The London session saw risk sentiment deteriorate

Market wrap

The London session saw risk sentiment deteriorate. Moody’s downgraded rating outlook for the European Union released earlier may have weighed, while a Die Welt article opining the ESM was illegal attracted attention, particularly from the EUR. US ISM data was a mild disappointment. The S&P500 was down 0.9% in early NY trading but it did stage a late rebound to be up 0.1% currently, the catalyst not obvious (media attributed it to Apple product news. The CRB commodities index is 0.3% lower, Brent oil 1.3%, and copper +0.6%. US 10yr treasury yields are 3bp higher than Friday’s close at 1.58%. Eurozone peripheral yields fell in response to leaked indications the ECB will table a bond buying plan at Thursday’s meeting, a Dutch media article adding hawkish member Weidmann was isolated in his opposition. Spain’s 10yr yield fell 28bp, Portugal -32bp, Italy -10bp.

The US dollar index (DXY) is slightly firmer. EUR fell from 1.2627 to 1.2555 following the Die Welt article and stabilised to 1.2579 with US equities. USD/JPY fluctuated between 78.29 and 78.47. AUD fell with the EUR from an early London 1.0288 to 1.0216 – a fresh six-week low - before stabilising with US equities. NZD fell from 0.7997 to 0.7922 - also a fresh six-week low - before settling in NY. AUD/NZD rose from 1.2860 to 1.2921.

Economic wrap

US ISM manufacturing slips from 49.8 to 49.6 in Aug, just below our low end 49.7 forecast, and the third month running below 50; the last time it dipped below 50 prior to this year was exactly 4 years ago in August 2008 when the economy was already in recession. The detail showed production sub 50 for first time since that recession; new orders sub 50 for 3 months running, almost repeating their Jun-Aug 2008 readings as the economy was entering recession; jobs stayed positive but at 51.6 recorded the lowest reading since 2009 as well. US construction spending fell 0.9% in July, a surprise given other improved housing data of late. There was broad based weakness in construction spending with private residential down 1.2% and private non-res down 0.9%, on top of renewed declines in public spending in the sector after an increase in May (first gain this year for public) and flat June.

ECB chief Draghi recorded in closed session telling European Parliament that ECB bond buying is not financing governments (not allowed under EU treaties) as long as it is maturities no more than three years. “If we are to buy long-term bonds we are in a very delicate situation. But if we go on the short-term part of the market where bonds have a length of time, a maturity of up to one year, two years or even three years, these bonds will easily expire, so there is very little monetary financing if anything at all that we are doing.” LTROs are not sterilised because they are paid back after three years; is Draghi implying the ECB’s bond purchases won’t be sterilised (as they were in the SMP) because they will be paid back in up to three years? Roll on Thursday!

Euro zone producer price inflation levels off at 1.8% yr in July, the equal lowest since early 2010.

UK PMI services rose from 51.0 to 53.7 in Aug, its highest reading since Feb. The report was released 18 hours earlier than scheduled, and suggests some benefit to the services sector from the Olympics. The construction PMI however dipped from 50.9 to 49.0 in Aug, its second month in three below 50, and its weakest string of three readings since early 2010. Also the BRC retail survey for August found same store sales down 0.4% yr in Aug, their weakest since weather-impacted April, a sign that the Olympics may have not been so helpful in that sector.

Market outlook

AUD and NZD Outlooks: Australian GDP (Q2) is the main local interest for markets today, 0.7% the median forecast. In NZ Q2 building work will be a useful Canterbury rebuild update but is unlikely to be a NZD-mover.

NZD/USD 1 day: 0.8000 should cap any corrections today, the month long decline intact for a test of 0.7860 next.

NZD/USD 1 month: Lower to 0.7800 or below. The NZD started a major reversal downwards on 6 August and this remains in progress, with a move to the mid-.70’s possible

NZ 2yr swap yield 1 day: Opening today 2bp higher at 2.67%.

NZ 2yr swap yield 1 month: Lower towards 2.50% on lower US interest rates and likely ECB disappointment this week. AUD/USD 1 day: 1.0290 should cap any corrections today, the month long decline intact for a test of 1.0177 next.

AUD/USD 1 month: Lower to 1.0100 or below. The AUD started a major reversal downwards on 9 August and this remains in progress, with an eventual move to 0.9700- 0.9900 possible.