India Booms

One key theme has been how well many emerging market economies have held up while the world's biggest economies slow. India's Q2 GDP report fits into that theme. The 8.8% year-over-year growth represents an acceleration from the 8.6% y-o-y pace in Q1. Its strong growth and elevated inflation keeps the door open to additional tightening. The central bank meets on Sept 16 and has already increased rates four times this year.

India, unlike many emerging markets, is not as reliant on exports. They account for less than 20% of the GDP. That said, the most recent data, covering last month, showed exporters increased at the slowest pace since the start of the year and Indian officials have acknowledged it might not reach its export target this year.

Currency Levels and Official Will and Tools

The level of speculation of month-end flows appears to be inversely related to the amount of hard evidence. Nevertheless, the market buzz attributes the euro’s modest recovery today to month-end demand. In order to be anything noteworthy, however, the euro needs to overcome resistance in the $1.2780 area. The gains in late Asia and extended in Europe are stretching the short-term technical readings, warning that the gains are unlikely to be extended very far in North America today. Look for offers in the $1.2720-30 area to cap the euro.

Sterling’s low for the month was set a week ago near $1.5375. It was approached in late Asia (~$1.5396) before stabilizing in Europe. However, the upticks appear half-hearted and a new low on the session seems likely. However, the recovery in euro-sterling looks likely to run out of steam as the GBP0.8230-40 two-week cap is approached.

Global Capital Markets

The US dollar is mixed as month end-considerations and risk aversion dominates. Given the heightened concern about the possibility of BOJ intervention, the Swiss franc has taken over the safe haven lead from the Japanese yen. The Swiss franc is near it best level against the dollar of the year and is at new record highs against the euro. UK data, including consumer confidence and mortgage approvals were firm, but has failed to buoy sterling amid talk of month-end sales. The relative weakness of the antipodean currencies today is also being linked to month-end activity, though risk aversion operative and is weighing on emerging market currencies too.

New Week, Old Drivers

There are four major considerations in the foreign exchange market as August winds down: the trajectory of the US economy, the outlook for US monetary policy, Japan’s policy response to the weakening economy and strengthening yen, and European strains.

There is a general consensus that although Bernanke essentially revealed what in pre-crisis times would have been called an easing bias, actual easing was not imminent. The bar for action was “significant deterioration” of the economic outlook. Such news is unlikely to be forthcoming today when the US reports July personal income and consumption data. Personal consumption expenditures has essentially been flat in Q2, but is expected to have risen 0.3%, the strongest since March. Personal income is expected to have recovered form the flat reading in June to also have risen about 0.3%. That said, there is plenty of scope for disappointment this week with the ISM, auto sales and employment reports.

Capital Markets Overivew

The US dollar is mixed at the start of the new week. The absence of London markets is serving to dampen turnover. The reluctance of the Bank of Japan to get ahead of market expectations saw the yen recover smartly after the greenback neared JPY86. Initial support for the dollar near JPY84.50 is likely to be tested shortly. For its part, the euro has been confined to its pre-weekend range. Three times in as many sessions, the euro was turned back from approaching $1.2780. Initial support is seen near $1.2680-$1.2700. Sterling is among the best performing of the majors, even though Hometrack house price index posted a large decline and the BCC opined the BOE is on hold until H2 2011, with the risk of a double dip. Cable faces resistance in the $1.5600-20 area. Emerging market currencies are narrowly mixed.

Europe's Feint

The euro has been sold hard across the board in recent days, taking numerous investors and observers by surprise. After all, the European sovereign debt crisis that was so threatening earlier this year had been resolved, the fiscal austerity measures announced had re-earned the market’s confidence, and the economies had strengthened in Q2 after nearly stagnating in Q1. No less an authority that the ECB President himself suggested that Q3 was off to a fine start.

At the same time, we are told that US policy makers have no sound fiscal strategy and under the weight of structural problems. Additionally the world’s biggest economy slowed down sharply in Q2 after above trend growth in Q4 09 and Q1 10. So what happened that sparked a nearly 5% drop in the euro over the past few days?

