Sterling Pounded, Euro Resilience In Face Of Dovish Draghi

Recall that in November, the UK's manufacturing PMI rose to a new 2-year high of 58.1 from 56.5. It had encouraged economists to look for a gain of around 0.4% in industrial production and manufacturing. Instead, both came out at flat.

Similarly, the construction PMI had risen from 59.4 in October to what appears to be a record high of 62.6 for this relatively new series. However, today's construction output report showed a 4.0% fall (consensus was around 0.8%). This is twice the gain posted in October. Adding insult to injury, the BRC reported a 0.4% rise in like-for-like sales and this was half of what the market expected.

Taken together, the reports should cool calls seen this week from some quarters for a BOE rate hike and the implied yields of short-sterling futures have eased a few basis points. 10-year gilts yields are pulling back from 3%, while dipping below similar US yields. Sterling itself has reversed yesterday's recovery. It is finding some support ahead of $1.6400, but this week's low, set Monday near $1.6340 beckons. The euro, which was near one year lows against sterling yesterday (~GBP0.8230) has rebounded back toward GBP0.8300.

In contrast, following Germany's stronger than expected industrial production figures yesterday, France and Spain reported better industrial production figures today. The former rose 1.3% in November. This is three times more than the market had expected and also in contrast to the weak PMI readings, though in fairness the strength in the industrial production report appeared to stem from electricity and refinery output.

Spain's industrial output rose 2.7% on a workday adjusted year-over-year basis compared with a 2.0% forecast. The report was marred by the revision to the October series from -0.7% to -1.4%. Nevertheless, the take away remains that the Spanish economic recovery continues, albeit uneven and fragile.

Separately, Sweden's industrial production figures were a positive surprise, rising 5.7% in November (consensus 1.0%). Here too, the October series was revised lower (-2.8% from -1.7%). Still, industrial orders were strong, posting a 2.9% rise. The krona is the best performing major currency thus far today against the dollar, rising about 0.4% near midday in London.

Perhaps it was also helped by the softer than expected Norwegian inflation figures, which spurred more speculation that Norges Bank may indeed see scope for a rate cut from the current 1.5%. That said, it is a relatively long time before it meets (March 27) and there are two more inflation reports it will see before then. December CPI slipped 0.1% to 2.0%. The market had expected a 0.2% rise for a 2.3% year-over-year increase. The underlying rate, which excludes taxes and energy, also slipped 0.1% for a 2.0% year-over-year rate.

Not that there is a one-to-one correspondence, but the US 10-year yields has yet to make a convincing break of 3% and the dollar has yet to establish a convincing foothold above JPY105. On the week the yen is fractionally lower. Economic data from Japan this week have been limited. The latest MOF weekly portfolio flow report showed domestic investors stepped up their foreign bond selling in the week ending January 3 and over the past four weeks have sold a net JPY902 bln worth (half last week alone).

For their part, foreign investors continued to trickle money into Japanese shares, purchasing another JPY68.2 bln. The JPY560 bln of Japanese equities bought in the past two weeks has been largely offset by the sale of JPY466 bln of Japanese bonds. In the past, it was thought that the yen would be hedged for the bond exposure but not the equity exposure. Last year seemed to change that pattern and many foreign purchases of Japanese shares were on a hedged basis.

Lastly, we note that China's December trade surplus was almost a quarter smaller than expected at $25.64 bln. Imports rose 8.3% after the 5.3% year-over-year increase in November. The market had expected a small decline. Exports, however, disappointed, with a 4.3% increase after a 12.7% jump in November, which may have been inflated by concealed capital flows.

The main feature of the North American session is the US employment report. The relative accuracy of the ADP report for the last several months suggests that barring a significant surprise, it is unlikely to provide the market with fresh information. The consensus view is that the path that Bernanke laid out last month of measured tapering is set to continue at the FOMC meeting later this month.

And even with this knowledge and after Draghi's relatively dovish comments yesterday, the euro is straddling the $1.3600 area. Thus far this week, it is the best performing major currency against the dollar with a flat showing. Good buying on the pullback to $1.3550 (ahead of the retracement objective near $1.3525) was seen. The premium the US offers on 2-year government paper is edging higher and now at 22 bp is at the upper end of the six-month range. Again, there is not a one-to-one correspondence here with the rate differential and euro-dollar exchange rate, but the larger US premium ought provide the dollar with some support.

Canada also reports December employment data today. The Bloomberg consensus calls for 14.1k net new jobs after 21.6k were created in November. The Canadian dollar is the weakest major currency this week, shedding 2% against its US counterpart. The speculative market, judging from the position in the futures market, was already bearish the Loonie, but the weak data (trade and IVEY) coupled with dovish comments from the central bank gave another push. That said, the market may be moving ahead of itself and seems vulnerable to a positive surprise and even some near-term consolidation may see some momentum traders take some profits off the table.