German Shine Dulls, BOC Meeting, Japanese Flows

European policy makers have successfully addressed the spring’s liquidity crisis. Portugal managed to hold a decent bond auction today even as the premium over Germany widened to new record levels. The underlying solvency issue—or more precisely—the need to restructure the sovereign debt—has not been addressed. This leaves Europe particularly sensitive to growth as a key. The strength of the German economy has obscured the weakness in the region, but that appears to be one of the key shifts in market psychology in recent days, almost a bizarro version of the slightly less angst in the US following the manufacturing ISM and employment data last week.

Yesterday’s news of a disappointingly large drop in German industrial orders (-2.2%), today Germany reported an unexpected drop (1.5% ) in July exports and only a 0.1% rise in July industrial production—one tenth of what the consensus forecast. The data is not exceptionally worrisome. Taken together it simply underscores that the strong pace of Q2 growth may have been the peak and that the slower German growth going forward will allow the weakness of much of the rest of the region to become more evident.

The Canadian dollar is little changed ahead of what promises to be a more exciting North American session. The Bank of Canada is likely to continue to be the only G7 country raising rates and the August Ivey PMI. A 25 bp rate hike by the Bank of Canada is mostly anticipated, with the better US economic data last week, pushing the consensus more decisively toward a hike, after a string of softer Canadian data gave rise to doubts. This would lift the overnight rate to 1.0%.

The key may be the statement. Most positive for the Canadian dollar would be a repeat of the last statement. However, there is some expectation that with this hike the BOC will take on a more neutral tone. The next meeting is October 19th as it prepares for the October Monetary report. The IVEY PMI is expected to have risen to 55.5 from 54.0. It would be the first increase since the May peak of 62.7. Canada reports trade figures tomorrow and on Friday is the import employment report. The consensus calls for a 30k increase in jobs after a -9.3k decline in July. Recall that the 139k loss of full time jobs (and a 130k rise in part-time jobs) was seen to be a seasonal adjustment distortion. The Canadian dollar itself has been rather uninspiring of late. The greenback bounced sharply off the CAD1.0340 multi-week low seen on Monday to test the CAD1.05 level earlier today. Above CAD1.05 there are likely to be dollar offers in the CAD1.0550 area, a retracement objective from the pullback from late-Augusts’ CAD1.0675.

There are two key developments in Japan. First, in terms of economic data, of note, Japan reported a stronger than expected rise in July machinery orders. The 8.8% rise compares with consensus expectations of a 2% rise. The strength of capital expenditures, for which machine orders are a leading indicator, is the key reason why Q2 GDP is expected to be revised toward 1.5% from the preliminary 0.4% tomorrow. Also Japan reported a larger than expected current account surplus for July. At JPY1.675 trillion, it is 26% larger than a year ago. It is the first increase after a streak of three months of declines. Second, in terms of capital flows, news that China bought JPY583 bln worth of Japanese government paper in July has sparked much speculation that this is behind the yen’s strength. Much of the discussion seems to exaggerate China’s role.

To begin with, note that China is buying Japanese bills and is actually selling medium and longer term government securities. China is shortening duration in Japan. Second, Japan itself in July bought JPY3.5 trillion of Us Treasuries in July after JPY2.2 trillion in June. The net Chinese inflow blunts this but there is more. Japanese investors have been buying an average of JPY1 trillion of foreign bonds a week over the past 16 weeks. Again the flows simply dwarf what China may be doing. In addition, note that the current account data indicates that often Japan’s income from previous foreign investments exceeds Japan’s trade surplus.

The UK reported July industrial output rose 0.3%, in line with expectations and blunts the impact of June’s 0.5% decline. Nevertheless this caps the weakest three month performance since the end of last year. Manufacturing output rose 0.3, also in line with expectations, but the three month pace is the strongest since 1995 and the year-over-year rise of 4.9% is the best since late 1994. Yet this data is seems too dated to matter much. The decline in all three PMIs last week seems more telling. Also, with dramatic fiscal tightening coming, the market’s confidence in the outlook for the UK economy is weak in any event. Sterling has come up against its 20-day moving average, which comes in just below $1.55 today. It has not traded above this moving average since for 3 weeks an