Can't Keep A Good Buck Down

The dollar's brief and shallow pullback provided a new buying opportunity. The greenback put the finishing touches on another strong weekly performance. Of the major currencies, only sterling and the yen have managed to hold their own, and are flat on the week.

The dollar-bloc continues to under-perform. The New Zealand dollar lost about 3% this week, through the European morning. The Aussie is off 2% and the Canadian dollar fell 1.5%. This seemed to be a function of unwinding of stale positions, joined by momentum traders. RBNZ officials stepped up their jawboning against the currency, while the RBA signaled macro prudential efforts to cool the housing market -- which was understood to mean not monetary policy.

The ECB has made no bones about it. A weaker euro is an important element in the effort to reflect the regional economy and help re-anchor inflation expectations. Swiss officials have made it clear, too, that it will not allow the Swiss franc to strengthen much against the euro. Some Japanese officials, including Prime Minister Abe and, earlier Friday, Cabinet Secretary Suga, have tried to either slow the yen's descent or demonstrate that fundamentals not verbal intervention is the main driver of the yen's weakness.

Currency markets are in play, and outside of that occasional journalist reference, there is not much talk of "currency wars". NY Fed President Dudley did comment earlier this week about the foreign exchange market, but a close reading of what he said does not show a resistance to dollar strength. First, his comments were conditional. He prefaced his remarks with "if the dollar strengthens a lot". Second, his comments were typical boilerplate stuff: A significant appreciation of the dollar would have consequences for growth and inflation, and this would have to be taken into account in setting monetary policy.

There does not seem to be a push back against the dollar's strength. From an economic point of view, the key is the dollar's performance on a broad, trade-weighted index. It is at the upper end of the three-year range, which is still in the trough of a large decline. Coming into this month, the Federal Reserve's broad trade-weighted dollar index was up less than 1% from the end of last year. It rose sharply this month, but in the bigger picture, the impact on growth and inflation seems mild by any definition.

Japan report slightly disappointing inflation figures. The nationwide August core measure eased to 3.1% from 3.3% in July. The BoJ assumes the sales tax increase boosts the core measure by two percentage points. It is this measure (core minus retail sales tax impact) that is key. It slipped to 1.1% from 1.3%. Tokyo, which reports CPI with a shorter lag, reported its core CPI eased to 2.6% in September. We expect that the yen's recent decline will boost CPI in the coming months. We expect this to be sufficient to keep the BoJ from accelerating its already aggressive quantitative easing. Focus will be on the supplemental budget.

Over the weekend, Catalonia's President Mas will take another step down the path to an unauthorized referendum on independence. A week ago, the Catalan parliament overwhelmingly approved a "referendum law". Mas will sign a decree that implements the law and sets the date for the non-binding plebiscite of November 9. No doubt the federal government will challenge the legality of Catalans' actions. Surveys show that a large majority of Catalans are in favor a the referendum, but it is not clear how many support independence. If the federal courts suspend and strike down the referendum law, which seems likely, it is possible that instead of a referendum, Mas seeks a new mandate via early regional elections.

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