Japan Shocks, BOE Warns, Europe Prepares

The US dollar is mostly higher to start the week, with two exceptions. The first is the yen. The unexpected contraction in Q3 GDP triggered a stock market slide (Nikkei off 3%, giving back around 40% of this year’s gains) and spurred a dramatic short-covering squeeze in the yen after the greenback first pushed briefly through the JPY117.00 level. The dollar found good bids near JPY115.50 from where it based and returned to the JPY116.30 area in the European morning. The New Zealand dollar is the other exception, helped by a strong retail sales report (1.5% in Q3 vs. consensus of 0.8%).

Dovish comments over the weekend by the BOE’s Carney and Haldine, who played up the disinflation risks, took a toll on sterling. It fell a cent from the Asian high near $1.5735 to return toward the 2014 low set before the weekend.   Economists are pushing out when the BOE will be able to raise rates, and investors are responding accordingly by extending the recent rally in the short-sterling futures contracts.  Since last week's dovish Quarterly Inflation Report, the implied yield of the December 2015 short-sterling futures contract has fallen 18 bp.  The 10-year gilt yield has fallen 16 bp. 

For its part the euro traded as high as $1.2580 in Asia, on follow through buying after the construction pre-weekend price action. However, sellers re-emerged; encouraged by comments from ECB’s Mersch suggesting, at least theoretically, a wide range of assets the ECB could buy, including gold shares and ETFs.  However, Mersch seemed to downplay market speculation that new initiatives would be launched as early as next month, noting that the covered bond and ABS purchases are just beginning.

Although more ECB officials are speaking today, including Draghi before the EU Parliament, the real news may be on the fiscal side.  Reports indicate that the EC is considering seeding new infrastructure investment with EU or European Investment Bank bonds.  This could be a 300 bln euro three-year initiative.  Although the press reports suggesting this is being discussed have not make the connection, it does fit in well with our notion that among the assets the ECB could buy, there is certain appeal and logic to purchasing the supra-nationals, including EU and EIB bonds. 

Equity markets are mostly lower and the launch of the Shanghai-HK stock connect failed to lift local markets.  The Shanghai Composite slipped 0.2%, while the Hang Seng fell 1.2%.   Still, most Shanghai shares climbed relative to their Hong Kong counterparts, as investors reached the daily maximum of mainland shares (CNY13 bln or ~$2.1 bln).  Upon reaching the limit, the link shutdown.  Mainland investors bought about CNY1.8 bln  of their CNY10.5 bln limit.

News of that China and Australia reached a free-trade agreement failed to lend either the Australian dollar or the Australian stock market much support today.    The equity market lost about 0.8%, while the currency is off about 0.25% from where it finished last week.  Two-way trade reached A$151 bln (~$132 bln) in 2013.   About one fifth of Australian's imports last year came form China.  China bought a little more than a third of Australia's exports.  Of note, China has agreed to reverse the recently announced duties on coal imports for Australian producers.  A the same time, private Chinese investment in Australia will be given the same threshold as the US and Japan of A$1 bln before requiring the approval of Australia's Foreign Investment Review Board.  What to do about investment from state-owned enterprises has been deferred in order to reach an agreement. 

There are two US economic reports of note.  First is the Empire State Manufacturing survey.  Its importance lies more with the fact that it offers the first glimpse into November than its particular correlation with other economic readings.  It is expected to rebound toward12 from 6.17, where it had fallen to from 27.54 in September.  The 12-month average is 11.6.   The US also reports October industrial output.  Recall in September it jumped 1.0%, the strongest since May 2010.    This pace is obviously unsustainable and a more modest 0.2% rise in expected in October (12-month average is 0.35%).   Manufacturing output rose 0.5% in September and is expected to have risen 0.3% in October, which is spot on the 6- and 12-month average. 

A key issue that will not be addressed by the data yet is whether the US economy can do well if Japan is contracting and Europe is stagnant.   If it does, will the growth differentials lead to a widening of the US current account deficit ?  If the global headwinds prove too strong, will the Fed  be able to use conventional monetary policy at the end of the business cycle, which is to ask, will it raises rates sufficiently to be able to cut them later. 
Japan Shocks, BOE Warns, Europe Prepares Japan Shocks,  BOE Warns, Europe Prepares Reviewed by Marc Chandler on November 17, 2014 Rating: 5
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