Dollar Consolidates Weekly Gain, while Equities Ease to Start New Month

The release of the manufacturing PMIs
confirm that the synchronized global
expansion remains intact. 
The focus today is on three unresolved
political challenges:  US tax reform, the UK-Irish border and the talks
that may produce another grand coalition in Germany.  

The US dollar is mixed, with the dollar-bloc currencies and Scandis
pushing higher. 
The euro and yen are hugging yesterday’s close, while
sterling is paring this week’s gains.  In fact, sterling remains the only
major currency that gained against the greenback this week.  It is holding
on to a little more than a 1% gain this week.  It is the fourth
consecutive advancing week and the largest move seven weeks. 

Equities were unable to follow the US higher.  The MSCI Asia Pacific Index made it a clean sweep with its fifth consecutive decline.   The Dow Jones Stoxx 60 is off 0.7%, which would be its largest decline since November 9.  It was flat on the week coming into today’s session.  Benchmark 10-year yields are mostly 2-4 bp lower, including US Treasuries, which have been turned back from the poke through 2.40% yesterday. 

While the UK’s willingness to raise its initial financial offer to the EU
for the amputation, the thorny issue of the Irish border is unresolved.
 
The problem comes down to this:  The UK’s decision to leave the EU and the
single market requires it to have border controls for people, goods, services,
and capital.  The EU and Ireland insist that there is no hard border
between Northern Ireland and Ireland.  That is an important basis of the
Good Friday Agreement that helped bring peace the Emerald Island.  May’s
political gambit of snap elections earlier this year resulted in a loss of the Tory’s majority.  The government now
depends on the Democrat Unionist Party from Northern Ireland.  The DUP insists that the hard border is not within the
UK, in a Hong Kong-like arrangement. 

Hence the problem: the hard border cannot be outside of the UK (between
Northern Ireland and the Republic) nor inside the UK (between the UK and Northern Ireland). 
The DUP is
threatening to leave the government if its demands are violated.  Monday is the EU-imposed deadline for an
agreement that would allow the next phase of negotiations to begin. Prime
Minister May is to have lunch with Juncker then and was expected to signal a
proposed resolution.   The deadline seems soft in the sense that
theoretically the real deadline in the middle of the month heads of state
summit.  

In the US, tax reform in the Senate hit a glitch yesterday.  The
issue is that the trigger mechanism that was introduced to secure sufficient
votes was ruled improper by the Senate parliamentarian.  There are four
Republican Senators that need to be
appeased and to appease them may alienate others.  The four senators to
watch today are Corker and Flake who want the trigger, Johnson, who wants a
greater pass-through tax break, and Collins, who
wants to consider the individual mandate for health care separate from the tax
reform and the preserve the federal tax break for state and local property
taxes.  

Like in the UK, the problem is not so much the opposition but trying to
manage the governing coalition. 
This
was the same challenge of the Affordable Care Act.  The Republicans agree
that they do not like it but cannot agree
on an alternative.  Moreover, there seems to be little doubt that the tax
reform will aggravate the disparity of wealth in the US.  The
Congressional Research Service estimate that the biggest increase in after-tax
income will be experienced by those
earning $500k to $1 mln a year, while those earning
less than 30k could see a tax increase as early as 2021. 

US corporates have an estimated $2.3 trillion of cash on their balance
sheets. 
The tax cuts envision would give them another $683 bln (over
ten years) according to the Joint (Congressional) Committee on Taxation that
would have under the current law been paid
to the IRS.    As a proportion of GDP, US corporate profits are
twice as large as when Reagan left office in 1988.  

The third political drama is in Germany.  After the Free
Democrats abandoned coalition talk, pressure mounted on the Social Democrats to
re-enter a Grand Coalition.  They have done so in two of three governments
led by Merkel.  The SPD appears to
have lost its way and support by voters fell to its lowest in the modern
era.   

Also, if the SPD enters the government, that would make the AfD the main
opposition party and with that comes certain parliamentary privileges that both
the CDU and SPD would want to deny it.
Merkel meets with the SPD head
Schulz today.  After a poor campaign, Schulz support within the party has
waned.  There is no immediate deadline, but the lack of a
government two months after the election could pose challenges German’s
European positions.  

Europe is fortunate that the economy is in a strong position. 
The German manufacturing PMI was confirmed
at 62.5, a new multi-year high.  It finished last year at 55.6.  The
EMU aggregate reading ticked up to 60.1 from the flash of 60.0.  It was at
54.9 at the end of 2016. It is not just a German story.  Consider that
Italy’s manufacturing PMI rose to 58.3 from 57.8 and 53.2 at the end of last
year.  France is also fully participating.  The flash manufacturing
PMI rose to 57.7 from 57.5 flash reading.  It was at 53.5 at the end of
2016. 

Outside of the eurozone, Sweden,
Norway, and the UK reported strong manufacturing PMIs.   Sweden rose to 63.3 from 59.3
. Norway’s reading
jumped to 57.1 from 54.8, and the UK’s manufacturing PMI rose to 58.2 from a revised
56.6 (initially 56.3).  

Several Asian countries reported stronger manufacturing PMI.  They include Korea, Taiwan,
Malaysia, and Thailand (which moved back above the 50 boom/bust level). 
Exceptions were China’s Caixin measure, which unlike the official report,
slipped to 50.8 from 51.0, and Japan, which saw its manufacturing PMI slip to
53.6 from 53.8.  

Japan reported a slew of data.  The unemployment rate was unchanged at 2.8%, but the
job-to-applicant rose to 1.55 from 1.52, which is a new record high. 
Inflation was spot on expectations, with the headline rate falling back to 0.2%
from 0.7%, due primarily to the base effect.  The core rate, which excludes fresh food, ticked up to 0.8% from 0.7%
Recall that it finished last year at minus 0.2%.  However,
excluding both fresh food and energy, and prices rose 0.2%.  It was 0.1%
at the end of last, but to say it has doubled is misleading.   The
upside surprise comes from the overall household spending.  It was flat year-over-year
after contracting 0.3% in September.  

The North American session will be
peppered
with data and the Senate vote, if it is held, will likely be well after European markets close. 

The US sees the manufacturing PMI and ISM, construction spending and auto
sales.  The PMI and ISM pose headline risk, but the more important number of economists will be the auto
sales.  The recovery from the storm helps
lift auto sales in September to a nearly 18.5 mln unit pace.  It eased
back to 18.0 mln in October and likely corrected further in November.  The
average monthly pace this year has been 17.08 mln compared with 17.44 mln last
year.    Before the storms, that is through August; the average annual pace was 16.8
mln.  The Bloomberg consensus is for a 17.5 mln unit pace in
November.  The risk seems to be on the downside.  

Canada reports September monthly GDP and Q3 GDP.  After several
quarters of strong growth, the Canadian economy hit a wall in the same quarter
that the central bank raised rates twice.  After an annualized growth pace of 4.5% in Q2, the Canadian economy is
expected to have slowed to a 1.6% pace.  Canada also reports November
employment data.  Job growth is expected to have slowed to 10k from 35k in
October and a 26.4k average monthly gain this year.  Last year, Canada
created about 19.1k jobs on average a month. 

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