The U.S. dollar is bid. It has recouped everything it lost in the first half the week against the euro. It is flirting with its 20-day moving average against both the euro ($1.3254) and Swiss franc (CHF0.9108). The constructive technical toned identified here at mid-week has undermined by what two considerations, the backing up of U.S. rates, which some attribute to Fed Chairman Ben Bernanke's testimony (though we are skeptical) and perhaps a buy the rumor sell the fact activity around the LTRO. A break of the $1.3230 area will immediately target the $1.3150-70 area next.
For its part sterling has been confined to Thursday's ranges and a better than expected construction PMI may have helped. It came in at 54.3 from 51.4 in January. The consensus had expected only a small increase. It is the best since March last year and is above the 50 boom/bust for the 14th consecutive month. New orders reached a 21-month high.
Given the relative size of the UK construction sector, today's report does not really offset the somewhat disappointing manufacturing PMI out yesterday (51.2 vs 52.0), However, the resilience of the UK economy is one of the pleasant surprises in 2012. Monday, the service sector PMI will be released and of course this is the largest sector and hence most important. Support has been seen for the past two days around the 200-day moving average, just below $1.59 today. The break warns of another cent decline.
The dollar made new highs against the yen and is building a base above JPY81.00. The driving force seems to be broad based dollar demand, but note BOJ comments warn that as long as inflation is below 1%, it is prepared to ease, suggesting a more aggressive stance than previously understood. That said Japanese 2-year yields are flat (US is off 1 bp), as is the 10-year.
However, Japanese economic reports were mostly disappointing. Unemployment ticked up to 4.6% from 4.5% in December and household spending fell 0.1% in January, whereas the consensus called for a 0.6% increase following the 1% decline in December. Core inflation, which in Japan excludes fresh food, was -0.1% year-over-year in January, the same as December, but was negative on a year-over-year basis for the fourth consecutive month. Excluding food and fuel, prices fell 0.9% year-over-yer after a -1.1% pace in December. Core Tokyo prices for February were off 0.3% after a -0.4% print in January.
The government subsidy for eco-cars helped pump up retail sales and industrial production, but it expires shortly, leaving Japan with soft household demand. The government's reconstruction budget, and recovery efforts after last year's tsunami and Thai floods may temporarily help lift the economy in the Jan-March period, but stagnation appears likely to return.
There are a few other developments to note in Europe, outside of the large (record) overnight deposits at the ECB (776.9 bln euros). The best way to understand those without getting too caught up in the nuances is that they are similar to the excess reserves at the Fed, which is really the counterpart of their operations.
More importantly, Germany reported a horrific retail sales report. Sales fell 1.6% in January. The market had been looking for a small gain. However, this time series is unstable. Look at what happened in December. It was originally reported at -1.4% and was revised to +0.1%. Still, the underlying message is that Germany continues to rely on the aggregate demand of other countries rather than its own. This is to say it exports around 40% of GDP.
S&P had nice things to say about Italy. It noted that Monti's reforms have prevented a further downgrade (now BBB+) and even suggested upgrade to A may be possible. Key hurdle now seems to be the labor reforms that need parliament approval, anticipated by the end of the March. Italian bonds did not respond to the S&P comments but are consolidating recent gains.
Lastly, note that Spanish unemployment rose further, but the bigger issue that is brewing is over the Spanish 2012 budget. Spain seemed to be seeking a relaxation of this year's deficit target (4.4%), which after last year's miss, would make it a simply herculean task. Yet Barroso seemed to indicate this was rejected by the EU summit. Spanish bonds continue to under-perform their Italian counterparts.