Market Turns it Attention Back to Europe on Eurobond and Hungary

Highlights
The US dollar made ground against most of the major currencies, rebounding from the declines in the latter part of last week. On 60 minutes yesterday Fed chairman Bernanke said QE2 could be extended – though he didn’t expect the economy to fall back into recession. He suggested growth was close to the point of not being self-sustaining and that it would take as much as five years at this growth rate to bring unemployment down to normal levels. The euro came under pressure, with EUR/USD dropping down to $1.325, as European finance ministers meet later today to discuss extending the bailout facility and the political rift between countries widen, coupled with the Hungarian rating downgrade. Sterling is mixed, down against the dollar but up versus the flagging euro, following weak data and downward GDP revisions from the British Chamber of Commerce. USD/JPY climbed, touching a high of ¥82.99 and subsequently fell back, as mixed equity returns weighted on risk sentiment. EM currencies were pretty mixed. The Hungarian forint sold off sharply in early London trading after Moody’s downgraded their sovereign bond ratings two notches to Baa3.

Global equity markets are mostly flat, despite the reassuring statement from Bernanke that the Fed would continue to purchase assets, as the euro-zone sovereign moves back to the fore. Asian stocks broke their three day gain streak with the MSCI Asia Pacific flat, although the trade agreement between the US and South Korea may be a longer-term boon to equities. Meanwhile, the Nikkei is down 0.1% as strong negative correlation to yen strength remains intact, plus implied weakness to Japan’s US export market following the weak Friday NFP payroll numbers. In fact, Canon, the no.1 maker of cameras and one of the big Japanese exporters to the US, saw its shares slide over 1.7% today. European bourses were mostly down, mirroring the flattish tone that was seen in Asian trading, with the Euro Stoxx 600 down 0.2%. The European benchmark was led by a 1.3% loss in financial. Meanwhile, the FTSE and Dax were both down over 0.1% with financials and consumer services weighing on the indices.

European sovereign bond yields reversed their drop as European leaders split over the steps needed to stop the sovereign debt crisis and markets await the budget vote in Ireland. Greece’s 10-year yield, for instance, is up 43bp with Spain’s yield up 10bp. Likewise, Portugal’s 10-year yields are up 8b followed by a 7bp decrease in Italy’s yields. At the same time, LCH Clearnet reduced the extra deposit it charges clients to trade Irish government bonds to 30% from 45% after the yield on the nation’s debt declined. Meanwhile, German yields dropped, supported by safe haven flows, with the 10-year down 2bp yet, despite the dollar strength the 10-year US Treasury dropped 6bp. Elsewhere, Japan’s JGBs had the biggest jump in two weeks on speculation the central bank will ease monetary policy further to counter the yen’s appreciation.

Currency Markets

The pessimism over the US dollar expressed last Friday after the disappointing US jobs data has eased. The market’s focus has turned back to Europe. Finance ministers meet today and tomorrow and appear hopelessly divided over how to restore market confidence. The IMF reportedly is calling for an increase in the EFSF and ECB bond purchases. Belgium, which has turned in among the worst euro zone bond performance over the past month, and holds the rotating EU presidency, though it continues to struggle to put together a government since the summer elections, supports the idea, but Merkel and Sarkozy have opposed. Recall under the EFSF, countries are providing guarantees behind bonds and are not providing direct funding. The EFSF will issue bonds shortly (~€8bln) to cover part of the Irish package. There is still plenty of capacity to issue more.

We have long argued that there was less to the EFSF that met the eye due to the need to maintain AAA rating when most members are rated lower. However, to increase the guarantees now could signal that officials are preparing to have to come to Spain’s rescue, as there are surely enough funds to cover Portugal. There has been some suggestion (from some like Eurogroup head Juncker) that there could be a European bond, but Germany is again cool to the idea on grounds that it may be more difficult to enforce fiscal discipline. That leaves the ECB as the main institution that can act. The ECB is believed to have stepped up its purchases of sovereign bonds at the end of last week. The market will look at today’s announcement of the weekly fixed-term deposit announcement insight into the size of the bond purchases. The market will likely be disappointed as the bond purchased last Thursday and Friday may not settle. In addition to headline risk from this and the finance ministers’ meeting, the market will also be watching indications from two Irish independent members of parliament to learn their voting intentions at tomorrow’s key Irish budget vote in parliament.

In the past few days the dollar has lost ground versus the yen, while European currencies have suffered from the continuing escalation of the sovereign debt crisis. The yen is consolidating in a narrow range within ¥82.5-83.00 after the fairly sharp drop from the upper reaches of the ¥83.00s on Friday, following the disappointing US NFP. The latest CFTC data indicated speculative accounts have built up a fairly large net long exposure to the yen, and stops from ¥83.15 (present point of the 20-day moving average) could come into play should a squeeze be seen, though the retreat in U.S. Treasury yields and continued uncertainty over the fiscal crisis in the euro-zone will likely pose more downside risks to the USD/JPY. The euro gave back more than 50% of the gain seen on Friday after making a $1.3284 low and is set to test the 5 day moving average ($1.3204) and if broken is set to take out the 200-day moving which happens to coincide with June’s 50% retracement level. On the back of the uncertainty surrounding the Irish budget vote and the continued political gridlock over the future of the EMU we look to see the euro test these new levels in the coming days.

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT Canada releases its October building permits. The m/m figure is expected to decline to -4.0% from a 15.3% in September. Next, Canada releases the November Ivey PMI index which is expected to decline to 56.4 from 56.7. In Mexico the IMEF manufacturing index is released at 1 PM / 17:00 GMT and is expected to increase to 53.7 from 53.4 while the non-manufacturing index is expected to increase to 53.1 from 52.3 in October. Events: Fed’s Lacker (FOMC non-voter) speaks at 1 PM/ 17:00 GMT.