Euro Recovery Stalls After News of Moody’s Portugal Warning

from the BBH Currency Strategy Team

Turnaround Tuesday appears to be in force today, with the dollar softer and EM firmer. However, ranges are fairly narrow as trading slows and markets thin ahead of the Christmas holiday.

Euro staged a recovery during the Asian session, due in part to supportive comments from China official. Vice Premier Wang said that China supports the IMF crisis efforts and that China “has taken concrete action to help some EU members counter the sovereign-debt crisis."

However, the euro recovery was later nipped in the bud after Moody’s announced that it was putting Portugal’s A1 rating on review for possible downgrade. We have been highlighting downgrade risk for Portugal, as our model shows it as A-/A3/A- vs. actual ratings of A-/A1/AA-. Moody’s said it may cut "a notch or two" but added that Portugal’s solvency is not in question. While that would match our model rating, we think the market clearly has other ideas. We also note that euro zone sovereign ratings are a moving target, with budget and debt numbers set to deteriorate further in 2011.

EUR/CHF recovery also stalled on Portugal news, and is making new record lows just above 1.26 even as EUR/USD looks likely to again test support at the 200-day average today around 1.31.

Last week’s ECB bond purchases were much smaller than expected. At EUR603 mln, purchases were the lowest since the last week of October.

Spain reported tax revenues for the first 11 months of the year are up 11% y/y.

Peripheral bond yields are all higher. Ireland 10-year bond is the worst performer, with yield up 32 bp on the day. Greece is next, up 17 bp. With German 10-year yields flat, the peripheral spreads continue to widen.

Asian equity markets were largely up, and European equity markets have also started the day higher despite the ongoing concerns about the periphery. US index futures are pointing to a modest up open. No US data today ahead of the deluge Wednesday and Thursday. Canada CPI and retail sales data will be reported today.

BOJ kept interest rates steady, as expected, and said it will continue its asset purchases “steadily” to provide liquidity and to help support demand. Governor Shirakawa warned about the risks of rising in bond yields. No reactions in the FX market, as dollar/yen has traded in a 23 pip range so far today.

UK budget deficit was wider than expected in November (net borrowing of GBP22.8 bln reported) despite austerity efforts by the government.

Brazil mid-December IPCA inflation lower than expected, while November current account report to be released today. We still expect 50 bp hike in January. BRL flirting with 1.70 area on improved EM sentiment today. HUF remains soft, however, after yesterday’s surprise hike by the central bank.

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