FX Market: Some Light But Little Heat

Three new pieces for the macroeconomic jigsaw puzzle have fallen into place today, but the price action in the foreign exchange market is lackluster, at best. Yesterday's standouts, the yen and sterling have seen their gains pared a bit, and the euro, which fell to three-month lows yesterday, is trading broadly sideways below $1.37.

First, HSBC's flash manufacturing PMI for China rose to a five month high, lending credence to our sense that the world's second largest economy is stabilizing, albeit at a somewhat slower pace of growth. Given the government's crackdown on ostentatious spending by party officials, the anti-corruption and anti-pollution efforts—let alone the larger reforms to rein in industries with redundant investment and shadow banking activity—seems wholly acceptable to senior officials. The PMI rose to 49.7 from 48.1 in April. The consensus expected a rise to 48.3.

Second, Japan's manufacturing PMI rose to 49.9 in May from 49.4 in April, which itself had collapsed from 53.9 in March, as the impact of the sales tax hike rippled through the economy. On the face of it, the report lends support to some anecdotal data suggesting that the economy is absorbing the tax increase well. After recent BOJ comments, many are reconsidering expectation that the central bank will have to provide more support for the economy. We had not been strong proponents of new BOJ measures, outside of tweaking some of their purchases, and surely not as early as July, when the consensus expected new stimulus to be provided. Still, the Japanese economy is not out of the woods, so to speak, and the erosion of new export orders (48.2 from 49.1) warns that foreign demand is unlikely to offset the compression of domestic demand.

Separately, we note the weekly MOF portfolio flow data. Foreign investors' appetite for Japanese shares has waned. They were net sellers for the third consecutive week. Japanese investors stepped up their buying of foreign bonds, despite the squeeze on spreads, apparently taking advantage of the firmer yen to go shopping. Japanese investors did not just buy foreign bonds for the fourth consecutive week, but at JPY1.414 trillion, bought the most since last August.

It appears that it was the slight backing up in US yields that helped lift the dollar back above the 200-day moving average that it was flirting with yesterday. Important resistance is seen near JPY101.80 and a move above there would help solidify yesterday's low.

Third, the euro area flash PMI was reported. It will not impact expectations for the June 5 ECB meeting. It does underscore the widening divergence between Germany and France. The pullback in the euro-area manufacturing was a bit more than expected at 52.5 from 53.4 in April. The services PMI was somewhat stronger than expected at 53.5 from 53.1 in April. This left the composite little changed at 53.9 down from 54.0 in April, but spot on expectations.

Germany's flash manufacturing PMI slowed to 52.9 from 54.1 in April. This is more than the market expected (Bloomberg consensus was 54.1). However, services accelerated to 56.4 from 54.1 in April. The French data leaves something to be desired. Both measures unexpectedly slipped back below the 50 boom/bust level. Manufacturing slumped to 49.3 from 50.9 in April. Services activity fell to 49.2 from 50.3. This puts the French composite at a three-month low.

Note that tomorrow there may be several rating adjustments within the euro area. S&P is likely to upgrade Spain from BBB to BBB with a positive outlook. This would be in line with Moody's and Fitch. Our own propriety assessment puts Spain at a BBB+ rating, suggesting there is scope for additional upgrades by the major rating agencies. Moody's may upgrade Slovenia to investment grade from Ba1. S&P places it at A-. Moody's may also lift France's outlook to stable from negative. Lastly, Fitch may upgrade Greece's outlook to positive, but it may prefer to wait until after the election results, which some fear could usher in a period of political, and, therefore, policy uncertainty.

The UK confirmed Q1 GDP of 0.8%. The 3.1% year-over-year pace is the strongest since Q4 '07. This quarter, the UK economy is expected to surpass its pre-crisis peak as the US and Germany have already done. Sterling, itself, however, has fallen victim to a light bout of profit-taking that is threatening to end its five day advancing streak. Support is seen ahead of $1.6840.

Yesterday's FOMC minutes failed to generate new insight into the Fed's exit strategy. Today's economic reports, including the Markit flash manufacturing PMI and weekly initial jobless claims, do not have the heft to move markets. The KC Fed survey for May is also not very interesting. Existing home sales, however, may be the most interesting today. The consensus expects a 2.2% increase, which would snap a three-month declining streak. Existing home sales have fallen in seven of the eight months through March. Although the poor winter weather may have aggravated the trend, the trend itself is disappointing and recognized to be so by the Federal Reserve.

Separately, Canada reports March retail sales. The Bloomberg consensus looks for a 0.3% increase after a 0.5% increase in February. The risk is on the downside. The dollar-bloc currencies have under-performed over the past five sessions, but the Canadian dollar seems to be going no place in a hurry. Canada reports April CPI data tomorrow.