First CPI Rise in 4 months and Small Bounce in Retail Sales

US July CPI rose 0.3%, a tad more than expected and the first rise in four months. Of note rents increased for the second consecutive month. Core prices rose 0.1%, leaving the year-over-year rate steady at 0.9%. Retail sales rose 0.4%, a little less than expected in July, but the June figure was revised from -0.5% to -0.3%. However, more importantly, retail sales excluding autos, gasoline, and building materials, which is what the Commerce Dept uses to calculate GDP actually fell in July after a 0.3% rise in June. Retail sales account for about 40% of consumption. Seasonally speaking, July is often a transitional month for retailers as they shift from summer merchandise to back-to-school.

Overall, the data does not shed much fresh light on the US economy. Inflation remains below desired levels and the US consumer, while not in complete hibernation, remains largely sidelined. The dollar may continue to consolidate ahead of the weekend and in North America this would imply a somewhat weaker tone.

Europe, Japan and the Dollar

The euro has failed to hold on to even modest upticks in response to stronger than expected euro-zone growth. This is important. It is among the conditions we anticipated would help reverse the trends that have emerged in the foreign exchange market over the past several weeks.

During this time, when the euro strengthened from $1.1877 to $1.3334, investors recognized that EMU would survive, but also the plethora of upside surprises in the more high frequent data. We have argued that the markets priced in a great deal of good news, leaving the euro vulnerable. We also identified as a key factor the swing in short-term interest rate differentials. Using the 2-year US-German spread, we note it has tracked the euro-dollar exchange rate fairly closely, especially recently. The spread went from 62 bp in Germany’s favor last Nov to almost 34 bp in the US favor by late May. It then swung back in Germany’s favor by about 25 bp. We argued that a swing back in the US favor would likely point to a greenback recovery. The spread is just below 13 bp today.

Friday Overview

The US dollar is consolidating this week’s gains in choppy activity. Stronger than expected euro zone GDP (1.0% quarter-over-quarter) failed to lift the euro as much as one might have expected. It appears the market quickly realizes this is as good as it gets. Heightened tensions remain evident in the European debt markets and this may also be helping to limit euro upticks. Heightened concern that Japanese officials are getting closer to intervention helped lift the dollar to almost JPY86.20 in Asia, but Europe has been less sanguine and sold it back off. Short-term participants may still be reluctant to go into the weekend with the dollar too close to JPY85.00.

Wheat and Currencies

Wheat is trading higher today, positioning to snap a 4-day profit-taking decline. The US Dept of Agriculture provided updated its forecasts for grain production. It now forecasts a global harvest for year than began June 1 at 645.7 mln metric tons, down from 661.1 mln metric ton forecast last year and 680 mln metric tons in the year that just ended. It also cut its forecast for the inventory that will be on hand at the end of the current planting year next May.

The USDA anticipates the harvest in Russia and Ukraine will be 15% lower and Kazakhstan's harvest will be cut by 18%. The EU's harvest forecast was cut 3%. Following Russia's export ban, there is talk that the Ukraine may also be announcing caps on exports or an outright ban as well. On the other hand, the USDA lifted the estimated size of the US harvest to 2.265 bln bushels from 2.21 bln estimated last month.

Tensions with China Rising

The dollar-yuan was fixed today at CNY6.8015 today. It closed yesterday near CNY6.7750 and was fixed yesterday at CNY6.7768. The greenback's broad rally yesterday contributed to the sharply higher fix today. Subsequently, the dollar eased to almost CNY6.78, generating one of the largest intra-day swings in recent weeks.

News earlier this week that Chinese exports jumped and imports fell followed the disappointing US employment report at the end of last week. Although the two are not really related, the politicos will make the connection nonetheless. Moreover, Washington contacts report that disappointment is growing in the Obama Administration over the less than 1% yuan appreciation over the nearly two months since China says it broke the peg with the dollar.

