Sterling Shines

Strong UK employment data helped sterling bounce back after being dragged by the euro to five day lows. Sterling recovered from a dip below $1.6740 in the Asia session to probe the $1.68 area, where the 5 and 20-day moving averages converge. It appears poised to retest the trend line drawn off the highs from early and mid-May and last week's high. It is found today near $1.6830.

The claimant count fell 27.4k, a little more than economists expected, and the April decline was revised to 28.4k from -25.1k. The ILO unemployment rate fell to 6.6% from 6.8%, which is also more than the market expected. While these figures suggest the UK labor market is tightening, the major piece of contrary evidence is that average weekly earnings (reported on a 3-month year-over-year basis) slipped to 0.7% from a revised 1.9% in March (reported with an extra month lag).

The lack of upward pressure on earnings suggests that whatever slack has been absorbed in the labor market, it is not yet sufficient to boost wages. The absence of wage pressures give the BOE great latitude in maintaining low interest rates, especially if rising house prices (notably in the south and London) are addressed with tighter credit (as seen by at least one major UK bank) or through macroprudential measures by the Financial Policy Committee, which meets next week. Nevertheless the expected a more hawkish faction to crystalize in the coming months, leading to a rate hike in Q1 2015.

For its part, the euro extended yesterday's losses and found support near $1.3520 in Asia and retested it in Europe. Losses against sterling (new 18-month lows near GBP0.8050) may have weighed on the euro. Resistance is seen in the $1.3560 area. There has been a dearth of fresh new. A light bought of profit-taking is being reported from the European bond markets and the core yields may be pushed higher by the backing up of US yields ahead of today's 10-year Treasury note sale (followed by 30-year bond sale tomorrow).

Profit-taking is more evident in the equity market, where two stories appear to be dominating attention. Italian banks are the poorest sector in Milan, where the overall market is off about 1.0% near midday. The new rights issue has weighed on Monte Paschi shares, whose shares were halted, limited down after surging more than 40% on Monday and Tuesday. The other main story stock is Lufthansa, which is posting its biggest decline in five years, following company's cut in its earnings projections, due to competition from the Gulf airlines, the early pilot strike and adverse currency changes, according to the company's statement.

There are three developments from late yesterday that are talking points today. First, the World Bank cut its world growth forecasts to 2.8% this year from the 3.2% January forecast. The cut reflects a slower than expected growth in the US (2.1% vs. 2.8%), which is about what one would expect given the unexpected contraction in Q1 GDP, Brazil (1.5% from 2.4%) and Russia (0.5% from 2.2%). The euro zone's growth projection was unchanged at 1.1%.

Second, MSCI not only did not lift Taiwan and South Korea to major market status, it effectively took them off the review list, citing the lack of significant efforts to boost the convertibility of their respective currencies. Separately, MSCI decided not to include China's A-shares (mainland) in its global indices. It cited the quota system, which currently limits foreign ownership to 3% of the market cap. It also thought the ban against same day trading, the prohibition against the use of multiple brokers, and an uncertain tax environment are significant barriers. MSCI did say it will review its decision again next year. In the meantime, before the end of this month, it is expected to announce a stand alone index for A-shares.

Third, the US Congressional elections are five months away, but there was a noteworthy primary yesterday that will be closely scrutinized for insight into the mood of voters. Eric Cantor, the Republican majority leader in the House of Representatives was defeated in the primary contest against a fellow Republican supported by the Tea Party. This appears to be the first time in US history that a sitting majority leader was defeated in a primary.

The strategy pursued by the Tea Party is much different from the protest movement in Europe. There, as seen in the European Parliament elections last month, many protest parties are largely marginalized, though you will not necessarily know that from the traditional media. Nearly 4 in five people who participated, voted for a mainstream party. In the US, the Tea Party is trying to capture one of the two mainstream parties. 

There are no US or Canadian data due today. Late in the North American session, the Reserve Bank of New Zealand is expected to announce a 25 bp rate hike (bringing the cash rate to 3.25%). It is discounted, and there is some scope for disappointment, which could come in one of three ways: stand pat decision, forward guidance that reduces the risk of a follow up move in July, and more strident efforts to talk down the currency.

Sterling Shines Sterling Shines Reviewed by Marc Chandler on June 11, 2014 Rating: 5
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