Dollar Consolidates Gains

Asian participants initially tried to extend the US dollar's pre-weekend losses found little satisfaction. This seemed to encourage momentum traders in Europe to pare back long dollar exposure. However, North American traders may take advantage of the pullback to get on an underlying trend.

The MSCI Asia Pacific Index slumped 1.75% and appears technically poised for additional declines. Japanese stocks initially rallied as the dollar extended its gains against the yen. However, profit-taking pressures proved too great. The Nikkei has risen 17% since the mid-June low. While the Nikkei was off 1.4%, Chinese shares were off nearly twice as much. The CSI 300 Index fell 2.8%, with the Shanghai Composite shed 2.4%, completely offsetting last week's 1.4% rise.

The dollar advanced against all the Asian currencies, with the Indian rupee's 1.25% drop (to new record lows) leading the way. Of note, South Korea will lean against the backing up of interest rates, sparked by the rise in US yields. South Korea indicated it will provide KRW6.4 trillion (~$5.6 bln) of support to corporate bonds. It will issue "primary collateralized bond obligations in an effort to provide more liquidity, that are backed by a KRW850 bln guarantee by the central bank and government.

Japan reported a somewhat smaller than expected May current account surplus (JPY540.7 bln vs consensus JPY604 bln) and is up 58% from a year ago. The trade deficit itself was JPY906.7 bln. This compares with a year ago shortfall of JPY804.9 bln. However, exports are recovering and the 10.1% year-over-year rise in May's merchandise exports (reported in mid-June) is the fastest pace since December 2010. The weak yen that boosts imports and may help boost exports also helps flatter the investment income surplus. This more than offset the trade deficit to produce the current account surplus. The investment income balance stood at JPY1.523 trillion in May (an 8.6% increase year-over-year). Separately, Japan reported the bank lending continued to expand. The 1.9% increase in June was most in nearly 4 years and represents the 20th month of gains.

In Europe, the Troika appears to have worked out a tentative agreement with Greece that will likely lead to the Eurogroup support for the disbursement of another tranche of aid. Greek bonds have extended the pre-weekend rally and the 10-year benchmark yield is below 10.6% for the first time in more than a week. The Portuguese coalition government has reconciled its differences and Portugal's bonds and stocks have rallied. Recall in response to the political stress, S&P had cut Portugal's outlook to negative from stable.

Investor confidence in the euro area was weaker than expected, despite the PMI data suggesting that cyclical recovery was unfolding, with the Sentix measure falling to -12.6 from -11.6. The consensus had looked for a small improvement.

Perhaps more importantly, a Der Spiegel article suggests that the ECB was closer to delivering a rate cut last week than is generally perceived. The article suggests that Praet, and perhaps Draghi, were inclined to cut the refi rate, but that seven members, including Weidmann, Asmussen and Knot opposed. Nevertheless, this seemed to help the Euribor futures extend their recent gains.

Meanwhile, data continues to warn that the German economic engine is slowing. Recall the manufacturing PMI disappointed, slipping from 49.4 to 48.8 and has not been above the 50 boom/bust level since February. Today it reported an expected decline in exports (-2.4% month-over-month in May, seasonally and workday adjusted). Imports increased 1.7%; producing a smaller than expected trade and current account surplus and implying a smaller Target2 surplus.

The 1.3% drop in May factory orders (vs +1.2% consensus) reported before the weekend helped prepare the market for today's 1.0% decline in industrial output. The weakness was widespread. Manufacturing output fell 0.7%, led by a 2.3% slump in capital goods. Construction was off 2.6% and energy output fell 1.5%.

Separately, Sweden also disappointed. Industrial output fell 2.6% in May. The Bloomberg consensus had expected a gain of 0.6%. Adding insult to injury the April's 0.5% decline was revised to -1.1%. This translates into a year-over-year contraction of 7.3% from -1.1% in April. Industrial orders slumped 2.6% in May after a 10.3% slide in April, suggesting the pipeline is drying up too. The economy is stumbling, yet the Riksbank last week was slightly less dovish. The market has responded by selling off the krona. Last Thursday/Friday, the euro recorded a low near SEK8.61. Today it briefly moved above SEK8.80.

The week begins slowly for North America. The US reports consumer credit, which is not a market mover. No Fed officials speak today, though Bernanke's midweek speech on economic policy in Boston is awaited. Canada reports building permits (where some weakness is expected) and the senior loan officer survey.