Disappointing Euro Area and Japanese Data Underpin Greenback

Ahead of the ECB's meeting on Thursday where details of the ABS/covered bond purchase scheme are expected to be delivered, the market is particularly sensitive to developments that could spur a strong policy response. Today's preliminary September CPI figures were seized upon to drive the euro to fresh lows, against both the dollar and sterling.

The disappointment was not so much with the headline rate that slipped to 0.3% from 0.4%, but after yesterday's somewhat firmer than expected Spanish and German readings there was hope of a slightly better report. Rather the problem was with the core rate, which the ECB does not give as much importance to in their rhetoric as the Federal Reserve. It unexpectedly slipped to 0.7% from 0.9%. After testing the $1.2700 area in Asia, but midday in Europe, the euro was pushed through $1.26. The $1.25 level is the next obvious target.

The news also helped lift Spanish and Italian bonds, and helped buoy the equity markets. Greek bonds continue to under-perform. The benchmark Greece 10-Year yield is up about 25 bp to bring the increase to almost 70 bp. We are picking up growing concern among investors about next year's Greek presidential election and the possibility that it forces new parliamentary elections. This in turn is thought to increase the likelihood of a Syriza victory and its anti-EMU stance.

Earlier in the European morning, France and Germany reported better consumption data. Household consumption rose 0.7% in France. The market had expected a 0.3% decline after the 0.9% rise in July. The 1.4% year-over-year rate in August was twice what the market expected, though down from the 1.8% reading in July. For its part, Germany reported a 2.5% increase in August retail sales. The markets expected a 0.5% increase after the disappointing 1.1% decline in July. Separately, Germany reported an unchanged unemployment rate (6.7%), but the second consecutive increase in the number of unemployed (12k), which is also the fourth increase in past five months.

The euro drew little comfort from the constructive consumption data but reacted strongly to the disappointing CPI report. This says as much about speculation that the ECB will be forced to take more action as it does about the market's bearish stance to the euro. Meanwhile, Germany's Sinn, which previously made a stir about the Target2 imbalances, which have been reduced, has an op-ed piece that urges a constitutional challenge to the ECB's asset purchase plans, The European Court of Justice is expected to make delivery a judgment on the OMT challenge toward the middle of October.

The small upward revision to the UK's Q2 GDP to 0.9% from 0.8% is lost in the shuffle. There is more talk about a third Tory backbencher defected to the UKIP. However, the Swedish and Norwegian currencies are strong. The krona is extending yesterday's gains against the euro, spurred by its strong retail sales report. The euro is approaching the lower end of its three-month trading range near SEK9.12. Norway reported slightly disappointing retail sales data today (0.6% vs 0.8% expected), but news that the central bank will buy NOK250 mln a day in October was more than twice as large as expected and helped underpin the krone. The euro is testing support around NOK8.10.

Asian news is mostly disappointing. The HSBC manufacturing PMI for China slipped to 50.2 from the 50.5 flash reading. It is unchanged compared with August. South Korea reported an unexpectedly sharp drop in August industrial production. It slumped 3.8% on the month. The consensus was for a 0.1% gain after an upwardly revised 1.5% rise in July (initially 1.1%).

Japan also reported disappointing industrial output figures. August was expected to have seen a 0.2% increase in output. Instead, it fell 1.5%. On a year-over-year basis, industrial production is off 2.9% in Japan. Separately, overall household spending is 4.7% lower in August from a year ago. The market expected only a 3.6% decline. This negates the stronger, but narrower, measure of retail sales which rose 1.9% in August, considerably more than the 0.5% expected.

Japan did report some better data as well. The unemployment rate fell to 3.5% from 3.8%. This was not expected. Cash earnings rose 1.4% in August (year-over-year). The consensus was for a 0.9% increase. The July series was revised to 2.4% from 2.6%. Base wages rose 0.6% year-over-year, which the fourth monthly gain and twice the pace of July. However, when all is said and done, the fact is, real wages are 2.6% lower than a year ago compared with 1.7% lower in July. It is the 14th month that wages have not kept pace with inflation.

We anticipate the weakness of the yen will boost inflation, and in turn, this will take off some pressure off the BOJ to do more. The economic weakness was a function of the fiscal policy (sales tax hike), and fiscal policy will have to be used to address it. A supplemental budget is given, the key issue not is the size. The Q3 Tankan report is out first thing on Wednesday in Tokyo. Softer sentiment is expected across the board.

Data from the US today tend not to be market movers. These include July CaseShiller house prices, where increases are expected to slow, the Chicago PMI, which is expected to tick down, and the Conference Board's measure of consumer confidence. Canada reports July GDP, which is expected to have risen by 0.3%, the same as June.

There is still much discussion of the impact of the departure of Bill Gross from PIMCO. Many observers suspect that his flagship fund was long credit and short Treasuries. The price action suggests that participants are trying to anticipate what the likely redemptions will mean and some credit products have traded heavily, while US Treasuries rallied yesterday.