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FX Market Looking for Direction

Highlights

The US dollar is narrowly mixed to start the new week.  It is hanged against most of the major currencies as the market waits for fresh trading incentives.  The euro was turned back on the initial test of the $1.24 area, Initial support is near $1.2320, but only a break of $1.22 would signal a break of the recent range.   The dollar has been confined to a little more than a 10 tick range on either side of JPY89.35.  Sterling is little changed and has held above the $1.50 level.  The Swiss franc is showing independent strength as it is bid to new record highs against the euro and is at its highest level against the dollar since the start of May.  Emerging market currencies are generally firmer. 

Asian equities were mixed, with the MSCI Asia-Pacific Index essentially unchanged, while European bourses are moving higher.  The large equity markets in Asia, like Japan, China, and Australia all slipped 0.5%-0.6% today, most of the other markets closed higher.  India and Thailand gained over 1%.  European equities are snapping a four day decline, with most bourses up over 1%, thought the FTSE is lagging.   Auto, basic materials, oil and gas were among the strongest sectors and of note financials were fully participating in today’s advance. 

There are two key developments in the debt market today.  First, European bond spreads are widening against Germany.  The premium Italy, Spain and Greece has widened by 10 bp or more today.  The market has absorbed supply in Italy, (3- year and 10 year) Slovakia (16 year), Belgian bonds (18 year) and German bills.  ECB money market operations will be closely scrutinized this week with the 12-month long-term refinancing operation set to roll off Thurs and ECB three-month refi operation on Wed followed by a special 6-day operation on Thur are expected to be heavily drawn upon.  Second, US 10-year Treasuries continue to drift toward the 3.0% yield level.  This is seen as a key area for foreign appetite, especially Japanese interest.  Note that the recent Federal Reserve custody holdings showed new interest in agency paper, ostensibly for better yields than Treasuries. 

Currency Markets

One of the recent developments has been increased fear that the global economic recovery is losing momentum and that renewed contraction is likely.  In the US, the string of economic data that began with disappointing May jobs data was followed by the retail sales report and poor housing data.  The composition of the revisions to Q1 GDP also warned of the fragility of the recovery.  Today’s US personal consumption expenditures for May will likely provide another piece in this story.  The consensus expects a minor 0.1% rise, though the risk is on the downside.  In Q4 09, personal consumption expenditures averaged 0.5% increase a month.  In Q1 10, the average monthly rise was a little more than 0.4%.  Here in Q2, even if the consensus is right the monthly average is less than 0.1%.    The ISM readings later this week are expected to soften as are June auto sales.  The economic highlight of the week will be the US jobs report.  The Census Dept will again play havoc with the data as it begins to lay off people.   The early consensus is for a decline of a little more than 100k.  However, the string of unfavorable news may be snapped if the private sector job growth picks up to show an increase nearly 3-times larger than the 41k increase in May. 

Retail sales in Japan played into the general theme of weak economic dataMay retail sales were 2.8% above year ago levels.  The consensus had expected a 4.8% increase.  This is the smallest gain since January. On a seasonally adjusted basis retail sales fell 2% on the month, the worst showing in five years.  Tomorrow’s data is likely more mixed with household spending expected to recover from the 0.7% decline in April (year-over-year) and the unemployment rate expected to slip to 5% from 5.1%.  However, May industrial production is expected to have stagnated after a 1.3% increase in April.  Like in the US, the streak of poor economic news may be broken later in the week with the Q2 Tankan Index, which is widely expected to improve.  While the diffusion readings for the large companies may still be negative, they are expected to be barely so and capital expenditure are expected to have risen for the first time since Q3 2008.   There is talk of new Toshin funds to be established late this week and this would represent new outflows.  However, the US-Japanese 10-year spread is less than 200 bp and this is seen as discouraging flows into US fixed income. 

There have been four developments in the Europe today.  First, the ECB reported much weaker than expected money supply figures.   M3 fell 0.2% in May from a year ago.  The consensus had expected it to have grown by 0.3%.  Adding insult to injury, the April figure was revised to -0.2% from -0.1%.  Growth in M1 slowed to 10.3% from 10.7%.  This is the general pattern seen in other major industrialized countries, including the US, where narrow money is growing but the broader measures are not.  One difference in Europe is that the ECB reported that loans to households and companies increase by 0.2% in May after a 0.1% gain in April.  Second, German states has generally reported softer inflation figures.  This is likely to translate into a 1% year-over-year rate for the country as a while, down from 1.2% in May.   While the periphery of Europe is experiencing deflationary conditions, Germany and France are not.  However, the risk is on the downside, especially looking at core rates.   Third, the Swiss franc continues to strengthen against the euro.  Swiss fundamentals are superior.  It continues to derive some safe haven demand.  The SNB has downgraded the risk of deflation.  The euro fell through CHF1.35 today, reportedly taking out some option structures on the way.  There is some talk of a move toward CHF1.30 now.  The dollar has retraced about 50% (~CHF1.0825) of its gains since last Nov lows.  A break of the CHF1.08 area targets CHF1.06.  Fourth, catching the market a bit off guarded, Greece reportedly will return to the market next month to roll-over 3, 6, and 12 month bills.  This is seen as a gamble.  If the reception is not good or if the market demands too high of yields, it could push Greece into tapping the line of credit from the EU/IMF established last month as well has have knock-on effects on the other weak credits in Europe. 

Upcoming Economic Releases
The US reports May personal income and consumption figures at 8:30 EST/12:30 GMT.  The consensus calls for a 0.5% increase in income and a 0.1% increase in consumption expenditure.  The core PCE deflator is expected to slip to 1.1% from 1.2%.  The Chicago Fed’s national survey is released at the same time and the consensus calls for a small rise from 0.29 in April.   At 10:30 EST/14:30 GMT, the Dallas Fed’s manufacturing survey is released.  The consensus expects a rise to 3.2% in June from 2.9% in May.  Lastly, just before 1:00 EST/17:00 GMT, the Fed’s Warsh speaks the Rotary Club in Atlanta.

Marc Chandler

About 

Marc Chandler joined Brown Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. In addition to frequently providing insight into the developments of the day to newspapers and news wires, Chandler's essays have been published in the Financial Times, Barron's, Euromoney, Corporate Finance, and Foreign Affairs. Marc appears often on business television and is a regular guest on CNBC and writes a blog called Marc to Market. Follow him on twitter.