Greenback is Unable to Recover Ahead of Jobs Report

Overview:  The markets have taken an important step away from the edge.  A major threat to investors emanated from the US as the "America First" agenda meant trade tensions with nearly every country.  Trump signaled yesterday progress in talks with China, and today the press reports that Trump has instructed his cabinet to draw up a potential trade agreement, ostensibly one that will form the basis of talks between the two presidents later this month.  At the same time, the embargo against Iran that will be extended to include oil next week, is also a disruption for many.  After resisting requests for exemptions, reports suggest as many as eight countries, including Iran's largest customers (China, Japan, South Korea, and India) may get some relief.  These developments are bolstering risk appetites and helping equity markets recover from last month's bloodletting. Asia-Pacific bourses are up 3-7% this week led by China and Hong Kong.  In Europe, the Dow Jones Stoxx 600 has moved higher every day this week and today's 1%+ gain puts the benchmark up nearly 4.5% for the week. The S&P 500 is up roughly 3.7% so far this week.  It gapped higher in the middle of the week, and that gap remains unfilled.  The longer it is not closed, the more bullish it appears.  Benchmark 10-year bond yields are firmer in the wake of the equity recovery.  Core European and US yields are up five-to-nine basis points this week.  Peripheral yields are up a little less.  Meanwhile, the correction in the dollar after a strong performance in October continues.  The only major currencies that failed to rise against the dollar this week are the yen and Swiss franc, which are often used financing currencies to purchase riskier assets. 

Trade

The US trade overtures on both exemptions for the oil embargo and toward China is spurring a collective sigh of relief by investors. The brutal equity slide in October was already easing before Trump's comments yesterday, providing some optimism on trade, and the "instructions to the cabinet" of today's reports. Political cynicism is making some observers concerned that this is part of Trump's last effort to impact next week's mid-term elections.  A week ago, Kudlow, Trump's economic adviser, bemoaned the fact that China had refused to engage the US in negotiations and did not make any counter-offers. There was a threat to take trade off the table when the two presidents meet on the sidelines of the G20 summit later this month.  On the other hand, others see a pattern, whereby a crisis is manufactured and resolved with mostly a modest adjustment that seems to have been achievable without the drama and crisis. 

EMU Manufacturing PMI

Eurozone growth has slowed this year, and it does not appear to have bottomed.  The manufacturing PMI reported today was even weaker than the flash report.  The flash report, out last week, showed a weakening to 52.1 from 53.2.  The final report edged down to 52.0, a two-year low.  Consider that the manufacturing PMI averaged 58.3 in Q1, 55.5 in Q2 and 54.3 in Q3.  The service and composite PMI will be reported next week.  

Germany, the economic engine is faltering.  Recall the Bundesbank warned last week that the German economy may have stagnated in Q3.  The flash manufacturing PMI for October showed a decline to 52.3 from 53.7, and the final reading shaved it to 52.2.  France's final reading was unchanged from the flash 51.2 after 52.5 in September.  Spain surprised on the upside at 51.8 from 514 in September  Italy was a disappointment.  It manufacturing PMI fell to 49.2 from the 50.0.  It is the first sub-50 reading in two years. 

While news of Merkel's decision not to stand for re-election as party leader (December) or Chancellor (which had been assumed) will shake up German and European politics, the pressure is also building in Italy.  The coalition between the Five Star Movement and the League is purely a pact of convenience.  Salvini is often perceived to have outmaneuvered  Di Maio and the M5S.  The performance in local elections and now the national polls show Salvini eclipsing its senior coalition partner. A breakdown in the coalition is possible next year.  Perhaps the League will see it in its interest, maybe ahead of the European Parliament election in the spring, to seek its own mandate. 

US 

The US jobs data caps off a week of relatively strong reports.  ADP surprised on the upside as did auto sales.  The ISM manufacturing index fell to 57.7 from 59.8 in September, but it still robust.  The details may reflect the trade tensions as new export orders fell and the industries that reported weaker conditions, like primary metals and fabricated metals were likely impacted directly by the tariffs.  Prices paid rose to 71.6 from 66.9.  It is the first increase in five months.  Manufacturing employment eased to 52.2 from 54.3 and maybe reflect in today's report.  Non-farm payroll growth has been averaging 208k this year, which is a little faster than the last two years (averaged roughly 180k in both years).  Weakness in September (134k) was the result of the storms.  Forecasts are looking for a rebound back toward trend.  The unemployment rate is expected to remain at 3.7%, the lowest in nearly 50 years, but there is more risk of it ticking down to 3.6% than rising to 3.8%.  Average hourly earnings are expected to jump above 3% for the first time since 2009.  Statistically, it is a bit of a fluke.  Last October's 0.2% is dropped out of the year-over-year comparison.  Although the debt market may not like the headline the year-over-year comparisons are less favorable in Q4.

Oil

The price of light sweet crude oil for December delivery tumbled 2.5% yesterday and the 0.5% follow-through selling today puts WTI  down about 6.2% for the week.  It is the fourth weekly decline, during which time the price of oil has fallen a little more than 15%.  The price broke below the 200-day moving average (~$65.40) for the first time since last October.  The next important technical target is seen near $61.If sustained, the decline of will ease headline inflation pressures and help extend the business cycle.  

Optimism that the US may grant some waivers for its embargo against Iranian oil that begins next week (and may include China, India, Japan, and South Korea), according to press reports and increased supply took a toll.  The EIA's monthly report showed US oil and condensate output is surging  It rose to a record 11.35 mln barrels a day in August from 10.93 mln a day in July.  On top of that, Bloomberg's survey suggests OPEC may have boosted output by 430k barrels a day in October.  The increase is split almost evenly between Libya and Saudi Arabia.  The latter's 150k a barrel a day boost brings Saudi output to its highest in several decades.  Libyan production is more precarious.  Russia also appears to have increased its output in October.  OPEC holds an interim meeting on November 11 ahead of formal gathering in Vienna, December 6-7. 

Dollar

The underlying dollar advance is, we argue, driven by the divergence in monetary policy, broadly understood, and the US policy mix (tighter monetary policy together with looser fiscal policy is associated with upward pressure on currencies).  We have been warning that nearly month-long advance had left the technical indicators stretched.  The dollar's downside correction began later than we anticipated and the pace is somewhat surprising, especially ahead of the US jobs report today and next week's FOMC meeting.  

The euro has been up to almost $1.1445 today.  There is a band of resistance that extends from about $1.1460 to $1.1500.  Some chunky options in that range that expire today, including roughly 1.33 bln euros $1.1450-60, and almost 715 mln euros in a $1.15 option.  The talk of Brexit deal in a few weeks may have been denied, but sterling's short-squeeze has continued.  The target is in the $1.3080-$1.3100 area.  With cross rate adjustments taking place, the dollar-yen is more sidelined.  The dollar is trading quietly between JPY112.50 and a little above JPY113.00.   The dollar fell for the second consecutive session against the Chinese yuan.  It is at three-week lows today, and the price action will reinforce the psychological importance of the CNY7.00 level (which we expect will still be broken in the medium term).  

 The Australian dollar has already taken out last month's high (~$0.7240).  It has approached the 100-day moving average (~$0.7270) and above there, the September high comes into view ($0.7315).  The New Zealand dollar is challenging its September high near $0.6700.  The US dollar is in a broad CAD1.28-CAD1.32 range.  The upper end was approached earlier this week, and a move back toward the middle of the range is likely now.  Note that Canada also reports jobs (median forecast around 15k) and merchandise trade (second consecutive surplus is expected).

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