains despite the fundamental backdrop is making short-term operators more cautious after having ridden the greenback's three-week advance to the bank. Many have given up on the idea that tomorrow's US jobs data will succeed in ending the broad consolidative phase that began last week.  

Outside of the oil story, the interest today is in the manufacturing PMI reports.Generally speaking, the PMIs suggest the manufacturing sectors are finishing the year in good shape.  Japan's rose to 51.3 from 51.1 of the flash reading.  It is still off slightly from October's 51.4, but it is well above the Q3 average of 49.7 and the year's average through October of 49.5.  

China's official manufacturing PMI rose to 51.7 from 51.2 and well above market expectations and more than a two-year high.  The details were constructive, with increases in new orders and new export orders.  Input prices rose to 68.3 from 62.6, and this will fan ideas that the PBOC will allow the month-end pressure in the money market (such as the one-week repo rate) to carry over.  The service PMI rose to 54.7 from 54.0, which is also a two-year high.  

The eurozone manufacturing PMI was in line with the flash report of 53.7, though prices rose more than the preliminary report suggested (51.4 from 51.1).  The tick down in Germany's reading to 54.3 from 54.4 (flash) was offset in full by the French improvement to 51.7 from 51.5.  Spain offered a big positive surprise with a 54.5 reading after 53.3 in October.  It was at 51.0 over the summer. 

 Italy also surprised on the upside.  The 52.2 reading compares with 50.9 in October and expectations for 51.3 now.  I t is the strongest since June. Separately, Italy reported the unemployment rate ticked lower (11.6% from 11.7%), even though it lost 30k jobs. Eurozone's October unemployment rate slipped to 9.8% from a revised 9.9% in September. 

 Although we recognize the likelihood that constitutional referendum losses this weekend and that it raises political uncertainty, to get to the Greek moment that some have suggested, seems considerably more complication.   Opposition to the referendum comes from across the political spectrum, including Renzi's own party, former PM Monti, and even the Economist magazine came out against it.  A defeat could be a victory for the 5-Star Movement, but that is glossing over many interim steps.  The Austrian election could be a different story.  The anti-immigration and anti-EMU Freedom Party could capture the largely ceremonial post of the Austrian presidency.  Although it tends to be passive, an activist in the office could be significant. 

Attention now shifts back to the US.  It reports weekly initial jobless claims, which over overshadowed by yesterday's ADP and tomorrow's national report.  ISM manufacturing will be released and is expected to continue to recover.  The median guesstimate from the Bloomberg survey is 52.5, which would be the highest since July.  US auto sales will also be reported.  A 17.7 mln unit pace, off slightly from 17.90 in October would still a relatively strong report.  

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