Euro Bears Advance, Yen Bulls Steady

The news stream from Europe has soured and this has overshadowed the FOMC decision to recycle the Agency and MBS maturing issues into the Treasury market. This still seems very benign in the sense that it is simply maintaining the size of its current balance sheet. The decline in inflation and inflation would suggest under some Taylor-rule-like application that the US ought to have an easier monetary policy than say was the case at the start of the year.

Maintaining the existing size of the balance sheet is to prevent is shrinkage, but to be sure the Fed is not crediting banks with new reserves or in any other way “printing” fresh money. The change of the Fed’s balance sheet is in terms of composition. It will have a bit more Treasuries and a bit less Agency bonds and MBS. In addition, that the US economic recovery has nearly slowed considerably—after yesterday’s US trade figures, it is becoming clearer that the economy may have grown half of the 2.4% initial estimate—had already largely taken on board. The new news is from Europe and it has not been good. In a post tomorrow, I will argue that while European officials addressed the liquidity dimension of the crisis, the solvency issue requires strong growth and that has been called into question.

Capital Markets Overview THursday

The US dollar is mostly firmer today after yesterday’s surge. After yesterday’s gains were briefly and marginally extended in early Asian trading, a consolidative/corrective attempt was made that was extended into early European activity, when the euro reached just above $1.2930 and sterling made two attempts runs above $1.57.

However, a poor news stream out of the euro zone, which included an unexpected decline in June industrial output (-0.1% vs consensus forecast of +0.6%) encouraged new selling. And a sloppy gilt auction helped send sterling back to its lows. Japan’s verbal intervention and indications that it checked rates has helped steady the yen, but may have deflected the speculative attention toward the Swiss franc, which is the exception today, posting across the board gains today.

CNBC: Dollar Rallies on China Data

More Thoughts about the FOMC and ECB

When the FOMC first indicated it was going to expand its balance sheet by buying Treasuries, Agencies and MBS, it explained that its goal was to improve the conditions the credit markets. Observers and investors may call it QE, but to Fed officials it was credit easing.

The Fed's decision to recycle the proceeds of its maturing MBS and Agencies into Treasuries seems less motivated by that, though the FOMC was not particularly clear on its goal. Ironically, the FOMC statement was the first of the year that did not cite financial conditions. In recent weeks, bank credit appears to have increased as banks have bought a greater amount of Treasuries that have more than offset their shrinking loan book and money supply has ticked up, albeit slightly.

Latam Update: ABC--Argentina, Brazil, Chile

Fears that the global recovery is faltering is unlikely to prevent Chile's central bank from hiking rates tomorrow. It had hiked rates last month and the data since has been strong and economists have generally revised higher growth forecasts and Chile's finance minister recognized this last week. The market expects a 50 bp rate hike to 2.0% Optimism over the Chilean economy helped strengthen the peso a bit more than 5% since July 1, which makes it the strongest currency in Latam in this time. However, with risk-off coming back into vogue and concerns about the world's growth outlook becoming more acute, the peso is losing ground today. There is scope for a 1% dollar near-term dollar advance toward CLP5.19.

Macros In Focus

Over the past week, US assets have outperformed the others in G10. The dollar has risen against all the major currencies, except the Japanese yen. The US 10-year yield has fallen 23 bp compared with 13 bp decline in German and UK 10-year yields and a 1 bp increase in the 10-year JGB yield. The US S&P 500 had generally outperformed going into today’s session.

New Global Growth Concerns Ignite the Dollar

The US dollar has fully recouped and more so the losses inflicted in the immediate aftermath of the FOMC’s decision to recycle the MBS and Agency bond holding proceeds backing into Treasuries. Its somewhat more gloomy outlook has been followed by a disappointing machinery order data from Japan and softer data from China has heightened growth concerns again and this has led to the buying of the low yield currencies today—the dollar, Swiss franc and Japanese yen.

