Dollar Demand Amidst News Turmoil

Market Drivers October 2, 2017
UK PMI Manufacturing misses
EUR Catalan referendum creates a stir
Nikkei 0.22% Dax 0.31%
Oil $51/bbl
Gold $1273/oz.

Europe and Asia:
EUR Manufacturing PMI 58.1 vs. 58.2
UK Manufacturing PMI 55.9 vs. 56.4

North America:
US ISM Manufacturing 10:00

The dollar saw strong demand at the start of week’s trade amidst political turmoil in Europe and hopes for stronger economic data from US.

In Spain, the Catalan independence referendum was met with violence and resistance by the Spanish national police, but the organizers claimed that it passed with 89.9% of the vote and intended to formally declare secession within a week.

Spanish cabinet will meet in Monday to respond to the crisis, but given the bad feeling on both sides, compromise seems unlikely at this point. Catalonia is one of Spain’s most productive regions responsible to 20% of the GDP and 25% of the country’s exports and the standstill could greatly complicate the situation on the ground. Spain has seen a strong rebound in economic activity from the financial crisis of 2008 and the turmoil could scuttle the recovery complicating policy action for the ECB.

The independence movement could also inspire other fracture across the region including in Italy where separatist forces have been gaining ground as well.

One great unknown is the long-term impact of these events on the euro itself. The currency is actually uniquely structured to accommodate such adjustments, as it allows for political autonomy while maintaining economic unity. There is no doubt that the Catalan government will want to remain in the euro, but the question is whether Spain will try to veto its entry. If Catalonia, as an independent entity remains within the EZ, the economic impact will be minimal as it will have to abide by the current European law. If, on the other hand, Madrid vetoes its entry the region will be left stranded and will likely trigger a political crisis with the union itself as it challenges the very foundations of the Eurozone ideal.

For now, the markets remained wary of risk and euro continued to slide throughout the night hitting a low of 1.1730 in mid-morning dealing. If the crisis exacerbates as the week proceeds the selloff could intensify as well and the pair could break the key support levels at 1.1650 as the political calculus suddenly changes.

In the US today, the focus will be on data rather than politics. The market will get a look at the ISM Manufacturing report which is projected to print at 58.0 versus 58.8 the period prior. There is, however, good reason to believe that ISM may beat the forecast given the strength in Philly and Chicago PMIs. Any print near 60 could generate a second wave of buy in the dollar with USDJPY pushing back above the 113.00 level as the day progresses.