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The US Dollar gained in overnight trading as a selloff on Asian equities exchanges drove demand for the safety-correlated currency after Japan's Tankan survey revealed that large companies' capital investment fell the most in nearly a decade in the third quarter. German Retail Sales and UK Manufacturing PMI are on tap ahead.

Key Overnight Developments

• Japan's Business Outlook Improves But Capital Investment Falls Most in 10 Years
• Euro, British Pound Sold as Stocks Retreat in Asian Trading, Boosting USD Demand

Critical Levels

100109

The Euro slipped as much as -0.2% against the US Dollar in overnight trading while the British Pound shed -0.3% as a selloff on Asian equities exchanges drove demand for the safety-correlated greenback. The MSCI Asia Pacific regional benchmark fell 1.1% as Japan's capital investment fell more than expected in the third quarter (see below), threatening hopes of economic recovery. We remain short GBPUSD at 1.6617 and EURUSD at 1.4710.


Asia Session Highlights

Japan's Tankan Survey revealed that large manufacturers' economic expectations improved for the second consecutive quarter in the three months to September, with the forward-looking Outlook gauge rising to -21, the highest in a year. Non-manufacturing firms also saw an improvement in their three-month forecast, with that metric up to -17, the highest since the end of last year. Both figures remain in negative territory however, which means pessimists continue to outnumber optimists among the firms polled for the survey, albeit by a smaller margin. Perhaps most tellingly, an index of capital investment fell -10.8% in the third quarter, the most in nearly 10 years, showing that firms continue to slim down their operations on expectations of lackluster demand. Indeed, the survey showed that sales are expected to fall -10.5% through the 2009 fiscal year (12 months ending April 2010), more than doubling the drop in FY2008.

Retail Trade added 1% in August, bringing the annual pace of contraction to -1.8%, the lowest since November of last year, and Large Retailers' Sales shrank at a slower than expected -6.8%. This makes sense considering consumer confidence rose for the eighth consecutive month in August, but sentiment has closely tracked the Nikkei benchmark stock index and so is highly vulnerable to any downward reversal in risky assets. Shares will be left wanting for a catalyst considering the sales outlook implied by the Tankan report, pointing to disappointing earnings and a downward reversal in equities and by extension in consumer confidence and retail activity. Rising unemployment also presents a considerable hurdle, with the jobless rate set to approach 6% by mid-2010.

Broadly speaking, today's data flow is supportive of the Bank of Japan world view: minutes from Augusts' meeting saw policymakers conclude that the pace and sustainability of any economic recovery remains highly uncertain after the effects of fiscal stimulus and the inventory restocking cycle run their course, while domestic consumption remains weak.

Euro Session: What to Expect

German Retail Sales are expected to shrink for the fourth consecutive month, although the pace of contraction is set to moderate to -0.8% in the year to August from -1.0% recorded in the previous month. The unemployment rate unexpectedly fell to 8.2% yesterday, which would seem to bode well for the outlook on spending, but a look past the headline figure reveals a picture that is not as rosy as it appears. Excluding statistical changes made in the September report, the economy actually shed 10k jobs rather than gained 12k. This is a wild swing, which surely calls into question the reliability of the data in projecting the underlying state of the labor market. Further, the 0.7% gain in private consumption that helped propel economic growth in the second quarter owed almost entirely to 85 billion euro government stimulus plan that included a subsidy to keep employers from firing workers (which allegedly saved close to 500k jobs) and a credit for scrapping old cars for new ones. Some of these programs have already expired (the cars scheme) and others are set to expire soon, with additional stimulus unlikely considering Germany's new ruling coalition has Angela Merkel's CDU party sharing power with the free-market oriented FDP who have been very critical of her intervention into the economy last year while the fiscal deficit will top 5% for the first time in at least a decade in 2010. This means that while job prospects in Germany have been relatively better than in the broader Euro Zone, where the Unemployment Rate is set to rise to a fresh record high of 9.6% in August, the removal of public support threatens to push up job losses and weigh on spending, undermining a sustainable rebound in retail activity.

In the UK, September's Manufacturing PMI is expected to print at 50.2, showing that the industrial sector expanded for the second time in three months, rising from 49.7 recorded in the previous month to match the July outcome. Teetering between expansion and contraction seems reflective of what policymakers at the Bank of England have said will be an uneven recovery that would amount to a long had slog before conditions returned to levels seen before the onset of the global economic crisis in 2008. Some moderation from last year's lows is reasonable considering governments around the world have collectively spent close to $2 trillion to prop up global growth, but it remains uncertain whether this can kick-start a sustainable recovery once fiscal measures are withdrawn.


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