The dollar dipped below the JPY85 level for the first time since late last year, but no follow through selling materialized. Stops are thought to lay below JPY84.80. The UK reported soft data as well (Nationwide consumer confidence lowest since April 09 and claimant count decline was a bit less than expected). This coupled with a dovish BOE quarterly inflation report overwhelmed the more favorable flows that market talk had linked to M&A flows and possible dividend conversion. Emerging market currencies are also under pressure today.

FOMC Recycles MBS into Treasuries, Dollar Hit

The FOMC voted to reinvest the maturing Agency and MBS securities into Treasuries, which is the type of asset purchases that some had been looking for. We had thought the Fed would refrain, but did not see it as having a major impact on yields or the economy. The dollar saw its earlier gains pared and the stock market recouped some of its earlier losses. The US Treasury market rallied in response.

Dollar Resilience Continues

One of the developments we anticipated that would be an early signal that may be poised for a reversal was in how the market responded to poor US economic data. If it sells off, it meant that the market had not fully taken on board the slowdown.

There was no follow through selling of the greenback after the knee jerk reaction to the disappointing jobs data at the end of last week. And just now the market has shrugged off the disappointing inventory data. The market expected around a 0.4-0.5% rise in June inventories. It came out at 0.1%. Sales fell 0.7%. This combination means that Q2 GDP is likely to be revised lower and that going forward businesses may be cautious about accumulating more inventory.

Latam Currencies Softening in the Wake of USD Recovery

The US dollar's recovery against the major currencies is corresponding with its recovery against emerging markets and the Latam currency performance is consistent with this . Both the Brazilian real and Mexican peso are about 0.5% lower in the early going.

The dollar had been flirting with the BRL1.75 support yesterday and is now testing offers in the BRL1.76 area. While we suspect that many investors are becoming less enamoured with Brazil, there is also appears to be another shift taking place. For most of the year so far, fixed income seemed to be the major draw, but recently it appears that equities have taken the leadership mantle.

Foreign Exchange Forces

The focus in North America today will be the FOMC meeting. Since the end of last week, there has been some re-thinking about the outcome of today’s meeting. In particular, many Fed-watchers are playing down the likelihood that the Fed renews its asset purchases. It was one of three steps that Fed chief Bernanke suggested (in late July) as possible ways the Fed could provide more support for the economy. The other two were to reinforce its guidance about the protracted period rates for which rates will remain low. The other was to lower the interest rate paid on excess reserves. Some recognition that the recent string of data has been weaker than expected, coupled with a commitment to do more if necessary may be the most likely outcome. This re-consideration may be encouraging some paring back of short dollar positions.

Quick Snapshot

The US dollar is trading with a firmer bias across the board. The main driver appears to be a reassessment of the likely outcome of today’s FOMC meeting as many Fed-watchers play down the likelihood of renewed asset purchases and this has been sufficient to force some weak shorts (dollars) to cover. In addition, a disappointing French industrial output report (June -1.7% month-over-month vs consensus of -0.3%) and widening sovereign spreads in Europe has weighed on the euro.

Weak UK BRC retail sales and the first decline in RICS house prices undermined sterling and better trade balance failed to repair the damage after yesterday’s failure at $1.60. The BOJ as widely expected left rates unchanged and refrained from taking new measures to combat deflation.

Swedish Krona Still in Play

The Swedish krona remains a market darling. Over the past 3-months it neck-to-neck with sterling as the strongest G10 currency, up about 7.75% against the dollar and about 4% against the euro.

It has strong macro-economic fundamentals. The preliminary estimate of Q2 GDP was reported in late July at 3.7% (year-over-year) after a 3% reading in Q1. With the July PMI near record levels, the positive momentum has carried into the start of Q3. The central bank expects 3.8% growth this year and 3.6% next. The government's estimates a 3.3% this year and 3.8% in 2011.

