Currencies Consolidate; Scottish Jitters Past Peak?

The US dollar is mostly softer, but a consolidative tone continues. The news stream is light. Participants are still trying to navigate the week while looking at next week's critical events. These include the Scottish referendum, FOMC and SNB meetings, Sweden's election, and the launching of the ECB's TLTRO facility. Catalonia's parliament will decide whether to authorize a referendum (early November), even though Madrid has rejected it.

There seems to be a reasonable chance that the anxiety induced by last weekend's YouGov poll showing a majority favored Scottish independence is past its peak. Three developments point to this possibility:

1. Other polls show the "No" camp still with a slight majority.

2. RBS, Lloyds and Standard Life have reportedly indicated that if Scotland votes for independence, they will consider moving their headquarters to London.

3. It is not fully appreciated, but the Scottish National Party confirmed last night (via UK Telegraph) that the Northern Isles, like Shetland and Orkney, could opt out of an independent Scotland (either as a separate country or remain with the UK) They would retain control over a large part of the North Sea oil and gas that was ostensibly going to fund that new independent Scotland.

Sterling itself staged a key reversal yesterday, making new lows for the move, down to almost $1.6050 and then rebounding to $1.6230 and closing above the previous day's high. There has been a little follow through buying that lifted sterling to $1.6255. This represents a new high on the week. It means that the gap created by the sharply lower opening in Asia on Monday has been entered, but not closed. It extends to last Friday's low just above $1.6280.

Recall, sterling fell a bit more then six cents from the middle of July through the end of August. It has fallen roughly another six cents since. The first half of the move seemed to have been about technical profit-taking, softer economic data, and "temporal inconsistencies" with forward guidance. The second half of the move was sparked by the surging US dollar and Scottish anxieties. The $1.6280 area also corresponds to a retracement objective of the last leg down. Above there, there is potential toward $1.6350. Ideas that a "yes" vote would hit the UK economy and push out the first rate hike mean that a "no" vote would see the UK debt market come under stronger pressure.

There are four other developments that are on international investors' radar screens today. First, Australia reported a too-good-to-be-true jobs report, and the knee-jerk positive reaction that lifted the Aussie above $0.9200 was quickly reversed. It was pushed to $0.9125 before finding a good bid. Australia reported 121k increase in employment. This consisted of almost 107k part-time positions. The statistical agency confirmed its figures, but the investors see some sort of statistical quirk. The unemployment rate fell from 6.4% to 6.1%, and the participation rate increased to 65.2% from an upwardly revised 64.9%.

Second, China reported subdued inflation in August, and this boosts speculation that this gives officials more space to pursue stimulative policies. August consumer prices rose 2.0% from a year ago, down from 2.3%, and lower than expected. The pace of food inflation cooled to 3% from 3.6%. Non-food prices increases slowed to 1.5% from 1.6%. The pace of producer price deflation quickened to -1.2% from -0.9%. It has not been positive for nearly two years.

Third, deflationary forces returned to Sweden. August CPI is -0.2% year-over-year from a flat reading in July. The year-over-year rate has been negative for seven of the past 11 months. The underlying rate of inflation eased to 0.5% from 0.6%. Separately, but also disappointingly, the unemployment rate jumped to 7.4% from 7.1% in July.

Fourth, Japanese life insurers and pension funds were reportedly heavy sellers of JGBs today. The poor reception to the Japan 5-Year bond auction did not help matters. Japanese investors themselves seem to be the featured yen sellers recently, though speculators in the futures market have continued to amass a huge gross short position.

The weekly MOF data showed Japanese investors have stepped up their foreign bond purchases, and last week was the highest in a month. They also bought foreign stocks. While foreign investors bought Japanese bonds and stocks, they did not have to buy yen to do this, as the sale of Japanese money market instruments is largely funding the purchases. There is much speculation about the government pension funds and their diversification.

The US dollar has made 10 consecutive higher highs against the yen and briefly poked through JPY107. The dollar bulls have met little resistance. They will continue to press their case. Since the greenback is at multi-year highs, it is difficult to find meaningful chart points shy of JPY110. Outside of the US initial jobless claims and Canada’s new house price index, the news stream from North America will be light.

There is much talk (see yesterday’s front page Financial Times report) trying to link the dollar’s rally to a changing view of Fed policy. This seems to miss the mark. We recognize that short-term US rates, most impacted by shifting Fed expectations, have risen. However, the move is minor. The June 2015 Eurodollar futures contract implies a 4.5 bp move since the end of August. It seems rather clear to us, the latest leg up in the dollar was spurred by the ECB’s decision last week, the threat of the SNB following with negative rates, and the heightened anxiety over Scotland.