Dollar Firmer, Euro Remains Resilient As Officials Deny Bailout Rumors


The US dollar is consolidating its recent losses and is enjoying a somewhat firmer tone today.  Although the initial advance in the euro was helped by a favorable news stream, macro-developments do not appear to be driving the foreign exchange market presently.  That said, the news stream out of the euro zone has soured since the start of the week, but the euro, even with today’s pullback from testing the June high, remains fairly resilient.  Position adjustments among momentum traders and by medium term investors as the half year end approaches may be having a greater sway. 

Yesterday’s advance in the US S&P 500 through its 200-day moving average to its best level since May 19th helped lift Asian equities today.  The MSCI Asia-Pacific Index rose about 1%, extending its advancing streak to 5 sessions, in which time it has rinse about 5.7%.  The resource sector was the strongest sector, helped by the higher commodity prices.   Foreign buying of Korean stocks for the fourth consecutive session is noteworthy and appears to have helped the Korean won rise to a 2-week high.   The global equity rally is more muted in Europe, with most bourses up less than 0.25% and several markets, including Italy and Spain, nursing losses. 

Strains in the periphery are evident.  News that the ECB will require a 5% haircut on the use of Greek bonds for collateral, following this week’s downgrade has weighed on sentiment and seen the Greek-bund spread widen out, but Spain is in the cross hairs, with its spread over Germany the widest since the start of EMU.  Continuing press reports of some kind of aid package for Spain have been met with repeated denials, but market anxiety is running high.  At the same time, the market is absorbing supply.  Germany’s 10-year bunds auction saw a 1.6 bid-cover, while Portugal successfully sold 718 mln euros of 9-month bills, with a 1.8 bid-cover.  As noted earlier in other peripheral auctions in recent days, the successful reception has come at a cost of sharply higher yields.  Fro example, the yield on Portugal’s bills (2.689%) was 2 ½ times higher than the yield on the previous auction for the same bills. 

Currency Markets

The euro’s resilience remains impressive.  The news stream has soured in the last 48 hours or so, following the Greek downgrade by Moody’s, the dropping of Greek bonds from a couple of industry benchmark indices, the haircut on Greek bonds the ECB is requiring, continued talk of some kind of financing package for Spain (the most recent in El Economista), and the new widening of peripheral spreads in Europe, the euro remains resilient.  The 5 and 20 day moving averages are set to cross higher today for the first time since April 21st.  As long as the euro holds above the $1.2220 area and ideally the $1.2250 area, the recovery would appear to remain intact.  The premium for euro puts over euro calls continues to decline and implied volatility has fallen from near 16.5% and is now back below 14%.  Both these readings from the options market are consistent with the firmer tone in the spot market.   

At the end of last week, the market shrugged off disappointing UK manufacturing output figures (-0.4% rather than a consensus forecast of a gain of a similar magnitude) and still extended sterling’s gains.   Today the market appeared to shrug off the better than expected employment data.  Sterling did turn higher against the dollar a couple of hours later with the help of purchases against the euro.  That said, the UK labor market recovery has been impressive.  The unemployment queues have fallen for the fourth consecutive month and the 6th time in 7 months.  The claimant count fell 31k in May and the April decline was revised to 32k from 27k.  Unexpectedly, the unemployment rate slipped to 4.6% from 4.7%.  The better employment picture does not appear to be spurring wage pressure.  The average weekly earnings are reported with a 1 month lag behind the claimant count and unemployment rate.  In April the average weekly earnings on a year-over-year rate stood at 4.2% down from 4.3% in March.  Excluding bonuses, the increase is 1.9% down from 2.0%.  It may be understandable that the investors ignore the recent string of economic data from the UK.   The key focus is on next week’s budget presentation and today’s Mansion House speech will be scrutinized for clues.  Lastly, note that the 10-year gilt spread over bunds has narrowed 12 bp over the past five sessions, which is reversal of the underlying trend.  Anticipation of a combination of tax hikes and spending cuts may be encouraging the “buying the rumor” type of activity.

For portfolio managers that believe that debt and deficits are a key investment consideration, Sweden has much to commend itself.  Sweden’s debt office official recognized significantly smaller budget deficits this year and next.  This year’s deficit is now projected to be about SEK14 bln.  In March it had forecast a SEK53 bln deficit.  Next year’s deficit is now anticipated to be SEK8 bln not SEK37 bln.  Total central government borrowing is put at SEK105 bln this year and SEK100 bln next year.  That said, Sweden failed to draw enough bids for today’s 29-year bond auction.  Sweden sold only SEK675 mln rather than SEK 1bln that it intended to of the 3.5% 2039 bonds.  Sweden’s bond market took the disappointment in stride.  The 10-year yield is unchanged.  The euro is about 0.3% higher against the krona today.  This seems largely technical in nature.  The single currency has been building a base for the past four sessions near SEK9.5450.  Meanwhile, next month, Sweden’s Riksbank is expected to raise rates for the first time in the cycle. 

Asian countries continue to look at ways to curb the volatility of their currencies.  South Korea had announced measure to curb forward trading in the won over the past weekend.  Today Indonesia announced measures that will try to achieve the same result, but with different means.  The central bank argued it was not imposing capital controls as much as trying to manage the inflows.  We will send of details later today, but the measures involve maturities of central bank bills and a minimum holding period of the bills.   Separately, India indicated that it will impose a capital gains tax on equity transactions by domestic and foreign investors.  The purpose of the tax is to raise revenue. 

Upcoming Economic Releases
The US reports PPI and housing starts at 8:30 EST/12:30 GMT.  At 9:15 EST the US reports May industrial production.  A 0.9% gain is expected and this would lift the capacity utilization rate to 74.5%.

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