Asian EM Currency Update

The US dollar is consolidating its post jobs loss against the major currencies, but it softened against most of the Asian currencies. The notable exceptions were the Singapore dollar and Philippine peso, both of which slipped ever so slightly. most of the Asian currencies. The notable exceptions were the Singapore dollar and Philippine peso, both of which slipped ever so slightly.

The Taiwanese dollar was the strongest, gaining a little more than 0.2% against the dollar. Foreign investors continued to purchase Taiwanese shares and with today's almost $170 mln of purchases, brings the month-to-date figure to almost $950 mln. This is on top of the nearly $2 bln in the Jan-July period. Taiwan reported a larger than expected July trade balance of $2.16 bln compared with $1.41 bln in June and expectations for a $1.35 bln surplus. Imports and exports were stronger than expected, with exports rising 38.5% from a year ago vs 34.1% in June. Imports are 42.7% above year ago levels vs 40.4% in June.

Fed Outlook, BOJ and China

The key event of the week is the FOMC meeting.

While no change in rates is expected, speculation has focused on two other elements. The first is a downgrade of its economic assessment. This seems eminently reasonable given the data stream and recent comments by Fed officials. The second is renewing asset purchases and here the focus has been on taking proceeds from its mortgage bond holdings (from early pre-payments and maturities) and purchasing more MBS. Some observers think the July jobs data makes it more likely.

FX Quiet on Monday in August

The US dollar is trading quietly within the ranges seen before the weekend ahead of tomorrow’s FOMC meeting. The BOJ concludes its meeting tomorrow, but the speculation has tended to focus on renewed asset purchases by the Federal Reserve, especially in the aftermath of the disappointing July employment figures.

The euro has been confined to less than a half cent range, though near-term the $1.3230-$1.3330 range looks likely to contain the single currency. The greenback put a little space between it and the JPY84.80-JPY85.00 support area, with the help of Japanese importers, but the resistance in the JPY85.8-JPY86.00 needs to be overcome to improve the tone. Meanwhile, sterling is consolidating just below the $1.60 level. It has tried three times now (once in North America before the weekend, in Asia last night and in Europe earlier today). It looks posed for another attempt in North America today and if it fails, there is a risk of a somewhat deeper setback toward $1.5850 before renewed buying is seen.

CNBC: Trading Block

Post-Jobs Data Thoughts--Vulnerabilities Abound

There is no doubt that the US jobs data is disappointing. The debate among the talking heads is the degree of the disappointment.

One of the key themes we have been hammering is that the shift in the incentive structure of interest rate differentials has swung against the dollar. We have focused on Euribor and the 2-year US-German differential. In response to the jobs data, US rates have fallen further and have spark a rally in European debt instruments as well. Interest rate differentials are moving further against the US. Equities are tumbling, but remain higher on the week still.

Jobs Data: Headlines Poor Details a Bit Better

Private sector pay roles gained a disappointing 71k and the June figure was revised lower. The headline lost 131k and here too downward revisions in prior months. The work week increased and hourly earnings ticked up. Manufacturing, education and health services grew jobs. The service sector lost jobs for the second consecutive month and construction lost jobs. State and local governments lost 48k jobs, while federal government jobs (census) lost 154k.

The implications are the report is mixed. On one hand, the overall labor picture, which includes the downward revisions, will excite those that expect the Fed to renew asset purchases to support the economy. This has seen the US 2-year yield fall to new record lows, for example. On the other hand, the details were somewhat more supportive. The larger than expected increase in mfg employment and the longer work week suggests industrial output increased. Income rose and this may help support expectations for a recovery in retail sales. Initial support for the dollar is seen near JPY84.80-JPY85.00. The euro faces resistance in the $1.3240-60 area. Sterling may retest the $1.60 area.

US Jobs Data, Soft European Data Featured

Today’s US jobs data is only focus ahead of the weekend. The data that economists use to help forecast this volatile series, like the ISM reports, Challenger survey, and the ADP report were generally supportive. The one important offset was the weekly initial jobless claims rose during the survey week.

