Lingering Periphery Concerns Pressure Euro
The US dollar is little changed since Friday but stronger against the euro, which is largely a sign of euro weakness as opposed to dollar strength. The euro is susceptible to event risk this week, after hitting recent highs, with the Euro group (today) and EcoFin (tomorrow) unlikely to make much headway in confronting the European sovereign debt crisis, prompting a rise in periphery yields. In addition, European data are likely to add to euro weakness this week as cold weather is the likely impetus for a weak GDP print. Sterling and Swiss franc, meanwhile, remain in Friday’s trading ranges, while the market awaits this week’s BoE inflation report. The dollar is softer against the yen amid reports of good exporter interest and a better than expected Japanese print, after pulling back from ¥83.50.
Global equity markets resume rally, as risk appetite returns, with turmoil in Egypt finally beginning to ease and markets shifting their attention to Yemen. Asian stocks rose with the MSCI Asia Pacific index rebounding 1.5%, after its worst weekly performance since August. Another source of demand was a 2.5% rise in China’s Shanghai index (best rally since December) amid speculation that tomorrow’s January inflation data may be on the lower side of expectations, while the Japanese Topix index rose for a sixth day as GDP shrank less than forecast. In Europe, stocks are off session highs but positive nonetheless with the Euro Stoxx 600 up 0.3%, while the strength in the DAX is bogged down by the financials. Copper remains well supported, up for a second day, while tin advanced to an all time high.
Global bond markets are mostly weaker following the return of risk appetite and the advance of stocks. In Europe, Italy sold €1.676bln of 2040 bonds with an average yield of 5.51%, while it also sold €3.5bln of 2015 bonds with an average yield of 3.77%. The latter is not overwhelming and euro zone peripheral bonds have been under pressure this morning, with the spreads over Bunds widening again as there is no sign of a quick agreement on a revamped euro zone rescue mechanism. Indeed, the cost of protection again default has increased the most in Greece with the 5-year CDS reaching a monthly high of 908bps, while Portugal’s 5-year CDS is at its highest level since January 20th. In Asia, Japanese 10-year yields reached 10-month highs, while 2-year Treasury yields reached eight-month highs.
The euro experiencing independent weakness today. There are a number of considerations at work, nearly all of which are negative. Peripheral tensions are running high. Portugal’s 10-year bond yield remains well above 7% for the seventh consecutive session and 12 of the past 15 sessions. A sustained rise through 7% seemed to have intensified the pressure on both Greece and Ireland to seek international assistance. Meanwhile on Wednesday Portugal will try to buy back paper set to expire in April and June and the small Left Bloc is pushing for a vote of confidence on the minority government. Q4 GDP came in line with expectations, contracting 0.3%, offsetting the growth in Q3. It is a useful reminder too that the central bank expects the economy to contract 1.3% this year and the pro-cyclical nature of fiscal policy.
EU finance ministers meet and key differences do not appear to have narrowed over how to address the crisis. Increasing the size of the permanent mechanism to 500 bln euros is hardly sufficient to stem the crisis. There is bound to be much discussion over last week’s surprise news that the BBK’s Weber will step down at the end of April and not be a candidate to replace Trichet at the head of the ECB. Merkel’s close economic advisor Jens Weidmann (previously headed up a monetary policy unit at the BBK) has been tipped to be announced Wednesday to succeed Weber at the BBK. Regling, the German head of the EFSF has reportedly indicated greater desire to head up successor to the EFSF rather than the ECB. A compromise candidate at the ECB will eventually be agreed upon, but the fact that it will not be the uber-hawk, would seem that the risk of a ECB hike late this year has risen.
A major knock against the dollar has been that QEII is capping US rates and fiscal expansion continues with abandon. Both are worth challenging. The US 2-year yield has doubled from the 42 bp low seen on December 7 and remains near the highest level seen since last June. Over the past month, the US 2-year yield has risen and the 2-year differential, which tracks the euro-dollar has moved 17 bp in the US direction over the past 8 sessions. The unexpected compromise on fiscal policy in the US seemed to be the last hurrah of the fiscal expansion phase today marks the turn of the debate. Obama will outline his budget strategy, which reportedly will propose halving the deficit by the end of 2012 and cutting the (projected) deficit by $1.1 trillion over the next decade. His plans are said to be 2/3 spending cuts and 1/3 tax increases. This is the opening gambit and the Republicans are likely to seek greater spending cuts and less tax increases.
Japan’s contraction in the Oct-Dec GDP (-0.3% on the quarter, -1.1% annualized) was a bit better than expected though the previous quarter was revised (0.8% from 1.1% Q/Q). However, tomorrow the BOJ is likely to revise up its economic assessment for the first time in nine months. China’s trade surplus was much smaller than expected, but the focus is on tomorrow CPI figures. Although the market consensus is for a 5.4% rate, a local paper reports a sub-5% reading. There is some speculation that the "food" weighting in the measure may be re-jigged. Tomorrow also sees the UK CPI/RPI report ahead of the BOE’s inflation report on Wednesday. Another jump in headline inflation is expected. The key to the policy outlook is whether there is some softening of the confidence of the majority that inflation pressures are transitory as they are not being picked up in wage growth or money supply. Lastly, Sweden’s Riksbank is widely anticipated to hike 25 bp tomorrow to 1.5%. The krona may be vulnerable to a "buy the rumor sell the fact" type of trading. Swedish officials seems to welcome the krona’s strength, but businesses are increasingly pinched and the Stockholm market is one of the few European bourses that remain lower on the year.
Upcoming Economic Releases
There are no important economic data releases in the US or Canada. Events: Obama to reveal 2012 fiscal budget proposal, Fed’s Dudley (FOMC voter) speaks at 10:00 EST / 15:00 GMT, Euro group meeting begins at 11:00 EST / 16:00 GMT.