US Dollar Marking Time, Aussie Steals Spotlight

The US dollar is little changed against most of the major currencies as the summer market awaits the week's key events that begin in earnest tomorrow. The Australian dollar is the biggest mover, dropping about 1.5% against the greenback in response to two blows: a collapse in building approvals (-6.9% vs a consensus forecast of a +2.3%)and dovish comments by the central bank governor. The OIS market is now pricing in almost certainty that the RBA cuts the cash rate next week. Further out, the market is pricing at least one more cut in the cycle.

Not only were the June building approvals weaker than expected, but the May decline was revised to -4.3% from -1.1%. RBA Governor Stevens reiterated that there was scope to cut rates after last week's CPI data and opined that the decline in the Australian dollar did not threaten the inflation outlook. Note that recent data has been soft, including a loss of full time jobs in May and June.

As a proxy for short-term interest rates, we note that the 1-year bill yield fell 9 bp and at 2.28%,appears to be a new record low. The cash rate sits at 2.75%. For its part, the Australian dollar fell to almost $0.9050. The three-year low was set on July 12 just below $0.9000.

Japan also reported disappointing data, but the dollar continues to straddle the JPY98 level. The preliminary estimate is that June industrial output fell 3.3%, more than twice the decline the consensus expected. It is the first decline in seven months and the respondents were optimistic going forward with the July forecast lifted to 6.5% from 3.3%. Nevertheless, the year-over year rate shows a 4.8% contraction from a 1.1% decline in May. This coupled with the deflation in the core measures of CPI suggest pressure may mount on the BOJ to take additional measures. In a different report, investors learned that vehicle production in Japan fell 9.5% from year ago levels in June after a 6.2% contraction was reported in May.

Meanwhile, another aspect of the creeping disappointment with Abenomics, which has seen support for Prime Minister Abe slip lower, despite the recent electoral victory, has been with consumption. Overall, household spending in June fell 0.4% year-over-year. The consensus called for a 1.4% rise. It is the second consecutive decline. Higher corporate profits has not translated into more hiring or wage increases. It is true that separately Japan reported that the unemployment rate unexpectedly fell to 3.9% from 4.1% in May, but this reflected a greater contraction in the labor force (-150k) compared with the number of employed (-10k).

Anticipation of either more BOJ measures or perhaps some measures to minimize the next April's retail sales tax hike helped fuel bargain hunting in the Nikkei after yesterday's more than 3% decline. The Nikkei recouped about half of those losses, with the oil and gas sector leading the way with a 5.4% advance. The Nikkei had gapped lower last Friday and again yesterday. Today's gains failed to enter yesterday's gap, which extends from 13954-14114.

One of the factors that may have helped lift the Nikkei and the MSCI Asia-Pacific Index (+~0.5%) was news that The PBOC injected liquidity into the banking system for the first time in five weeks and used 7-day reverse repos as the tool of injection (CNY17 bln) for the first time since February. Separately, we note that to address the earthquake region in Lushan, the PBOC has cut the required reserves for local banks by 1% and will allow mortgages in the region to be set at 60% discount to the benchmark rates.

European news has been limited. The biggest mover has been the Swedish krona. A soft preliminary Q2 GDP figure has seen the krona lose almost 1% against the dollar and a little more against the euro. Sweden reported the economy had contracted by 0.1%, whereas the market had expected an expansion of the same magnitude.

Exports declined by 0.8% on the quarter and household consumption slipped 0.1%. Government spending rose 0.2% and investment rose 0.1%. The data are subject to revisions in September and it is too soon to expect a monetary policy response. Fiscal policy is a different matter, and the Finance Minister Borg has already suggested more stimulus next year.

The euro move toward SEK8.69 and has been held in check by a downtrend off the June 24 high (~SEK8.8990) and July 8 high (~SEK8.8165). The immediate euro buying exhausted itself, but pullbacks should be limited to the SEK8.64-SEEK8.66 area near-term.

Separately, we note that Spain reported Q2 GDP. At -0.1% it was in line with expectations as was the EU harmonized CPI of 1.9% (down from 2.2% in June). Meanwhile, market awaits the Italian Supreme Court's decision on Berlusoni's final appeal on tax fraud charges. It is not clear that a final decision will be made today, but it is possible. Upholding Berlusconi's conviction may spur some political uncertainty as some of the center-right members of parliament have threatened to withdraw support for the Letta government.

In the US, the two-day FOMC meeting begins and, the only data of note is the CaseShiller house price index. A further modest rise is expected. Tomorrow brings the first estimate of Q2 GDP (and revisions to include research and development and copyrights as investments) and the ADP estimate of employment, as well as the FOMC statement.