As is often the case, it seems likely the real issue is expectations. Strong private sector jobs growth in March and April (158k and 241k respectively) were outliers. The 3-month average of private sector job growth is 119k, but this includes April’s jump. The last two month average is 58k and the July reading is expected to be well above this. The headline figure though is going to be skewed by the census workers.

Dollar Firmer After Soft Foreign Data

The US dollar is a bit better bid today ahead of the July jobs data, which apparently many believe is key to whether the Fed resumes its asset purchases next week. Softer than expected UK industrial output data and some last minute position squaring appears to be the main driver of the price action, which may be best characterized as a consolidative to rather than some added significance.

The euro was confined to very narrow ranges that were extended largely in a knee jerk response to news that S&P withdrew its AAA rating for the Swiss National Bank. However as it became clear that the reason for this was that the SNB has not debt led the euro to recover, though that recovery was limited by the unexpected decline in German industrial output figures. Even sterling, which was sold off on data and the inability to push through yesterday’s highs, held above yesterday’s lows.

Russia Grain Export Ban may Help CAD

Due to a horrible drought, Russia has announced it is banning grain exports form mid-Aug to the end of the year. A state of emergency has been declared in many crop growing regions. The most important grain is wheat and the price of wheat is jumping to 2-year highs. The government has cut its crop forecast to 70 mln metric tons. The crop ws around 97 mln tons last year. Agriculture accounts for a small part of Russia's GDP, so growth forecasts are unlikely to be cut very much.

SNB and QE Implications

The Federal Reserve and the Bank of England have not purchased assets since Q1. The ECB has purchased covered bonds and sovereign bonds in the secondary market. The BOJ has continued its monthly purchases of JGBs in its rinban operations. The Swiss National Bank was arguably the most aggressive and it continued to buy foreign bonds and sell the Swiss franc through the middle of June.

Speculation that the Federal Reserve may resume its asset purchases as early as next week has been a factor that has been cited as a weight on the dollar. But there does not appear to be a good correlation between QE (or the extraordinary monetary policy that in the market's vernacular has been lumped together as QE) and currency movement.

News Stream and Price Action Illustrates Themes

Today’s developments and price action illustrate several of the important themes in the foreign exchange market. The news stream from the euro zone has improved from the dark days in Q2. Spain, for example, easily raised the 3.5 bln euros it was looking for at a yield around 100 basis points lower than it paid that the previous auction in June (2013 maturity 2.28% vs 3.32%) and the bid-cover did not suffer much (1.9x vs 2.1x). The IMF has indicated that Greece’s reforms are on track and that it will receive the second tranche of its aid.

Thumbnail Sketch Capital Market

The US dollar is seeing gains over the past 24-hours pared. No single event appears to be the trigger, though a successful Spanish bond auction and indications that Greece will receive the second 9 bln euro aid tranche from the IMF/EU may have helped spark the euro’s bounce from near $1.3120. The Swiss franc is actually leading the move in the majors today.

The Bank of England left rates on hold as widely expected and despite the string of relatively good bank earnings reports continuing today, sterling is lagging, though many still look for a test on the $1.60 area. The ECB meeting, and more importantly, Trichet’s press conference is the main focus ahead of tomorrow’s US employment report. Stepped up verbal comments from Japanese officials may have helped keep the dollar in a narrow 25 tick range on either side of JPY86.25 thus far today.

ISM and ADP Better than EXpected, but Can It Really Help the Dollar?

The non-manufacturing ISM surprised to the upside, actually improving over June and this follows on the heels of a somewhat better than expected ADP report. The dollar is finding support in response.

The ISM headline was 54.3 up from 53.8. The consensus had looked for a decline. Of note, the forward looking orders index jumped to 56.7 from 54.4. The employment component rose back above 50 (50.9) from 49.7. This coupled with the ADP report (42k vs consensus of around 30-35k), and a continued decline in Challenger job cuts may see some economists revise up forecasts for Friday's US jobs report.

