Dollar Soft, Licking Wounds

The US dollar is continuing to sport a soft profile.   In recent sessions, the dollar's weakness has been concentrated against the euro and sterling.  It has been better bid against the yen, dollar-bloc and many emerging market currencies.  However, today it is down across the board, and is essentially flat against the Japanese yen around JPY102.

News that Australia's Q3 capital expenditures were stronger than expected at 3.6%, rather than decline as the consensus expected, helped trigger a bit of a short squeeze.  The Aussie was lifted off of 12-week lows seen yesterday.   The bounce is really more about market positioning than the news as Q2 capex was slashed to 1.6% from 4.0%.  Still, there is potential from a technical perspective toward $0.9200 initially and possible $0.9250.   

The dollar's advance through JPY102 yesterday helped lift Japanese shares.  The Nikkei jumped 1.8% to bring the month-to-date advance to an impressive 9.7%, easily the best performing major market.  The advance is more than 3-times the gain in the S&P 500 for the same period.  Foreign investors still have not had their fill.  The MOF data shows non-resident investors snapped up another JPY707 bln worth of Japanese equities last week on top of the nearly JPY1.3 trillion bought the previous week.  The four-week average of JPY631 bln is the highest since May.  Here in November, foreign investors have bought about $25.2 bln of Japanese shares to bring this year's total to $131.2 bln.  That said, anecdotal reports suggest that these foreign purchases may carry high hedge ratios.  

On the other hand, Japanese investors continue their buying spree of foreign bonds that has been extended into the seventh week. This appears to be the longest buying streak of the year.  Over this period, Japanese investors have bought about $52 bln of foreign bonds.   

Worries about deflation in Europe may ease a bit with today's report.  Spain reported that the EU harmonized measure rose to 0.3% from a flat reading in Oct.  Its own national measure rose to 0.2% from -0.1%.  Germany's harmonized measure is expected to have edged up to 1.3% from 1.2%.   The disinflation or even deflationary conditions in the periphery of Europe may be desirable(from an official point of view) insofar as it reflects the kind of internal devaluation that is necessary to restore competitiveness under the conditions of monetary union and the ordo-liberalism being enshrined.  

However, the headwinds on the financial conditions remains strong, even though the DAX is trading at new record highs.  These headwinds are evident in today's money supply report.  M3 slowed to 1.4% from 2.1%.  The 3-month average also slowed to 1.9% from 2.2%, which is the slowest pace in two years.   Even more striking is that fact that lending to households and businesses continues to contract (-2.1%). Lowering the repo rate is obviously not going to spur fresh lending. Nor will a negative deposit rate, which seems to be potentially very disruptive.  

Ironically, the latest reports suggested that ECB is considering its own funding-for-lending scheme just as the BOE's Carney announced a reduction in the UK's version.  According to the press report in a German paper yesterday, the ECB may make new LTRO borrowing conditioned on new lending.  We are concerned that will the looming stress tests that the strongest financial institutions will not be very interested in new LTRO borrowings, leaving the weaker banks.  This means unlike the previous LTROs, there may be a stigma attached.  In addition, it appears regulatory pressure and the ongoing deleveraging is a critical driving force of the lack of lending.  It is not some much a question about the level of interest rates or even access to funding any more.  

Separately, the euro area SENTIX surveys generally showed improvement and Italy reported a modest increase in business confidence for the seventh month in November and it now stands at a 2-year high. Berlusconi was evicted from the Italian Senate without much fanfare.   A few months ago, this could have unsettled Italian markets, but now have taken it in stride.  

The split in the center-right and the passage of the 2014 budget with a confidence vote suggests greater political stability than had appeared to be the case.  Prime Minister Letta faces a leadership challenge early next month.  However, even if Letta loses, it is not clear that Renzi, his most notable rival, will try to push him out.  It may make more political sense to push Letta to make some hard decisions and make some real reforms first.  

The euro edged through yesterday's highs by a few ticks.  It has neared the 61.8% retracement of the decline seen from the year's high set in late Oct near $1.3830.  That retracement objective is found just below $1.3630.  The $1.3560 area now offers support.  Meanwhile, the euro continues to make its way toward JPY140.00.  

Sterling has risen nearly 2 cents from Monday's lows to test the $1.6350 area today.  The home builders' shares did not react favorably to Carney's changes in the funding-for-lending scheme, which will no longer support mortgages and the FTSE is under-performing.  However, despite denials by Carney, the market sees the move as signaling the increased risk that UK rates rise early.  The implied yield on the short-sterling futures strip has risen a few basis points.  The Dec 2014 contract implies a yield of about 75 bp compared with the 50 bp base rate.  Initial support for sterling is seen near $1.6300.  

Lastly, we note that as widely expected Brazil's central bank hiked the Selic rate 50 bp to 10% late yesterday.  It is the sixth hike in the tightening cycle that began in April.  The Selic has been hiked by a cumulative 275 bp.  The statement, however, was neutral and by reminding investors of the magnitude of the past hikes, the central bank may be signaling that it may slow the pace.  The next hike, early next year, may be a more modest 25 bp.