Dollar Correction Continues

Corrective forces continue to take hold of the foreign exchange market. It is long overdue and does not appear to be sparked by fundamental developments per se. Many short-term momentum participants had jumped aboard what had looked (and behaved) a one-way train. Late dollar longs were in weak hands, and once the momentum faltered, were squeezed out.

However, the dollar pullback has been minor, so far. We suspect it may have a little more room to run, but anticipate a hawkish read to the FOMC minutes that will be released in tomorrow in the NY afternoon.

The $1.2700 area in the euro, just above the Friday-Monday high (~$1.2675) is the next immediate target. Sterling has bounced smartly off yesterday's $1.5945 low to re-take the $1.61 handle, but has stopped in front of $1.6130, the main technical obstacle in the way of a push toward $1.6200. The dollar has been pushed marginally through its 20-day moving average versus the yen (~JPY108.50) for the first time in nearly two months. Additional support is seen near last week's low around JPY108.00. The Australian dollar extended yesterday's gains to probe above $0.8800. Immediate resistance is pegged near $0.8830.

Both the Bank of Japan and the Reserve Bank of Australia concluded their meetings earlier today. There were no significant surprises, and both central banks kept policy on hold. The BOJ's Kuroda continues to suggest that the recovery is intact but that the central bank is prepared to do more if necessary. He did not object to the yen's weakness and commented that there was nothing "abnormal" about it as it reflected the divergent path of monetary policy.

Of note, a Bloomberg story indicated that a majority of the BOJ board favors shifting the inflation target from next April to the medium-term. The logic being that the date-specific target has fueled expectations, and that if the target appears unattainable (and a Bloomberg survey found 29 of 33 do not expect it to be met), then the BOJ will take additional measures (about half the Bloomberg survey respondents expect more action by April 2015). If the BOJ does shift its "forward guidance", it is not expected to be imminent.

Meanwhile, there is lingering interest in the story that broke over the weekend that indicates the GPIF asset review may be delayed from the September-October time frame to mid-November or later. The main reason appears to be that the health ministry, where the oversight rests, needs more time to prepare organizational and investment reform simultaneously. The 0.7% drop in the Nikkei earlier today seems to be more a function of yesterday's slide on Wall Street and gains in the yen, rather than the GPIF speculation.

The RBA statement and Governor Stevens press conference will not change views of the trajectory of policy (on hold), or that the decline in the Australian dollar has been sufficient. The RBA did drop the reference to its observation that the Aussie remains above its fundamental value. However, it kept other comments that indicated that it would like to see further declines, including the reference to it being high by historical standards, especially given the fall in commodity prices. There was also no reference to the macro-prudential policies that it may rely on, rather than monetary policy, to address the housing market.

Following yesterday's dramatic drop in industrial orders, the sharp 4% month-over-month slide in German August industrial output was somewhat less shocking. Nevertheless, it does suggest that European locomotive continues to face strong headwinds late in Q3. On the other hand, as we suggested yesterday, weaker German data, if sustained, will help align German interests more with the euro area.

UK industrial production figures were in line with expectations. The market has already taken on board the loss of UK economic momentum. Industrial output was flat in August after a 0.4% rise in July. The year-over-year pace ticked up to 2.5% from 2.2% but was a hair below the consensus of 2.6%. Manufacturing itself rose 0.1% for a 3.9% year-over-year rate, up from 3.5%, and better than the 3.4% the consensus expected. We note that implied rate of the March 2015 short-sterling futures contract has edged lower, and this continues to seem to be a weight on sterling.

Norway offered the only upside surprise today. August manufacturing jumped 1.0% on the month. The consensus was for a 0.2% decline. The 5.2% year-over-year rate is the strongest since July 2013. Inflation figures are due out at the end of the week. The underlying rate is expected to rise to 2.6% from 2.2%, while the headline rate is expected to rise to 2.6% from 2.2%.

While the divergence of the trajectory of monetary policy is widely recognized to favor the US and UK over the euro area and Japan, we think Norway should be considered closer to the former than the latter. It is not that it will hike rates in the near-term, but the fundamentals are among the most constructive. That said, the problem with the krone, despite the large surplus on its net international investment position, is it is thinly traded, and there are not a great deal of assets that attract international investors. Therefore the currency often trades more like the dollar-bloc and emerging market currencies (high beta?).

The North American session features the US JOLTS data and consumer credit. We note that yesterday’s Labor Market Conditions Index (new from the Fed) rose 2.5 points in September. This is about half the pace seen in H1 and lower than any month in 2013. It warns of the risk of some moderation of the labor market, which does not appear to have been picked up last week’s monthly report. Consumer credit is again likely to be lifted by auto and student loans, though revolving credit (credit cards) have slowly been improving. Fed speakers today include Kocherlakota (dove), Dudley (part of the Troika) and Potter (after the markets close). Canada report building permits, which are expected to have corrected lower after the outsized 11.8% rise in July.