Bloom off the Brazilian Rose

Latin American currencies continue to perform well despite the recent string of disappointing US economic data. There is only one Asian currency that has out performed the Mexican peso for example over the past month (the Korean won is up 5.1% while the peso is up 4.3%). Brazil on the other hand has appreciated 1%, which is less than most of emerging Asia except Thailand, Hong Kong and China.

Brazil has disappointed many. The central bank was expected to have hiked by 75 bp and it only hiked by 50 bp last month. There are signs that the Brazilian economy may be losing some momentum. Industrial production slowed more than expected and today's report on service sector confidence fell to the lowest level of the year. With the economy slowing, some investors are growing more concerned about rising debt/GDP ratios. This may be a factor behind the rise in the 5-year credit-default swaps to their highest level since late 2008.

UK, Euro Zone, Rate Differentials and Asia

Sterling’s nine-day advance has been placed in jeopardy today by the weakest service sector PMI in over a year. The 53.1 headline reading is the lowest in 13-months and contrasts with the 54.4 reading in June and expectations for a decline to around 54.0. Business expectations did rise, but CIPS noted that cancelled contracts and fewer business enquires. Sterling dipped below $1.59 briefly but quickly bounced back. Support is seen in the $1.5850-80 band and only a break of this would suggest corrective phase is at hand. The market does seem to have given up on a genuine test of $1.60.

The euro zone PMI figures weren’t anything to write home about either. The headline was reported at 55.8, down from the flash estimate of 56, though still above the June reading of 55.5. It stood at 56.2 in May. Spain and Italy surprised on the downside. The latter fell back below the 50 boom/bust level since Nov 09 and new orders were particularly weak. On the other hand, France surprised on the upside and the German report was spot on.

Capital Markets Overview Tuesday

The US dollar is sporting a somewhat firmer profile against most of the major currencies, with the exception being the Japanese yen, against which the greenback has fallen to new 8-month lows. This has brought it within striking distance of the JPY85 level, which has been suggested as a pain threshold for Japanese officials.

Modest profit-taking, encouraged by softer economic data, consistent with the price action in the other risk-on trades, is largely responsible for the modest pullback in the European currencies. The shallowness of the pullback, talk that the market may be reducing estimates for the US employment report and speculation that the Fed may renew asset purchases suggests the bearish sentiment to the greenback remains intact even if the correction is extended somewhat.

Currency Thoughts in Late NY Afternoon

The major currencies traded choppily in the NY session today, largely within the ranges establishing in Europe. Of note today, the US economic reports warn of the risk of a downward revision to Q2 GDP and probably softer retail sales than had been expected. It helps serve to keep the speculation a renewed QE by the Fed alive.

The BEA had assumed that nondurable inventories rose, but today's factory goods orders indicate they fell. The revision to GDP could bring it closer to 2%.

Yen in Play

The Japanese yen remains firm even as the other major currencies see their early gains pared. Many players have their sights set on the multi-year low set last Nov near JPY84.85.

There are several factors behind the yen's rise. Many will talk about the concerns about the world economic outlook. Others will emphasize the narrowing of interest rate differentials. Some may cite the fact that the finance minister seemed to ease the risk of intervention earlier today by noting that the yen's level is set by the markets.

Pressure for Rate Hike Builds in Indonesia, but No Move Yet

The central bank of Indonesia meets tomorrow and although pressure is building for a rate hike, officials still appear willing to resist for a bit longer.

The economy is growing robustly and Q2 GDP will be out early Thurs local time and is expected to show a 6% annualized expansion, the fastest in a couple of years. At the same time inflation is firming. Last month it stood at 6.22%, up from 5.05% in June and compared with news wires consensus of 5.73%.

Five Factors Impacting Position Adjustment

The main feature of the foreign exchange market remains the relentless pressure on the US dollar.

