The US dollar fell against most of the major currencies on Thursday when the US markets were closed for the Thanksgiving holiday.  After a firm start to the week, the greenback has traded with a heavier bias for the third consecutive session.

With the dollar retreat, many tried linking it to comments by Fed Chair Yellen on Tuesday evening in NY and the FOMC minutes released late in the Wednesday session.  This seems to be an example about how the price action generated the stories more than the stories generating the price action.

Specifically, if the markets' view of the Fed policy had changed, the Fed funds futures (or their equivalent like overnight index swaps) would reflect it.  Next month's contract was unchanged for the fourth consecutive session at an implied rate of 1.29%.  We calculate fair value, assuming a 25 bp rate hike next month at 1.295%.   The December 2018 contract finished at an implied yield of 1.7455, up to a basis point since the end of last week, and up seven basis points since the end of October.

The US two-year yield rose 5.5 basis points to almost 1.78%, its highest level in nine years on Tuesday and retreated in North American on Wednesday.  It settled a little below 1.73% on Wednesday, largely unchanged on the week.   Neither Yellen nor the FOMC minutes changed market expectations.  It continues to price a hike next month and the little more than one hike next year.

At least seven Fed officials speak next week, including Yellen before the Joint Economic Committee of Congress and Powell in his confirmation hearings.  Also, the US reports the core PCE deflator, the Fed's targeted measure.  The decline from 1.91% last October to 1.290% in August is the decline that Yellen admits is mysterious, but likely results of transitory and idiosyncratic developments.  It has already begun recovering and was just below 1.33% in September, and the median expects 1.4% in October.

There were three developments in Europe to note. First, the flash November PMI was strong, and Markit, who conducts the surveys, suggest is consistent with 0.8% growth in Q4 and 0.6% in Q3.  The composite PMI rose to 57.5 from 56.0 in October.  It is the highest in nearly 16 years.  Manufacturing jumped to 60.0 from 58.5.  The market had expected a small decline.  The service PMI rose to 56.2 from 55.0.  Of note, France, who has been a laggard, appears to have turned the corner.  The composite surged to 60.1 from 57.4, and a separate business confidence survey was the strongest in almost a decade.

Second, German politics continue to draw interest.  It seems clear that a Jamaica Coalition is not possible.  That leaves three possibilities, a Grand Coalition with the SPD, Merkel heading up a minority government, or new elections.   SPD leader Schulz, who led his party to the worst showing since WWII, categorically refused to join a coalition government, is under pressure some centrists to compromise.

The compromise he appears to be offering is support for a minority government. Merkel has said she prefers new elections to a minority government, may also be under pressure to compromise.  In any event, the forces lifting the Germany economy remain intact, evidenced by the PMI, and this appears to trump the near-term political uncertainty.

Third, on Tuesday the EC pushed against next year's budget proposals by France, Italy, Belgium, Austria, Portugal, and Slovenia.  These countries were judged to be " at risk of non-compliance" with the agreed upon fiscal rules.  Also, France, Italy, and Belgium additionally seen at risk of falling short of their debt reduction commitment. European bonds yields were mostly 1-2 bp higher on Wednesday.

The Canadian dollar was one of two major currencies to slip against the US dollar on Thursday.  The Canadian economy appears to have slowed dramatically in H2 after a stellar H1.  The disappointing retail sales report released while US markets were closed is the latest addition to the accumulating data.  The median Bloomberg forecast looked for a strong bounce back from the -0.3 decline in August.  Instead, retail sales rose a slight 0.1%.  A small part of the story is that August was less poor, and was revised to -0.1%.  Excluding autos, retail sales were up 0.3%, a third of what was expected, though here too August was revised up to -0.4% from -0.7%.

Sterling was the other major currency to lose ground against the greenback.  Sterling had climbed to the top of its nearly 2.5-month trading range near $1.3340 on Wednesday.  The budget did not seem to be the main driver.  There were few surprises.  The government continues to increase the funds set aside for costs Brexit and is reportedly on the verge of doubling its offer to the EU.  The budget put aside GBP3 bln for administrative costs associated with Brexit and earmarked GBP2.8 bln for the National Health Service.  The OBR forecasts are sobering and reinforce our sense that the UK will be smaller and poorer on the other side of Brexit.

The euro is firm, within a spitting distance of the mid-November high near $1.1860  The October high was near $1.1880, just shy of the 61.8% retracement of euro's pullback since the year's high was set in early September close to $1.21.  A convincing close above the October high will be seen by some technicians as confirmed head and shoulders bottom pattern, which projects a little beyond those September highs and toward the 50% retracement of the decline since mid-2014 (~$1.2170).

The dollar broke down to nearly JPY111.00, its lowest level in two months.  It corresponds to the 50% retracement of the bounce off this year's low in early September (~JPY107.30).  The next retracement is seen near JPY110.15.  A move above JPY111.65-JPY111.80 is needed to stabilize the tone.  The US 10-year yield and the forces that drive it still seem to be key for the yen.

A softer US dollar backdrop could see sterling push through that $1.3340 nemesis.  The next target would be near $1.3420.  On the other hand, a break back below $1.3260 would signal that the broad trading range will likely remain intact.

The Canadian dollar may lag behind the other majors.  The US dollar finds bids around CAD1.2650 and offers CAD1.2840.  The Australian dollar posted key upside reversal on Tuesday, and after a slow start closed firmly on Wednesday and saw additional follow through on Thursday.  A weekly close above $0.7640 would further lift the technical tone and signal the potential for another cent in the near-term.

The MSCI Asia Pacific index and the Dow Jones Stoxx 600 eked out minor gains on Thursday.  The most significant development was the large drop in Chinese shares.  The CSI 300 of the largest companies fell nearly 3%, the largest loss since June 2016.  The intensification of losses in late dealers also unsettled participants.  Ideas that officials are putting more emphasis on deleveraging, and curbing what is perceived to be excess speculation was seen as the proximate spur to the sell-off.  Unlike in 2015 and early 2016, the global knock-on effect from the slide in Chinese share prices seemed modest, but it is something investors will be monitoring.

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