Sentiments Weighed Down By Data From Japan And China

Major currencies weakened against dollar and yen in quiet holiday trading. Weak economic data from Japan and China were part of the factors that's driving risk aversion. Meanwhile, uncertainties in eurozone also weighed down on sentiments. The Dollar Index broke 80 psychological level but there is no sustainable buying so far. Looking ahead, PMI data will be the main focus today with Swiss SVME PMI, eurozone PMI manufacturing, UK PMI manufacturing and US ISM manufacturing featured.

In Japan, the Tankan survey showed that the countries' manufacturers have turned more pessimistic as weakness in exports delays recovery. According to the BOJ, the sentiment index for large manufacturers slipped to -3 in 3Q12 from -1 in the prior quarter.

Confidence of small manufacturers dropped for a 4th consecutive quarter to -14 in 3Q12, compared with the second quarter's reading of -12.On "all industries" basis, sentiment weakened in all scales of industries as strong Japanese yen dampened exports while anti-Japanese sentiment in China due to the Diaoyu Islands dispute pressured Chinese demand on Japanese goods with the biggest sufferer the automobile sector.

The official Chinese manufacturing PMI climbed higher to 49.8 in September from 49.2 a month ago. Despite the mild improvement, a reading below 50 signaled that the manufacturing sector remained in contractionary basis. Over the weekend, the data compiled by HSBC and Markit was revised higher to 47.9 from the flash reading of 47.6. Indeed, the September reading should be a seasonally strong one. The disappointment coming from the 2 sets of data heightened concerns about the outlook of China's economic growth.

Earlier last week, the PBOC reaffirmed that it would "fine tune" the monetary policy to ensure achievement of the annual growth target. However, liquidity injection to the market through reverse repos over the past weeks was obviously insufficient to bolster the slowing economy. The market is hoping for more substantial measures such as RRR reduction and rate cut.

Results of an independent bank stress test in Spain showed that there is a capital deficit of EUR 59.3b. That's the amount of extra capital needed to ride out a serious economic downturn. And, such amount was slightly lower than June's estimate of EUR 52b. Taking merges and tax effects into considerations, the needed capital would be further reduced to EUR 53.7b.

Under the worst case scenario, Spain's GDP would contract -4.1% in 2012, -2.1% in 2013 and -0.3% in 2014. Unemployment would also jump to 27.2% in two years' time. Prime Minister hailed that the stress tests were the "biggest transparency exercise ever done" and he emphasized that Spain will pay back the needed money. ECB also hailed the stress tests as "stringent and the asset quality review as thorough."

Moody's said that "recapitalization will materially enhance the solvency of affected institutions and help restore market confidence in Spain's banking system as a whole." And the rating agency noted that "the upcoming recapitalization is intrinsically credit-positive for all Spanish banks because it includes more banks and more capital than prior efforts."

However, Moody's noted that "the recapitalization amounts published by Spain are below what we estimate are needed for Spanish banks to maintain stability in our adverse and highly adverse scenarios." And "negative sentiment could undercut the government's efforts to fully restore confidence in the solvency of Spanish banks." Also, Moody's is set to publish a review on Spain's rating after September but no firm date is set.

The Troika team also returned to Athens yesterday. Greek prime minister Samaras will need to finalize the EUR 13.5b austerity package to secure the EUR 31.5b tranche of bailout funds. Also, Samaras will need to use his last efforts to seek a two year extension to the fiscal adjustment program. Eurozone finance ministers will meet next week on October 8 and after that, the EU summit on October 18 and 19 are expected to decide on the issues.

Latest CFTF data showed that Euro shorts dropped to 50.2 contracts on September 25, comparing to73.5k contacts a week ago. That's also half of 102k contracts in early September. Sterling longs gathered momentum and rose to 27.1k, a 2012 high. Yen longs are relatively unchanged at 21.1k. Due to improvement in risk appetite, Australia longs rose again to 89.6k contracts, making a 2012 high. Canadian dollar longs dipped a bit to 105.3k contracts, comparing to the 111.9 contracts of 2012 high a week ago.