There are several forces at work and seem to reflect both short-covering and outright longs. The net speculative position at the IMM futures remains short euros and sterling. The euro’s net short position has been cut dramatically from a record 114k contracts in mid-May to 21.3k as off early last week. Sterling shorts have been reduced from 76.7k in early May to 18k early last week. The net speculative sterling position has not been long since Aug 2008. The dollar’s slide has been of sufficient duration and magnitude to have encouraged momentum traders and model-driven funds to get short.

There are a number of fundamental reasons for the position adjustment:

Global Market Overview

The US dollar remains under pressure today as low US interest rates, speculation that the Fed may be edging toward renewed asset purchases, and generally poor sentiment, continues to take a toll.

There are exceptions, notably within the dollar-bloc, where consolidation is more the rule. Softer than expected retail sales and building permits data and a neutral RBA statement that largely repeat last month’s message has slowed the Australian dollar’s advance. Sterling also remains fairly resilient in the face of the disappointing construction PMI (54.1 vs 58 expected after 58.4 in June), but the market has not given up a test the $1.60 level proper ahead of tomorrow’s more important service sector PMI. The euro is trying to establish a foothold above $1.32, with more talk of a $1.3500 near-term objective, barring a strong US jobs report on Friday.

Data and RBA Meeting--Not Much for Aussie Bulls

The Australian dollar has been on a tear. It was the strongest of the G10 currencies over the past month, appreciated 8.6% against the greenback, nearly a third more than the New Zealand dollar and more than twice the performance of the Canadian dollar.

A great deal of good news has been discounted. The non-commercials at the IMM have recognized this and have amassed a net long position that is nearly six times larger than existed in late May. In the week ending last Tuesday, the non-commercials increased the net long position by around 25%.

Bernanke Somber, but Seems Cautiously Optimistic

Fed chief Bernanke is speaking on the economy to a a gathering of southern state governments. Given Bullard's concerns about deflation expressed last week, Bernanke's comments were anxiously awaited. They do not seem as worrisome as many had expected. He does not address monetary policy per se, but does seem to hold out the possibility that rising wages will help spur household demand and this coupled with rising demand from businesses should allow the economy to continue to expand at a moderate pace. At the same time, he recognizes the forces restraining the economy, among which he cited the efforts by state governments to reduce their combined $84 bln deficit.

More Tightening To Underpin Rupee

The central bank of India tightened policy last week by raising the reverse repo rate 25 bp to 5.75%. It is the fourth tightening move in five months and more tightening is likely in the coming period.

The central bank raised its 2010 GDP forecast to 8.5% from 8% last weekand lilfted its inflation forecast to 6% from 5.5%. The strength of the economy is running into capacity constraints and officials have signalled more forceful restraint is needed.

Capital Market Developments on Monday

One of the key fundamental developments that have helped spur the downside correction in the US dollar in recent weeks has been the divergence of economic data between the US and Europe. This trend is continuing and the contrast is clear with today’s purchasing managers’ surveys.

The euro zone reading of 56.7 was a little above the flash reading of 56.5 and well above the June reading of 55.6. Of note, Spain and France surprised on the upside, while Italy was a bit softer, while Germany was spot on. While the pace of the manufacturing recovery is expected to slow by many economists, there is little evidence in today’s data. And Spain’s showing (51.6 vs 51.2) included a strong rise in the output sub-index, would seem to dilute, at least on the margins and for the moment, the IMF’s concerns expressed last week that Spain’s deficits projections were based on too optimistic of growth forecasts.

New Month Same Forces

The US dollar is broadly mixed. Poor sentiment toward the greenback, following last week’s soft Beige Book, talk of the potential need for quantitative ease by a Fed official often seen as a hawk, soft Q2 GDP figures, coupled today with fairly positive European PMI readings have conspired to keep the pressure on the dollar in general. The dollar, bloc, sterling and the Scandi currencies are leading the way. The euro, for its part, is trading choppily in the upper end of last week’s trading range. The Swiss franc and yen are under-performing and are losing a bit of ground amid a stronger appetite for risk. Emerging market currencies in Asia and Europe are generally extending recent gains and Latam is expected to do likewise.