Ireland’s Rating Cut, Dollar Continues to Rally

Highlights
The US dollar headed higher, except against the Australian dollar, but continues to outperform against the rest of the G10. The euro, after earlier losses accelerated around $1.332, traded below $1.320 following the news that Fitch downgraded Ireland to BBB+. Ireland currently holds an A rating from S&P and Aa2 rating from Moody’s with a stable outlook, but nonetheless the euro should find support outside of Friday’s range. Meanwhile, cable traded at session lows around $1.574 in line with the soft euro tone, but most surely the down move was not helped by the unexpected widening of the trade deficit. At the same time, as expected, the BoE left rates unchanged at 0.5% with the stock of asset purchases continuing to remain at £200bln. USD/JPY reclaimed the ¥84.00 area, after falling to ¥83.65 on the back of stronger GDP revision and large increase in the 10-year bond yield, which increased 4bp. Elsewhere, subsequent the strong employment figures AUD/USD jumped immediately to A$0.9855 from A$0.9780, then stretched that to a high of A$0.9885 before settling in a A$0.9860-80 range while kiwi remained flat following the dovish tone from the Reserve Bank of New Zealand.

Global equity markets are mixed again following another choppy trading session in North America. Asian stocks, though, are mostly higher as strong Australian jobs and an upward revision in Japan Q3 GDP underpinned hopes that the global economy’s recovery continues apace. At the same time, Asian equities continue to trade higher despite the near certainty of a rate hike by China this weekend. The MSCI Asia Pacific Index was up 0.75% while the Nikkei was up 0.6% led by a rise in financials and technology. Meanwhile, European bourses marginally increased gains from yesterday with the Euro Stoxx 600 up 0.2% led by a 1.5% gain in financials. Irish financials, for instance, are up 6.2% despite the Fitch ratings cut. The FTSE and Dax were both up with the FTSE outperforming led by a gain in telecommunications.

Euro-zone spreads continue to moderate with the 10-year yield of Irish debt falling 2bp, though Greece’s yield is up 10bp. As outlined above Ireland had its credit rating cut three levels by Fitch, which cited the mounting costs of rescuing the banking system after the country sought international assistance last month, although their outlook is stable. At the same time, France today backed the German stance against eurobonds and an immediate increase in the stability fund. In particular, the French officials said that the bailout fund is big enough and that a eurobond is unnecessary, considering the available funds are entirely sufficient at the moment. Meanwhile, German government bonds rose, snapping a two-day decline, as appetite for securities increased after declines this month sent 10-year yields above 3% for the time since May. Japanese debt sold off after the revision to GDP growth, with the 10-year JGB up 4bp and the US 10-year yield dropped 3bp, limiting the strength of the dollar versus the yen. Elsewhere, the Bank of Korea left rates unchanged at 2.5%, which coincided with the decision by Brazil’s central bank, while Thailand’s outlook was raised to stable from negative by S&P.

Currency Markets

The sharp rise in bond yields emerged as an important market force in recent days. US Treasury yields are stabilizing today with notes and bond yields near six-month highs. The sell-off in US Treasuries in the past two days is the largest in a couple of years. Indeed, it has caught the market wrong-footed in light of the disappointing jobs data last Friday and the ongoing Fed purchases which were meant to keep a lid on bond yields. In fact, it has taken the widening in the 10-year spread to five month highs (just above 200 bp) to keep the dollar at the upper end of its 2 1/2 month trading range. The sharp rise in US yields, in our view, is the single biggest factor driving up global yields this week. As a result, the 2-year US-German interest rate spread (which we find tracks the euro-dollar exchange rate closely along with the 10-year spread) has moved in Germany’s favor over the last few days and it now near 41 bp and is accordingly the biggest discount for the US since Nov 26. That said, this suggests the euro may find support around $1.3180.

The US Treasury is finishing this week’s $66bln auction today with a $13bln 30-year bond sale today. Although the 30-year yield has risen 18bp, the 10-year yield has risen 26bp over the past week, suggesting the concession may not really be that large to spur demand for a maturity that may be too long for large pools of capital, like reserve managers and sovereign wealth funds. The focus, then, is shifting toward next week’s FOMC meeting. On the one hand, some observers suggest that Bernanke’s "60-Minutes" interview was a pronouncement that the Fed may announce an increase in Treasury purchases, extending beyond the $600bln that has already been announced. This would come, of course, after the FOMC completed its first tranche of pre-announced purchases and would be highly contingent on the economic data at hand as the Fed attempts to juggle its dual mandate of growth and price stability.

On the other hand, others are saying the Fed may seek to protest (curb) the sharp backing up of US interest rates. Yet that seems to pay due respect to Bernanke’s guidance that in addition to the growth and inflation path, the efficacy of the purchases would be taken into account when evaluating the program. Part of the premise of this round of asset purchases was that fiscal policy levers were off the table. The surprise, of course, came immediately following the electoral results as it became clearer that the 2001 and 2003 tax cuts would be extended. What is new is the 2% payroll savings. Many economists are now updating their forecasts and revising GDP estimates higher by 0.5-1.0% next year and revising unemployment forecasts a touch lower. However, when calculating the fiscal costs do not seem to be allowing for the greater revenue associated with the stronger growth and slightly less counter-cyclical spending.

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT the US releases last week’s jobless claims. After last week’s data hit a two-year low, this week’s data are expected to improve to 425k from 436k last week. Continuing claims are also expected to drop to 4237k from 4270k the previous week. Following the claims release is wholesale inventories which are expected to decline to 0.8% from 1.5% in September. New home prices in Canada are reported at 8:30 EST / 12:30 GMT and are expected to drop to 0.1% from 0.2%. Meanwhile, in Mexico the m/m consumer prices for the month of November ate expected to increase 0.81% from 0.62% while the y/y is expected to increase to 4.33% from 4.02%.