Dollar Broadly Mixed As Corrective Forces Try To Take Hold

The overall theme today appears to be one of consolidation, encouraged by European data, which included a slightly higher than expected UK CPI and a considerably better German ZEW survey. Japan's Prime Minister Abe has not disappointed the market; delaying the sales tax hike and calling for elections next month.

Still, the major currencies are trading inside yesterday's ranges. Core bonds are a touch firmer as is gold and oil. Equities are moving higher. The Nikkei recouped two-thirds of yesterday's decline, and Europe's Dow Jones STOXX 600 is up 0.7%. The Hang Seng and the Shanghai Composite fell. The two-day drop of the Hang Seng is the largest in nearly 2 1/2 years. International investors used their full quota (CNY13 bln) yesterday on the launch of the HK-Shanghai link, but today only CNY4.8 bln was used. The disappointment weighed on brokers and security houses.

Separately, we note that Hong Kong officials have cleared some of the Occupy Central barriers with little fanfare. There was not a significant confrontation in this delicate situation. The Mong Kok occupation, which has been more aggressive in recent weeks, may pose a more formidable challenge.

Following last week's BOE Quarterly Inflation Report that highlighted the downside risks to inflation in the coming month, the UK today reported slight higher than expected consumer prices. The year-over-year pace rose to 1.3% while most had expected an unchanged reading at 1.2%. Education and clothing prices were firm. Fuels and transportation prices fell. The core rate was unchanged at 1.5%. Input producer prices fell 1.5% on the month to bring the year-over-year rate to -8.4% from -7.4% in September. Output prices fell 0.3% on the month for a -0.5$ year-over-year rate.

We would not read too much into this data. The implied yield of the December 2015 short-sterling futures contract slipped and is now 16 bp from last Tuesday, the day before the QIR. The OIS curve implies that the market has pushed out the first hike toward November 2015.

Turning to politics, we note that UK polls show a virtual dead heat between the Conservatives and Labour. However, polls in Scotland have shown that Labour's opposition to Scottish independence is likely to cost it most of its seats there. Many see this as increasing the likelihood of a Tory victory next May.

The better than expected German ZEW survey may help ease concern about Europe's locomotive. The assessment of the current situation rose to 3.3 from 3.2. It does not sound like much, but the consensus expected another decline. This measure has fallen four months in a row after peaking in June at 67.7. The expectations component jumped to 11.5 from -3.6. The consensus was for 0.5. This component had fallen every month this year until now.

The euro extended the upticks seen in Asia and in early European morning, peaking near $1.2540. Yesterday's high was just below $1.2580. We have noted that the euro's upticks have been checked by the 20-day moving average. It frayed yesterday but quickly reversed lower. Today it held.

Although the media made a big deal about Draghi's testimony yesterday before the EU Parliament, we do not think new ground was broken. At the ECB meeting earlier this month, Draghi indicated the staff would expand its efforts to look for other ways for the ECB to expand its balance sheet, with an eye toward downward revisions to its economic assessment. However, if there is a takeaway, we suspect it's that officials want to give more time to current efforts, which means no major new initiatives next month. We note the ABS program has yet to be launched. The covered bond purchases are a bit stronger than many expected, averaging a little more than 500 mln euros a day. The second TLTRO is in a few week and is expected to be around 175 bln euros.

Japan’s Abe did as widely anticipated following yesterday’s horrific GDP data. The sales tax increase will be postponed and there will be an early election for the lower house next month. The sales tax was not popular, yet the delay might not help Abe and the LDP very much. Many anticipate the LDP to lose several seats, but not to jeopardize its majority. Simply, if crudely put, there is no compelling alternative.

At the same time, we would argue that the media reports calling Abenomics a failure are missing the key point. Abenomics was about aggressive monetary and fiscal stimulus. The sales tax increase was not part of Abenomics. Indeed it countered it. The postponement of the sales tax, coupled with a supplemental budget, puts Abenomics back on track. Structural reforms are still important, but rather than a big bang, there are many modest measures that can culminate into a more significant impact over time, though there is more work to be done.

The rating agencies will not like the delay in the sales tax. Fitch has already warned of this. It will complete its review of Japan’s rating before the end of next month and a downgrade is possible. An impact of the downgrade, however, may not be significant, with the BOJ aggressively buying JGBs.

The North American session features the US PPI and TIC data. US producer prices are likely to be softer due to the fall in commodity prices, especially energy. The core rate may be firmer. However, the market impact is likely to be minor. This general pattern is likely to be repeated later in the week with the CPI report. The TIC data tends to be too volatile and too dated to have much market impact either.

Lastly, note that the US Senate is expected to vote on the Keystone Pipeline. The Senate had passed the measure before, but not by enough to overcome a presidential veto. The key number is 60 votes, and the press reports that there are 58-59 votes lined up, making it a bit of a cliff hanger. If it fails to muster the 60 votes, there will likely be another attempt early next year, when the new Congress is sworn in and the Republicans have a majority in both houses, which makes passage more likely.