The U.S. dollar remains confined to its recent well worn ranges against the major currencies. A quiet Asian session gave way to a euro bounce in the European morning, which was the main price action. Euro gains were across the board and but with intra-day technical readings stretched, look for the $1.2335-50 area to cap it.
The much anticipated cut in China's required reserves failed to materialize and Japan reported Q2 growth at 0.3% (quarter-over-quarter), half of the consensus expectation. This weighed on Asian equities and the MSCI Asia Pacific Index slipped 0.2%. The 1.5% loss in the Shanghai Composite is the largest in a month, with industrials, technology and financials the weakest sectors.
After a soft starts, European bourses turned higher, led by utilities and financials. The U.K. is under-performing, but the financials are the strongest sector. A respectable 12-month bill auction in Italy may be helping Italian equities outperform today. Italian and Spanish 10-year yields are a few basis points lower, while 2-year yields are a few basis points higher. Core bond yields at both ends are a bit higher, while U.S. yields are a touch softer.
Many, if not most, investors continue to expect the Federal Reserve to announce new balance sheet expansion support for the U.S. economy in a few weeks. Nevertheless, long-term U.S. yields have backed up quite noticeably in recent weeks. The 10-year yield is at three-month highs. It has risen for three weeks, the longest streak in six months.
The latest CFTC Commitment of Traders report, covering the week ending August 7 showed the net speculative position swung to the short side (-14.6k contracts) from being net long 2k the week before. That was the first net long position since late January. However, since early April, when the net short position had swelled to 212k contracts, the net speculative short position was trending smaller.
We expect the economic data out this week to generally show that the U.S. economy stabilized in the beginning of the third quarter. On the inflation front, the PPI report risks being reported lower than expected follow the soft import price report last week. The headline CPI is expect to moderate as well. The combination of the backing up of U.S. 10-year yields and the easing of headline inflation means that real U.S. yields (crude model: yield minus year-over-year CPI) may be turning positive.
While we like others, recognize that Bernanke's speech at Jackson Hole is the next big event for Fed watchers, unlike 2010, we do not expect fresh clues and instead will be watching closely the trends in weekly jobless claims and in the August jobs report (released September 7).
Data released last week from Japan's Ministry of Finance showed that despite the narrowing of interest rate differentials, U.S. Treasuries accounted for about 45% of Japan's JPY1.924 trillion of foreign bonds bought in June. In the emerging market space, Japanese investors love affair with Brazil has waned. They have bought $1.5 bln of BRL uridashi bonds this debt this year, compared with $4.5 bln last year. Turkey lira has replaced the Brazilian real as the uridashi currency of choice.
Bloomberg data suggest that the lira accounted for about 20% of the uridashi issuance last month. Industry reports suggest that already this year, Japanese investors have bought $2.3 bln worth of TRY uridashi bonds compared with less than $140 mln all last year. The Turkish lira has appreciated almost 8% against the yen this year, while the Brazilian real has depreciated by nearly 6% against the yen.
We took notice recently of reports by Stratfor that have shown a build-up of U.S. aircraft carriers and amphibious groups near Iran. Reports suggest that the sanctions are beginning to have material impact on the economy and the rise in food prices has reportedly increased social tensions.
In this context, a few developments in Israel in recent days are particularly noteworthy. The most important is the extended authority granted Prime Minister Netanyahu yesterday (Aug 12). It makes is easier for him to override domestic opposition to a military strike. This follows comments in the middle last week by Fisher, the Governor of the Central Bank of Israel that acknowledged that steps were being taken to prepare the financial system for a possible strike in Iran.
This week, Israel is holding exercises to prepare the people for a possible counter-attack. Some Israeli officials are warning that the window to prevent Iran from acquiring nuclear weapon capability is running out. In addition, it may appear easier to deliver the U.S. a fait accompli as the presidential election draws near.
Leaving aside the human tragedy that hostilities would not doubt engender and the political ramifications, oil, gold and the dollar would likely move higher and potentially dramatically so. It would also likely put additional pressure on the Swiss franc, where the SNB continues to amass foreign securities in trying to maintain a cap. The yen may strengthen, but in such an environment, the risk of intervention would increase.