Germany Blocks Feint

The foreign exchange market is quiet, and the US dollar has been confined to narrow ranges.   Sterling's probe higher faltered in front of $1.7150.   The dollar steadied against the yen, but only after slipped to JPY101.45, a five-day low.  The euro rose to $1.3630, a four-day high.  The dollar-bloc is flat, though the New Zealand dollar remains firm.  

The news stream is light.  China's inflation readings were the most important data reported.   However, it did not seem to impact the market and Chinese shares, like the region as a whole, fell in the wake of Wall Street (S&P 500) largest decline in nearly a month.    After the US market closed yesterday, Alcoa kicked off the earnings season with a report showing stronger than expected profits and revenues.  Conviction is low.  Many had argued that the market needed a pullback, but what was in mind was more than a one-day event.  Since mid-May such pullbacks have lasted 2-3 days.  

China's CPI rose 2.3% from a year ago.  This was a touch less than expected and down from the 2.5% pace reported for May.  Food price rose 3.7% in June after a 2.7% pace in May.  However, non-food prices remain tame at 1.7% (up from 1.6%).  Producer prices continued to fall as they have since early 2012.  The 1.1% decline in June (year-over-year) is the smallest decline in two years.  With inflation contained, there is some room to maneuver if needed.  The yuan traded at its best level since early April today, as the Strategic Economic Dialogue talks with the US begin.  This area (a little below CNY6.20) appears to be the lower end of the new trading range.  

The Bank of England starts a two-day MPC meeting today.  The weakness in industrial output figures yesterday and the BRC shop price report likely ensures an uneventful meeting.  The BRC reported the largest fall in shop prices in 8 years.  The 1.8% decline in June  follows a 1.4% decline (year-over-year) in May.  Non-food prices fell 3.4%, amid cheaper furniture, electrical appliances and clothes.  Food prices rose 0.6%. Pushing in the same direction was the softer than expected Halifax house prices, which eased 0.6%, twice what the consensus forecast in June.  

As is their wont, many seemed to over correct expectations for the first BOE rate hike.   The swing from late 2015 to late this year seems to have been exaggerated.   Price pressures are still easing in the UK and sterling's appreciation on a trade-weighted basis, has already tightened conditions.   Wage growth is nearly non-existent.  While enjoying robust growth, the UK economy no long appears to be accelerating.    

This sense of a lack of urgency likely shrouds expectations for the FOMC minutes as well, which will be released in the US afternoon.  There US is in a sweet spot, as it were.  Tapering itself is on auto-pilot.  It is too early to spend much energy on the timing and pace of future tightening.   

 More people participate in the FOMC meeting than actually vote.  This gives the minutes a more diffused sense.   There are two issues that seem to be potentially contentious, but we continue to argue that Yellen provides the signal.  First, is the willingness to dismiss the recent rise in various price measures.  Second, is the role of monetary policy in securing the Fed's third mandate--financial stability.  Yellen's argument that this macro-prudential policy and regulation is the first line of defense has been echoed by the BOE and the ECB, over the objections of the BIS. 

As the JOLTS data yesterday underscored, the Federal Reserve is making palpable progress toward its other two mandates--price stability and full employment--as they have defined them.  Also the consumer credit data showed another healthy rise.  However, the jump in credit card usage in April was not repeated in May.  The $19.6 bln increase in overall consumer credit in May caps a three month period that saw the fastest rise since early 2011.  Non-revolving credit, which increase auto and student loans, rose $17.8 bln, the most in a year.  For the record, loans by the Federal government (mostly student loans) rose by $4.4 bln.  Revolving credit (credit cards) increased $1.79 bln after the $8.85 bln increase in April, which was the largest since before the crisis. 

Lastly, we note the German success yesterday in beating back an unorganized attack by a challenger that the media appeared to have bolstered.   No, this is not a reference to the World Cup, but to Italy's Renzi's attempt to exempt "digital infrastructure" from deficit calculations.  It was a poorly planned feint to soften the Stability and Growth Pact restraints.  Renzi's own Finance Minister Padoan seemed to cast dispersions on the idea.  The attack was easily blocked and deflected.  It is unfortunate way to start Italy's 6-month stint as the rotating EU president.  

There are two weaknesses of Renzi's parry.    It might have been more persuasive if Renzi had argued that spending on immigration or military (a NATO commitment that Germany falls shy of fulfilling) should be excluded while "digital infrastructure" sounds like a boondoggle, especially given other infrastructure funds available that have not been spent.  On the other hand, trying to separate good from bad expenditures is more smoke and mirrors.  

European officials pride themselves on the elaborate construct of rules.  Often the key is in the interpretation, or the spirit not the letter of the law.  The real battle that is being fought out is over the interpretation of the Stability and Growth Pact.  Lawyers can have their say, but it is ultimately a question of politics.   It might not be a 7-1 score, but the first victory of the Italian EU presidency goes to Germany.