German Bund Sell-Off Drives Euro Higher

The US dollar's losses have accelerated. The key drivers are not domestic but emanate from Europe and Japan. Evidence continues to accumulate that points to a moderate recovery in the US economy. The JOLTS data showed job openings are at new cyclical highs. The wholesale inventory data was also positive. Tomorrow the US reports May retail sales. It is expected to be among the strongest reports in many months.

The dollar approached JPY126 at the end of last week. It had established a near-term base near JPY123.80. It finished the North American session near JPY124.30. Comments by BOJ's Kuroda knocked it through its 20-day moving average, for the first time since May 18 (~JPY122.70) to about JPY122.45. We had detected some shift in Japanese official rhetoric toward more cautionary views of the yen though admittedly comments in the press were not always consistent.

Nevertheless, Kuroda's revelation the he does not see more yen weakness on a real effective basis (REER) spurred the immediate sell-off. The range over the last several hours has been roughly JPY122.50-JPY123.15. This could mark the North American range as well. Japan's economic news was also favorable. Machine tools (part of capex) rose 3.8% in April. The Bloomberg consensus expected a 2.1% decline. Japan's measure of producer prices also rose a little more than expected. The 0.3% increase in May follows a 0.1% rise in April. The consensus expected a 0.2% rise.

Separately, we note that the Nikkei failed to close yesterday's gap and edged lower, filling an earlier gap created in its run-up in mid-May. Two Japanese corporate acquisitions caught our attention. Tokio Marine Holdings, Inc. (TOKYO:8766) bought US insurer HCC for $7.5 bln (cash), which is the largest foreign purchase in this sector. Panasonic Healthcare will buy Bayer's diabetes devices holdings for about one billion euros.

At the same time, the continued sell-off in German bunds appears to be helping drive the euro higher. It has briefly traded through last week's high of $1.1380. It did not stay near its highs for long and has dropped back to straddle the $1.1300 area near midday in London. There does not seem anything new to have stirred the pot. The momentum has taken on a life of its own now that deflationary risks have diminished. The 10-year German yield poked through the 1.0% area. It is approaching the high yield level from late last September near 1.11%. Beyond there, the next key area is near 1.25%.

The news stream from Europe is thin. The Greco-creditor wrestling match continues, and every day it does, the Greek economy worsens, and the costs increase. The EU summit (June 25-26) may be the next key window for the crisis. The only eurozone economic data to note was the horrible French industrial production report, warning that Q2 is off to a poor start. Industrial output fell 0.9%. It was expected to have risen by 0.4%. The upward revision to the March series from -0.3% to flat is nice, but hardly makes off for the disappointment. Manufacturing output itself was 0ff by 1.0%. The consensus was for a small increase. The year-over-year rates slumps to -0.4% from a revised 1.0% in March (initially 0.6%).

In contrast, the UK reported better than expected industrial output data. The 0.4% increase surpassed the cautious consensus forecast for 0.1%. However, manufacturing itself disappointed. It fell by 0.4%, fully offsetting the March gain. It was expected to rise by 0.1%. Sterling has extended yesterday's gains to reach $1.5470. It has surpassed the 20-day moving average (~$1.5445) for the first time since May 26. The next hurdle is seen near $1.5500. The market is vulnerable to headline risk at the Mansion House dinner.

Separately, note that Norway reported slightly higher than expected underlying inflation (2.4% instead of 2.3%, up from 2.1% in April). This forced the market to reconsider its expectations for a rate cut next week. Sweden reported a considerably stronger industrial production figures. The 2.0% month-over-month increase blew away expectations for a 0.2% increase, and the March gain was revised to 1.1% from 0.8%.

Chinese equities had a mixed reaction to news the MSCI still does not think that conditions warrant including the A-shares in its indices. The Shanghai Composite slipped almost 0.2% while the Shenzhen Composite gained 2%. Even though China has taken important steps to open its markets, MSCI remains concerned about 1) the allocation of quotas, 2) capital mobility for daily liquidity, and 3) lack of clarity regarding ownership of separate accounts in the Hong Kong-Connect facility. At the same time, MSCI made it clear that it is simply a question of time, and importantly, that time need not wait until next year's annual review. Note that when the A-shares are included China will account for nearly 44% of the MSCI's Emerging equity market index.