FX Consolidating Into The Weekend

The foreign exchange market is digesting this week's developments, and especially signs that the period of peak liquidity remains for the foreseeable future. At her confirmation hearings, Yellen gave no succor to those thinking a December tapering was likely after the recent constructive data, including last Friday's stronger than expected employment data. The ECB's chief economist Praet played up the central bank's options to prevent Japanese-style deflation. For Japan's part, surveys continue to indicate widespread expectations that the BOJ will have to do more to achieve its 2% core inflation target for the next fiscal year.

Arguably, the BOE stands out as an exception in that it now projects reaching its unemployment threshold sooner than it had thought a few months ago. Yet on the week, the implied yield on the Dec 14 short-sterling futures fell 7 bp this week to 73 bp and the implied yield on the Dec 15 contract fell 11 bp to 1.34%. Sterling has under-performed this week. It has gained about 0.30% this week, half as much as the euro.

General consolidation appears to be the rule of the day. The euro is trading in narrow ranges, within Wednesday and yesterday's range. The $1.35 level has blocked the upside, while support has been established near $1.3350. Sterling is quiet in the upper end of its two week trading range, which comes in near $1.6100-20. Although it briefly broke through the neck line of the double top pattern we have been monitoring, which comes in just below $1.59, it has not closed below it.

Today is the fourth consecutive session the Australian dollar has chopped in the $0.9280-$0.9400 trading range. It is not immediately clear whether is its building a base or nesting before taking another leg lower. Similarly, this week the US dollar has confined, with a few brief exceptions to last Friday's trading range against the Canadian dollar; roughly CAD1.0445-CAD1.0500.

The lack of fresh trading incentives today has conspired with the need of participants to digest this week's developments to allow the $5.3 trillion a day foreign exchange market go into the weekend quietly. The Japanese yen is the notable exception. The dollar has broke above JPY100 for the first time in two months. The yen was the worst performing major currency this week, losing about 1.3% against the greenback. While the yen is soft against most currencies, of note, sterling is trading at four-year highs against the yen.

The premium the US offers over Japan on 10-year money widened 6 bp this week, but has been turned back after approaching the multi-year high set in September near 222 bp. It is now near 207 bp. The yen's weakness help push the Nikkei some 7.6% higher this week, easily the best performing of the major markets.

The euro area confirmed that preliminary October harmonized CPI figures showing a 0.1% decline on the month for a 0.7% year-over-year pace. There is much talk that the ECB can take additional measures next month, though as we have noted, the euro has been fairly resilient. Despite the decline in excess liquidity within the euro system, EONIA, remains stable and low near 7.5 bp this week, little changed since last week's surprise rate cut. Although we have argued that that repo rate cut was largely symbolic, one effect of it is to lower the carrying cost of the LTRO borrowings (the rate is tied to the repo rate). This may slow the return of those funds, on the margin.

Italy reported September's trade surplus was shaved to 0.79 bln euros from a revised 1.07 bln in August (initially 0.98 bln). This is a good reminder of the reduction of the external deficit by the peripheral countries in Europe. On one hand, domestic demand has been squeezed by the economic weakness, and although the euro area reported positive GDP for the second consecutive quarter, it is not clear that the recession has really ended. Yes, many use the two consecutive quarters of negative growth as an indicator of recession, but that is only down and dirty short hand. Note that that is not the definition used by the NBER, the official arbiter of the US business cycle, for example.

On the other hand, many countries in the periphery have seen a drop in unit labor costs, especially owing to cuts in the public sector, and this has helped improve export competitiveness. The problem, as has been increasingly discussed since the US Treasury expressed concern, is that Germany in particular, but the creditor countries in the euro area, have not offset the peripheral austerity with meaningful stimulus, leading to a growing imbalance with the world.

Before the weekend, the market will see the US Empire State manufacturing survey (Nov) and industrial production/manufacturing output (Oct). The risk on both reports appears to be on the upside. The consensus is for the Empire State to improve to 5 from 1.52, while industrial production is expected to rise 0.2%, the same as manufacturing output. If the Fed's decision is data dependent as nearly every one is saying, then the dollar should be supported by firm US data. Yet, there is data and there is data and today's reports do not have the heft to alter views of Fed tapering, where after being out of consensus in September, we find ourselves part of the consensus in terms of a March tapering.