Dollar Slips, Dollar-Bloc Still Heavy, Market Awaits Fresh Push

Fresh dollar positive developments have not materialized. Moody's did not downgrade France before the weekend. The ECB's Visco played down the need for additional stimulus after last week's disappointing TLTRO. Iwata, formerly at the BOJ, cautioned against continued yen declines, suggesting that the JPY90-JPY100 range reflects fundamentals.

The dollar's pullback has been quite modest, and it remains well within the ranges seen before the weekend. The divergence between the US and UK on the one hand, which are expected to raise rates next year, and the eurozone and Japan, on the other, which are easing and may ease further, remains a dollar bullish story.

US yields have also eased in recent sessions. The U.S. 10-Year yield is trading near 2.56%, down 8 bp from the recent high, and near a five-day low. European bonds have also rallied, and spreads have narrowed against Germany. This is especially true of Italy and Spain.

In a weekend interview, the Bundesbank's Weidmann left no doubt that he opposed the ECB's recent decision to cut interest rates and introduced an asset-backed securities purchase program. Weidmann argued that it posed a moral hazard for banks. Being able to sell ABS to the ECB allowed banks to transfer risk from themselves to taxpayers. This is the point that most observers stress, but Weidmann's critique is broader.

Weidmann argues that this is exactly the opposite of the direction that officials have agreed to move to. He argues it is bad politics in that it takes pressure off governments to implement structural reforms. If the ECB would stop trying to "rescue" the EMU, governments, especially in France and Italy, would be more incentivized to enact the reforms that create the conditions for growth and stability.

Therein lies the rub. ECB words and deeds have helped push down interest rates to incredibly low levels. This eases the debt servicing burden, and in turn allows the issue of structural reforms to be demoted to only important, and no longer urgent. Yet, if Draghi and the ECB did not do anything, the existential issues, like the sustainability of the EMU itself, would overwhelm policy makers and investors.

The euro's recovery from the last pre-weekend sell-off faltered near $1.2870. A move above $1.2910 would likely squeeze some of the late shorts, many of whom are looking for $1.2750 as the next downside target.

Sterling was hit by a classical "buy the rumor sell the fact" type of activity after the Scottish referendum. Speculators bought into sterling's decline toward $1.60 and had driven sterling up four cents off its lows ahead of the results. There was no follow-through selling in Asia or Europe after the horrific price action before the weekend. $1.6400 offers initial resistance. It may take some upward pressure on UK rates to strengthen the bulls' conviction.

In recent days, there have been a number of voices that have begun cautioning about continued yen weakness. This reinforces our sense that the JPY110 represents what could be the top of the new range for dollar-yen. First, the junior coalition partner in the LDP-led government, the New Komeito, suggested last week that excessive yen weakness needed to be avoided. Second, there was a news wire survey that found many Japanese corporations do not see a weaker yen as helpful. Third were comments earlier today by Iwata, formerly of the BOJ, cautioning against a yen over-shoot to the downside.

These are not the usual voices that would be heard if there were some caution as a preemptive move ahead of the US Treasury's next report on the international economy and foreign exchange market. The report is expected next month. Much to the surprise of economists and much to the chagrin of Japanese officials, the weaker yen has not spurred much of a rise in Japanese exports. This may help temper a more strident reaction by Japan's trading partners. Nor is Europe really in a position to push back, as ECB and French officials have been explicitly taking the yen lower.

The dollar-bloc remains heavy. The Australian dollar is said to have been dragged lower by concerns about China ahead of the release of the flash HSBC manufacturing PMI first thing tomorrow in Beijing. In addition, there have been press reports highlighting the possibility that macro-prudential measures are used to rein in the housing market. The Australian dollar is making new lows for the move, approaching a target near $0.8850.

The Australian dollar is the weakest currency today, losing about 0.65%. The New Zealand dollar is down half as much and is the second weakest of the majors. Prime Minister Key won an absolute majority in parliament, but it does not impact sentiment much. It is barely holding above last week's lows, near $0.8080. The Canadian dollar is third weakest of the majors, slipping about 0.25%. The Bank of Canada's Poloz pressed his point that the uptick in inflation is temporary, and the excess capacity will still take several quarters to absorb.

The US reports August existing home sales, which have been on a rising trend since the end of Q1. However, the focus will be on Draghi's speech to the EU Parliament committee in Brussels. His comments in light of the poor TLTRO launch will be important. In the US, given the confusion between the dovish FOMC statement and the hawkish forecasts, Fed comments are likely to be scrutinized. NY Fed's Dudley speaks around the same time as Draghi. Although he is a regional president, we identify Dudley as part of the signal-generators at the Fed. Kocherlakota also speaks today. The Minnesota Fed President is a bit more dovish that the Troika (Yellen, Fischer and Dudley).