The U.S. dollar is narrowly mixed as North American traders return to finish out the week. The euro and Swiss franc are the strongest majors on the day and week. Continued recovery in Spanish and Italian bonds and stocks has helped lift the euro. The rise in core interest rates (15-17 bp this week for U.S., U.K. and German benchmark 10-year bonds) appears to have been one of the key drivers weighing on the Japanese yen.
After moving convincingly through the 200-day moving average yesterday, the dollar has stayed above there (~JPY79.20) , while the euro is trading at one month highs against the yen as well. The antipodeans and Scandis join the yen in under-performing this week. Unwinding of crosses against the euro seems like a common thread. Weak iron-ore prices, some weak sentiment readings and concerns about China also may have weighed on the Australian dollar.
The pullback in the yen continues in helping underpin Japanese equities. With the 0.8% rise in the Nikkei today, its weekly gain is 3%, which is more than a third of the year's rise. Despite good foreign buying this week, the Korean and Taiwan equity markets were uninspiring with today's losses, leaving both up about 0.3% for the week. After testing last month's multi-year low near 2100, the Shanghai Composite recovered to close fractionally higher. European bourses are higher, with the Dow Jones Stoxx positing 0.5% gains near midday in London, led by Spain and Italy. Technology and financials are the strongest sectors in Europe today.
The news stream is light today. Although Merkel's endorsement of Draghi's conditionality was cited as a euro positive factor yesterday, comments by Finland's foreign minister confirming preparations for an eventual EMU break-up and Austria's foreign minister advocating a formal mechanism to eject non-compliant members can only increase re-denomination risk, but are not market movers now. Nor is the Bank of Spain's report showing bad loans rising to 9.42% in June from 8.95% in May a market factor. Yet we suspect these developments will come back to bite.
Meanwhile, the current and capital account report for June helps explain the euro's 2.4% rally then. The current account surplus swelled 20% to 12.7 bln euro, but more telling was that the euro area recorded a 59.7 bln net inflow of portfolio capital (roughly evenly divided between equities and fixed income), which is more than twice the inflow in May. Also in June, the net short speculative position at the IMM was cut by 30%. Presently, the main driver seems to be position adjustment ahead of next month's key events.
Outside of the flash PMIs, the economic calendar in Europe is light next week and this will likely encourage continued positive euro consolidation. We are concerned that what we identify as the key mechanism that is broken -- the private sector recycling from the surplus to the deficit area in the euro area -- will not be addressed next month and the euro will remain vulnerable.
The Canadian dollar has been the best performing major currency against the U.S. dollar this month, appreciating almost 1.6% to its best level since early May. There are three considerations that have helped the loonie outperform. First, the Bank of Canada has not backed away from its relatively hawkish stance. The 2-year yield has risen about 35 bp since the bottoming on July 23 near 90 bp. The premium Canada offers over the U.S. on two year money has risen to 95 basis points. The Canadian dollar is about 0.66 correlated with its two-year yield (60-day) and its correlation to the two-year spread between Canada and the U.S. is even higher at 0.76.
Second, the Canadian dollar's correlation with oil prices is not particularly stable. On a 60-day percentage change basis, the correlation was actually the inverse early last year. It is now near 0.80, the highest since at least 1993. The September West Texas Intermediate crude oil futures contract pushed through $95 a barrel on August 16, its highest level since mid-May.
Third, the Canadian dollar's correlation to the U.S. S&P 500 appears to be the most stable among the major currencies. The 60-day correlation (percent change) between the Canadian dollar and the S&P 500 is now at 0.86. Going back to 1993, the correlation has only been above 0.80 a few times and only since 2010. The record high was set at the end of last year just below 0.90. The S&P 500 is at a four-month high. Near term, the break of CAD0.99 opens the door for a move to the year's low near $0.9800. However, barring a significant surprise on the July CPI data today, a consolidation is more likely flavor today.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.