Focus Shifts To The US

The US dollar is narrowly mixed in choppy month end turn-over ahead of a slew of US data and the conclusion of the FOMC meeting. Global equities are mixed, with Asia dragged lower by the 1.5% decline in the Nikkei, while Europe is faring better with the Dow Jones Stoxx 600 posting fractional gains near midday in London. Bond markets are mostly a little softer, though Italian, Spanish and Portuguese bonds are slightly firmer.

Although the focus will shift to the US, there have been a number of developments earlier today that are important. Beginning in Japan we note that manufacturing PMI slipped to 50.7 from 52.3. This is the lowest in four months and follows the disappointing industrial output figures out earlier this week (-3.3% in June vs consensus -1.5% and offsetting in full the gains over the previous three months). In addition, Japan reported weak wage earnings, with base wages actually falling 0.2% year-over-year, even though unemployment, we learned earlier this week, fell to 4.5 year lows.

The softness of the manufacturing sector and the lack of upward pressure on wages spurs talk that the biggest impact of Abenomics may be past. That said, housing starts and construction remains strong. Starts rose 15.3% year-over-year in June, up from 14.5% in May, with construction orders up almost 22%.

The dollar slipped to new 4.5 week lows just below JPY97.60. A convincing break of this area warns of a test on the JPY96.75 area. A move back above JPY98 is needed to stabilize the tone.

In Europe, Italy and Germany reported better than expected jobs data, but this is not translating into aggregate demand. German unemployment slipped 7k in July after a 13k fall in June. The unemployment rate was steady at 6.8%. Italy reported a 12.1% unemployment rate for June. It unexpectedly fell from 12.2% in May. Although the Letta government has provided a tax break to younger workers, youth unemployment continued to rise.

Separately, Germany, France and Spain reported poor consumption figures. Spain reported that retail sales, when adjust for work days, fell 5.0% from a year ago. The consensus was for a 4.7% decline after a revised 4.4% fall in May (from -4.5%). France was household consumption fell 0.8% in June (month-over-month). The consensus had expected a 0.1% rise after an upward revision to 0.7% (from 0.5%) in May. Of note, cyclically sensitive spending on durable goods fell 0.3% (+0.8% in May). German figures were even more disappointing. Retail sales fell 1.5% in June. The consensus had expected a 0.2% rise. The June decline wipes out the 0.3% rise in April and the 0.7% rise in May.

In addition to the data, there have been two other developments to note. First, reports suggest that at tomorrow's ECB meeting, Draghi is likely to announce that going forward the central bank will release some form of minutes, like other central banks. Asmussen and Coere have been building the case in public and Draghi seems sympathetic. The minutes are, in part, a tool for helping to shape market expectations, which are all the more important at time that the ECB is relying more on forward guidance. Political necessity is once again the mother of innovation at the ECB.

Second, although the Italian Supreme Court resumes its hearing on Berlusconi's appeal. The public prosecutor appears to be seeking a shorter ban from politics (3 years instead of 5), but does appear to be insisting on a 1-year prison sentence, which, if so ruled, would still be up to the Senate. A decision is now expected today or tomorrow.

For its part, the euro remains firm. Yesterday's outside day (trading on both sides of Monday's range) failed to translate into a key reversal (by closing below Monday's low). The euro tested the $1.33 level again, for the fifth session and again was turned back. We find that sterling often leads the euro. Sterling peaked last Thursday near $1.5435 and has been sold down today to $1.52, almost a two-week low. We are inclined to see sterling's losses as a lead indicator for the next move in the euro. A break of yesterday's low near $1.3235 would strengthen this view.

There are five items that are on the radar screen for the US today. In time sequence, the first is the ADP employment estimate. On a monthly basis, it does not do a particularly good job tracking the BLS report (though last month it very close), but still is closely watched. The consensus is for the July estimate to be little changed from the 188k reported for June.

This will be followed by the first estimate of Q2 GDP. Over the past week of so, estimates have been shaved and we suspect a sub-1% figure is expected. There will be important methodological adjustments (to include R&D and copyrights as investment) that are expected to boost the overall size of the economy by about 3%. This will have the knock on effects of lowering ratios that use GDP as the denominator, such as debt to GDP and will likely bring back into line the GDP with GDI (gross domestic income). The latter has been running ahead of the former, even though the two should be equivalent.

At the same time, the US Treasury will announce its quarterly refunding needs and given the downward revisions in to the deficit forecasts, the borrowing needs are expected to be cut 20-25%. This will be followed by the Chicago PMI (and Milwaukee ISM). Both are expected to have ticked up.

The big event, of course is the FOMC meeting and the statement, which will not be followed by a press conference. Many expect the Fed to begin tapering in September. Since there is no meeting in August, there should be a clearer signal in today's statement if the Fed is indeed about to begin tapering. Some observers have suggested that the primary reason the Fed has to taper is that the supply of Treasuries will be reduced. We're not as convinced and suspect that there are ways to minimize the potential disruption, even if it means modifying some of the Fed's self-imposed rules on its purchases. Nevertheless, what the Fed says about its asset purchases program will likely overshadow its economic and inflation assessment.

While the FOMC statement will likely inject volatility into the markets, regardless of its decision, a dollar decline is likely to be tempered by expectations of a dovish BOE and ECB tomorrow.