Euro Resilient In Face of Weak European Data

Highlights

The US dollar is mixed in choppy trading.  The euro has shrugged off a weaker than expected ZEW survey (28.7 vs. 42.0 consensus after finding a bid near $1.2170.   The BOJ unveiled a new JPY3 trillion loan facility to aid business and, although equity prices are firm, the yen remains somewhat better bid.  Slightly softer than expected UK inflation figures have done sterling little good and its remains the laggard among the G7.  The dollar-bloc itself is mixed, with profit-taking among the antipodeans, but a firmer Canadian dollar.   To the extent there is an overall theme, it may be the consolidation of the recent foreign currency recovery in a market that lacks conviction of the near-term direction. 

Global equity prices are generally firmer.  The MSCI Asia-Pacific Index was slightly higher and managed to close at its best since 19 May.  The pullback in commodity prices, including the snapping of the 5-day rally in copper, weighed on the basic materials sector.   Of note, progress on a China-Taiwan trade pact appears to be helping underpin the Taiex, the best performer in the region (+0.9%) ahead of tomorrow’s holiday.   European bourses are most 0.25%-0.50% higher, as opening gains are extended through the European morning.  Consumer services and technology sectors are leading the way. 

Following Moody’s downgrade of Greece’s sovereign rating yesterday; a couple of bond indices have announced intentions to drop Greek bonds from their benchmarks as of the end of the month.   Peripheral spreads in Europe are widening out today, especially Greece and Ireland.   Spanish bill auction was well received, but as we saw last week, at a cost of sharply higher yields.  Belgium’s bill auction was better received and without much of an increase in yield, despite the political uncertainty following the weekend election. 

Currency Markets

The resilience of the euro in the face of the yesterday’s announcement by Moody, the warning by the chairman of BBVA, the weaker than expected German ZEW survey, and news that euro zone exports in April declined by 2.4% is noteworthy.  In recent days we had noted that the news stream had improved and that this had encouraged a bout of short-covering.  Gains on the back of good news are one thing, but gains after disappointing news are more impressive.  There is talk of sovereign interest and some bottom pickers when it became clear that the $1.2150 support area would remain intact.  On the upside, the $1.23 high from yesterday appears a bit too far as the short-term technical indicators are over-stretched at the start of the North American session. 

The UK reported slightly lower than expected May inflation.  The 0.2% increase in headline CPI pushed the year-over-year rate to 3.4% from 3.7% in April.  The monthly increase was about half of what the consensus had expected.  The core measure slipped to 2.9% from 3.1%.   The BOE’s King has argued that the elevated inflation is temporary and that the weakness of the economy will ease price pressures in the period ahead.  Today’s report is a single data point but it probably is seen as a bit of a relief.  At the same time, the resilience of UK inflation had previously prompted four of the 9 shadow MPC committee to call for a 50 bp rate hike.  Meanwhile next week’s budget announcement is key for investors.  The fiscal drag that is expected to be unveiled may also take some pressure off the BOE.  On the other hand, some BOE members, like Sentence, are arguing that the spare capacity in the UK may not be as great as is being assumed.  Capacity is indeed difficult to measure and the argument is that during the recent recession, businesses got rid of capacity.   Sterling has been confined to yesterday’s ranges against the dollar.  The $1.4780-$1.4800 denotes the immediate cap.  Support is seen near $1.4680.  Short-term technical readings suggest resistance may be stronger than support.

As widely anticipated, the BOJ left policy on hold.  The important take away from today’s meeting, however, is that the BOJ announced details of a new JPY3 trillion loan facility.  This facility is aimed at boosting corporate lending.  The BOJ envisions each bank is able to lend up to JPY150 bln under the program, probably beginning late August, and the banks then will then lend to high growth businesses.  New loan requests can be made through March 2012, and the loans, the BOJ says, can be rolled over for a year, as many as three times.  The facility seems to assume that the reason that Japanese bank lending is so weak is that the banks simply do not have the money or the risk appetite.  While there may be something to this, there probably is a demand component as well.  Capital expenditures, primarily geared for exports rather than domestic demand, appear to be largely financed out of retained corporate earnings.  In terms of the bank’s themselves, deposits continue to run ahead of loans.  In addition, this appears to be a global phenomenon.  US, Europe and Japan are experiencing weak bank lending.   The dollar found support in front of JPY91.00, but the upside does not have much to recommend itself today.  Resistance is seen in the JPY91.40-60 area.  For its part, the euro is steady against the yen.  The euro’s uptrend, reflected in higher lows being recorded, remains intact today for the sixth consecutive session.  Resistance is seen in the JPY112.40 area, below yesterday’s JPY112.87 high. 

The ECB invited bids for its term deposits of 47 bln euros.  Recall this is the facility for sterilizing its bond purchases.  This amount is slightly larger than the market expected.  It means that the ECB bought more sovereign bonds last week than it did the previous week and this is the first increase in the five week old program.  The first week, the ECB bought 16.5 bln euros, followed by 10 bln and then 8.5 bln and 5.5 bln.   Last week the ECB bought 6.5 bln euros of periphery bonds.  ECB officials are adamant.  This is not quantitative easing.  It is aimed at ensuring that the transmission mechanism of monetary policy—that is the credit markets—are functioning properly.  Given the stress on the peripheral bond markets it would not be surprising to learn shortly that the ECB continues to be active.

Upcoming Economic Releases
The US reports May import prices and the June Empire State Manufacturing Index at 8:30 EST/14:30 GMT.  The April TIC report is released at 30 minutes later.  Note there have been reports of good foreign interesting in the US “Build America Bonds” and note that this would be picked up by the TIC data under corporate bond purchases