The US dollar is little changed. The consolidative tone, however, does not hide the fact that, despite the stretched technical conditions, participants are still buying the slightest dollar pullback.
The euro sold into the early gains that carried it to $1.3215 in early European activity. Sterling stalled in front of $1.66 yesterday and again today. The dollar slipped below JPY103.80 in Asia and eagerly bought back. As yesterday, we see technical resistance in the euro extended toward $1.3240 and support for the dollar near JPY103.50. With the Salmond getting credit for winning last night's debate on Scotland's independence, sterling may underperform.
Global equity markets are consolidating as well, but the bond markets remain in rally-mode. Core European bonds are off 1-2 bp, though the UK 10-year gilt yield is off 4 bp, while peripheral 10-year yields are off 4-7 bp. In past notes, we noted that although some peripheral yields have fallen through US rates, that real rates have actually risen, as consumer prices have fallen faster than yields.
However, main takeaway many observers drew from Draghi's Jackson Hole speech was that QE may be imminent. We are less sanguine about, and understand that the effect of the June actions and TLTRO need to be seen first, making an asset purchase program more likely next year than this year. Nevertheless, such expectations are having such an impact on nominal yields that real yields are falling. Look at Spain. It is due to release its preliminary August CPI figures on Thursday. The harmonized measure is expected to slip from -0.4% to 0.6%. In the past month, Spain's 10-year yield has fallen 34 bp.
The political turmoil in France is more a cabinet reshuffle than a collapse of the government as it had appeared yesterday. Prime Minister Valls is expected to name new ministers today. The market continues to take this political development in stride as the French premium over Germany has continued to narrow incrementally. With the German 10-year yield moving further below 1.0%, some classes of investors appear to be deterred from new buying. Large asset managers have often related to us how 1) there are not enough bunds to satisfy the desire, and 2) French bonds trade like bunds on the assumption that there is no real break-up risk or default risk, with a slightly higher yield.
Japan Prime Minister Abe is expected to announce a cabinet reshuffle next week (September 3). It has already been tipped that Finance Minister Aso and Economic Minister Amari will retain their posts. Separately, the Japanese government kept its economic assessment generally unchanged, after raising it in July. Officials want to believe, as Kuroda demonstrated at Jackson Hole, that the impact of the sales tax hike is fading.
However, a small tell that it is not as confident as it may appear was revealed in how it characterized industrial output. Previously, it said that industrial production had "weakened recently." This time, it dropped the word "recently." We would not make a big deal about this, but it should raise the significance of Friday's industrial production report. A 1% rise is expected in July, and the risk is on the downside. Yet, even if the consensus is right, the year-over-year rate would fall into negative territory.
The July US durable goods orders report the main economic data of the day. The headline will likely be flattered by a sharp jump in Boeing orders, which will be unwound (not repeated) next month. The details are unlikely to confirm an acceleration of capital expenditures, despite low interest rates and strong corporate earnings.
The consensus continues to be for the first Fed rate hike in Q3 next year. A CNBC poll conducted prior to the Jackson Hole gathering found that expectations had been pushed into July from August. In talking with clients, it seems that many are looking beyond the time of the first hike, and are thinking more about the terminal rate for Fed funds in the coming cycle. Many seemed to think that it may peak below CPI (~2.25%). However, the CNBC poll found a consensus for a 3.16% peak in Q4 2017. This compares with a 5.25% peak in Fed funds in the last cycle (2004-2006).
On the political front, the Russian-Ukraine-EU meeting is very much the focus. The situation is very dangerous. The entry of unauthorized Russian trucks and tanks (according to reports) is tantamount to an invasion. However, once it is officially classified as such, it would demand an immediate and strong response, which will escalate the crisis quickly.
Putin's ploy should be well understood in the United States. The Gulf of Tonkin incident was, according to some accounts, a manufactured crisis that allowed the US to dramatically escalate its operations in Vietnam. Of consider, that after Lincoln's victory in 1860, he was warned against rearming federal forts in the South. He sent postal workers. And the Civil War was on as Lincoln had maneuvered the South into firing the first shot.
There will be two important political developments in Brazil today. First, a major poll is expected, and rumors suggest that Marina Silva will get closer to President Dilma. This is in part what supported the Bovespa yesterday to reach its highest level since early 2013. Second, the candidates face each other in the first debate.
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