Dollar Mixed while Equities Recover to Start Eventful Week

The US dollar is mixed against the major currencies, and while it is firmer against the euro and yen, it is within last week's ranges.   The success of Macron's new party in France, and the majority is secured, was well anticipated by investors and is having little effect on today's activity in the capital markets.  

The start of Brexit talks also is spurring little response in the market.  Sterling is steady to a little firmer and holding below last week's high just shy of $1.2820, though a more important barrier is seen near $1.2850, where the 20-day moving average and a retracement objective converge.  Steps were taken by the government, like going forward with Queen's Speech, even though an agreement with the DUP is not secure, and indicated a two-year parliamentary session suggest that the election has not changed the main thrust of the Brexit strategy.  Talk of a more business approach flies in the face of the continued commitment to leave the single market.  Meanwhile, some polls over the weekend suggest that many people's attitude toward Brexit has changed.  

The market has also shrugged off weekend developments in Italy, where it appears that the two troubled regional Italian banks will not get a precautionary line of credit that seemed like the most likely scenario late last week.  It is not clear exactly what is going to happen, but the fallback strategy under the Bank Recovery and Resolution Directive (BRRD) may be to establish a good and bad bank, and this could, in theory, avoid "bailing in" depositors and subordinated creditors, as equity investors have already been wiped out.  Italian bank shares fell in the second half of last week but are steady to a little higher now.  The sovereign five-year CDS is also little changed.  Italy's 10-year bond yield has dropped four basis points, which is among the biggest moves today, while the two-year yield is little changed.  

Italian equities are lagging a bit.  While most European bourses are up closer to 1%, the FTSE Milan Index is up around 0.25%.  The Dow Jones Stoxx 600 is up 0.8%, led by industrials and materials, and financials. Real estate is the only losing sector by mid-morning activity.  

MSCI Asia Pacific Index extended the pre-weekend rally and rose 0.6%.  It has closed marginally lower for past two weeks.  MSCI will announce its decision on whether to include China mainland (A-shares) in its emerging market equity index.   Mainland share was up around 0.5%-0.6% today, but the H-shares (those that trade in Hong Kong) rose 1.3%, the most since the middle of May.  Hong Kong stocks themselves rose almost 1.2%, bringing the year-to-date gain to nearly 18%.  On the other hand, there is some hope that MSCI lifts South Korea from emerging market to its developed market equity index.  Despite a recovery of the technology sector, the Kospi gained a modest 0.4%.  

The recovery in the technology space was clearly seen in Japan.  The Nikkei rose about 0.6%, while the information technology and telecoms sectors gained around 1%.  The dollar firmed in the Asia session but ran out of steam in late-turnover near JPY111.20.  US 10-year Treasury yields are offering little new support for the dollar against the yen.  The yield is near 2.14% after bottoming last week at 2.10%.  The dollar recovered against the yen after reaching almost JPY108.80 last week.  A break below JPY110.50-JPY110.60 would suggest the bounce was corrective in nature and may be complete.  

There are two main Japanese talking points today.  First Japan reported an unexpected trade deficit for May.  The May balance nearly always deteriorates from April, but it was more than expected.  The trade surplus was expected to fall from April's JPY481 bln surplus to about JPY43 bln.  Instead, it fell to a JPY203 bln deficit.  Exports were strong, rising 14.9%, accelerating from 7.5% in April and the strongest in two years.  Recovery from an earthquake helped auto exports increase.  Steel and flat screen exports also were featured.  Exports to the US rose 11.6% year-over-year, and they rose only 24% to China (flat panels and equipment for semiconductor manufacturing were highlighted). On the other hand, imports surged 17.8% year-over-year from 15.1% in April. More expensive oil was a major culprit. 

Second, some polls suggest Japanese approval of Prime Minister Abe and his cabinet has fallen sharply in the wake of several scandals that involve favoritism.  There is also push back against what are seen as high-handed tactics to ram through a conspiracy crime bill.   If Abe is not able to reverse this slide, it could undermine his efforts to implement his political agenda (constitutional changes), and he could face a leadership challenge next year.  

Investors have taken in stride news that Moody's cut the rating of the four major Australian banks, citing exposure to the housing market.  Rising home prices, rising household debt, alongside weakening household income growth pose a growing threat to the banks.  Recall that last month S&P cut the ratings of many of Australia's smaller banks on similar grounds but spared the large banks ostensibly on ideas that they would get government support if needed.   The Australian dollar initially fell to near $0.7585 after closing last week near $0.7620.   By earlier in the European session, it had nearly recovered in full.  

Aside from the French electoral outcome (marred by the very low turnout), the Italian banking news and the beginning of Brexit negotiations, the news is light.  The euro closed near the session highs before the weekend and quickly traded to nearly $1.1215 as the market re-opened in New Zealand and Australia for the new week.  It was not able to sustain the momentum had slipped back to almost $1.1180 before European markets got under way.  Ranges remain tight today.  In the broader picture, the $1.11-$1.13 range continues to dominate.  

Neither Canada nor the US has economic data being released today.  However, after last week's FOMC meeting, official speeches and engagements resume. NY Fed's Dudley speaks before the equity market opens, while Chicago's Evans speaks after the markets close.  After lambasting the Federal Reserve for being too dovish, many observers switched after last week's rate hike and criticized the Fed for being too hawkish.  We are more sympathetic to the Fed's position, and understand why it is prudent to look through some of the volatility in the high frequency data.  The June Empire and Philly Fed surveys released last week showed an acceleration of both new orders and prices received.   

Meanwhile, as we have noted,  Congress is still at work and progress is being reported in various parts the economic agenda.  The way the Senate is going about its healthcare legislation is controversial and antagonizing Democrats, but the Senate Majority Leader McConnell is reportedly looking to have a full Senate vote on the bill by the Fourth of July so to allow tax reform to move to center stage.  




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