The U.S. dollar has been confined to ranges against the major foreign currencies that have largely been seen already this week. The exchange rates may feel fixed now, but they are not, and today marks the 41st anniversary of the end of the Bretton Woods agreement. They are churning as the players mark time in lieu of fresh incentives and holiday conditions prevail in parts of Europe. There may be a bit of disappointment with the lack of follow through gains in the euro, leading to some liquidation. Initial support for the euro is seen in the $1.2240-60 area, with $1.2320-40 serving as a cap. U.S. data, especially the industrial production/manufacturing reports, but also the Empire State survey, should add to the accumulating evidence that the economy has improved here in Q3.
South Korean and Indian markets are also closed for holiday. Equity markets are mostly lower. The MSCI Asia Pacific Index fell 0.5%. As hopes fade of near-term stimulus Chinese shares tumbled 1% and posted the lowest close in nearly two weeks. In Europe, the Dow Jones Stoxx 600 is off about 0.25% near midday in London, led by a decline in basic materials and miners are particularly hard hit. Going into this week the Dow Jones Stoxx 600 had advanced for ten consecutive weeks. It is currently unchanged since the end of last week. Spanish and Italian yields are lower.
U.K. gilts are under performing after a slightly stronger than expected employment report, which saw a 5.9k decline in the claimant count rather than the 6k increase the consensus expected. The BOE minutes were not surprising. The decision to maintain rates and the gilt purchase program were unanimous. Yet because there was some debate over extending the current gilt purchase program, which will be complete in November, it is possible that the decision is made to extend it before then. Any data that points to a continued economic contraction in Q3, which would be the fourth consecutive quarterly decline, strengthens the likelihood that QE is extended. October would seem a such a window of opportunity.
The better U.S. jobs data earlier this month, coupled with the large and broad based jump in retail sales, (including the measure that excludes autos, gasoline and building materials) appear to have helped spur some re-thinking about Fed action. This may be a factor weighing on the U.S. Treasury market with 10-year yields, for example, rising to near 1.8%, the highest since late May. It is less dramatic at the short end of the coupon curve as it is anchored by the strong conviction that there won't be a hike in the Fed funds rate for the next two years at least.
Nevertheless, the 2-year yields are up about 8 bp in since the start of the month. The rise in U.S. rates seems to offer a more compelling explanation of the dollar's modest strength against the yen. The dollar has grown near the JPY79 level for the first time since July 19. Over the past 60 days, the correlation between the U.S.-Japan 2-year interest rate differential and the yen is -0.74. As the interest rate differential widens, the yen falls against the dollar. However, as recently as mid-July, there was a positive correlation. The correlation with S&P 500 is -0.25 by comparison. With the U.S. Treasury making its mid-August coupon payment today, there is talk of chunky Japanese offers and option-related barriers near JPY79.