May Day Surprises, Dollar Mixed

The May Day holiday has limited market participation, but has not prevented surprises.  The Reserve Bank of Australia kicked it off the celebration with a 50 bp rate cut. 

Although after the recent series of soft price data there was some risk (about a 1 in 3 chance according to market indications) of a 50 bp move, most observers, like ourselves, thought  central bank would move gradually as is its modus operandi.  However, in hindsight, what seemed to be a important factor is that, as we had noted at the time, Australian banks had increased mortgage lending rates despite the RBA's rate cuts.  The 50 bp move increases the likelihood that lower rates are passed on to the consumer and more the overall economy more broadly. 

Australia's manufacturing PMI was also dismal, falling to 43.9 from 49.5.  The weakness was broad based and or particular concern new orders fell to 42 from 48.2.  This forward looking measure encourages ideas that the RBA is not done.  The market is pricing in another 50 bp worth of cuts later this year, starting again toward the second half of Q3. 

The Australian dollar is easily the weakest currency today, dropping over 1%, looking poised to retest the $1.02-$1.0250 support band.  Ten -year Australian interest rates now stand at record lows. 

Japan has surprised the market too.  Well, not really Japan, but the yen.  The dollar fell to near two month lows against the yen near JPY79.65.  The yen has now recouped the bulk of the weakness sparked, at least in part, but the unexpected easing in mid-Feb.    Japanese official jawboning has begun again with the break of the JPY80 level.  However, material intervention is unlikely at this juncture.  It probably requires a move toward JPY76 to increase odds.   Meanwhile, the JPY80 area should now offer resistance.  

Two other elements to note in Japan.  First, auto sales have surged in April to 92.6% year-over-year.  It is true the year-over-year comparison are skewed by the horrific events a year ago and helped by government incentives, but still is consistent with the modest economic recovery that appears to be taking hold.  Second, the yield on the 10-year JGB fell to about 88 bp, the lowest since Oct 2010.  The yen and JGBs continue to move inversely to the Nikkei. which lost nearly 1.8%, led by financials and technology sectors.

The UK disappointed the market.  The CIPS manufacturing PMI slipped to 50.5 from 51.9 in March.  The consensus was for a smaller decline toward 51.5.  Two sub-components stand out.  The first is the largest decline in exports in nearly 3 years.  This will turn more observers' attention to the TWI, which we noted yesterday , has appreciated and has offset some degree of monetary loosening. 

Second, the price component (factory gate) rose to a seven month high.   While the Berlin Consensus has it that debtor countries should experiencing domestic deflation to restore competitiveness, the sticky prices in the UK, despite base effects, suggest different approach.  One of the reasons why we have not joined the chorus of "UK in a recession" is that the preliminary estimate of Q1 GDP may be revised and our economic assessment should not be altered by a statistical adjustment. 

Another reason is that two quarters of contraction as a definition of recession is not very robust and appears to be journalistic rather than analytic.     Stagflation is, we suspect, a better characterization of the the state of the UK economy.   Sterling may have bottomed for the day just below $1.6200.  Initial resistance is seen near $1.6240 now. 

Most of continental Europe is off celebrating May Day.  The euro is confined to less than half a cent range thus far today.  Initial support in the $1.3230-40 area held on tests in Asia and in thin European activity.  Another run toward $1.3280-$1.3300 looks likely in North America today. 

Two euro zone countries have reported April manufacturing PMIs.  The Dutch reading fell to 49.0, a three month low.  On a positive note, exports rose.  Ireland's PMI slipped to 50.1 from 51.5, though employment and new orders were firm.  On Wednesday, more countries will report the PMI.

Separately, we have noted that the full range of austerity measures by the Monti government have not fully kicked in and this includes tax increases.  Now we learn that Monti is looking for 4.2 bln euros in new savings to avoid the planned hike in the VAT. 

US reports construction spending, but as it is for Q1, barring a major surprise is unlikely to impact the market, which at the same time will see April manufacturing ISM.  The risk is on the downside of the 53.0 consensus forecast (53.4 in March).