After Portugal Cut, Push-Me Pull-You Choppy Price Action

Highlights

The US dollar is broadly mixed as the news stream buffets the foreign exchange market.  A better than expected reception to  the Greek T-bill auction helped mitigate the reaction to Moody’s decision to cut Portugal’s credit rating two notches to A1.  The ZEW survey captured the nature of the push/pull impulses today as the economic sentiment component was weaker than expected but the assessment of current conditions was stronger than expected.  In a similar fashion, sterling was initially weighed down by lingering disappointment, S&P maintained its negative outlook,  and the RICS fell to an 11-month low only to reverse in response to slightly higher than expected inflation (3.2% year-over-year vs consensus of 3.1% and 3.4% in May).  Choppy price action may continue as many participants seem to lack near-term conviction.   Short-term momentum indictors warn that the foreign currency recovery may not be sustained in North America today. 

News that’s contrary to speculation, China indicated it would continue to curb real estate speculation weighed on Asian equity markets, despite the better than expected start to the US earnings season.    The MSCI Asia-Pacific Index was off 0.4%, with the 1.6% drop in the Shanghai Composite the biggest decline in the region.   Weak commodity prices took a toll.   European stocks are advancing for the sixth consecutive session, encouraged by favorable earnings news.  Favorable guidance by BMW helped lift the auto sector, which is the top industry sector today.    In North America, Intel’s earnings are reported after the market closes today.  About 5% of the S&P 500 will report this week. 

The combination of the Portugal’s downgrade and rising equity markets is weighing on European bond markets.   The 10-year bund is 4 bp higher and most of the peripheral spreads are steady today except for Portugal, where the spread has widened 3 bp to about 280 bp.   The pressure on Portugal is clearer in the 2-year tenor where the yield is up 13 bp and the spread has widened 11 bp to 244 bp.   The US Treasury will sell $21 bln of 10-year notes today and yields have resurfaced above the 3% threshold. 

Currency Markets

Moody’s downgrade of Portugal was not all that surprising.  The 2-notch downgrade to A1 brings it in line with the way the market already is trading it.  It adopted a stable outlook.  We suspect there is scope for another downgrade, which after its Q2 move to AA- still seems to be the outlier.  Moody’s cited concerns about the deterioration of the fiscal situation over the medium term and questions about Portugal’s growth prospects if the structural reforms do not work over the medium term.    The euro fell on the news to the session low near $1.2522 to record a five day low.  There was talk of sovereign bids ahead of $1.25, around where option structures are thought to lay.   The 20-day moving average comes in today near $1.2440.  The euro has not traded below this moving average since 1 July. 

The euro fully recouped the downgrade inspired losses on the back of the better than expected Greek bill auction.  Greece was returning to the market for the first time in several months seeking to sell 1.25 bln euros of 26 week bills.  It ended up selling 1.625 bln euros and the yield was a modest 4.65%; up 10 bp from the last sale in April and well below the 5% than had been bandied about.  The bid-cover was a strong 3.64, though off the 7.67 level from April.  Greece will sell 3-month and 1-year bills later this week and today’s auction was a promising start.   The euro recovered to almost $1.26.  Resistance is seen near $1.2630, which may be sufficient to check near-term gains. 

The Germany ZEW survey had something for every one.  The sentiment measure slipped to 21.2 from 28.7, well below consensus expectations of a 25.3 reading.  On the other hand the assessment of the current situation jumped to 14.6 from -7.9 in June, while the consensus had still looked for a negative report.   ZEW’s comments were not very inspiring, warning that there was limited potential for additional improvements and that investors expect the German economy to slow down later this year. 

A German paper is reporting that German Chancellor Merkel is pressing to formalize a default mechanism that would allow a restructuring that would take Germany out of the center of the solution.  While many observers see this as necessary, the timing, before next week’s results of the stress tests may not be particularly helpful.  Meanwhile, although Slovakia has still not ratified the European Financial Stability Facility there is much talk about how the 440 bln euro fund can be used.   For example, some had suggested that it could buy the 60 bln euros of sovereign bonds the ECB has purchased in the secondary market.   There has also been some suggestion that should European banks need to raise capital after the stress tests, they might be able to borrow from the EFSF.  But this seems like a non-starter.  The fund was created to assist sovereigns, not private sector banks.  EU officials seem to recognize this and are insisting that banks first try to raise capital in the markets before turning to national governments and supervisory authorities. 

The most important piece of UK news today was the resilience of UK inflation and in the current context, when the deflation continues to befuddle Japanese officials and the deflationary threat in the US has emerged as a key talking point, it is supportive of sterling.  This is not to say that there was no slackening of price pressures, it is just that the slackening is more modest than expected.  The June CPI rose 0.1%.  The consensus expected a flat report.  The year-over-year rate eased to 3.2% from 3.4%.  The consensus was for a 3.1% reading.  The core measure was even more stubborn.  It rose to 3.1% from 2.9% and the consensus was for a dip to 2.8%.    Petrol, clothing and footwear helped ease price pressures, while air travel and insurance prices rose.  The BOE’s hawkish dissenter Sentance is speaking at 8:30 EST/12:30 GMT and after today’s inflation report his remarks are awaited.  That said, he does not seem to have won over other members of the MPC yet.   Sterling held above yesterday’s low near $1.4950 and bounced above $1.5100 (~$1.51218) before running of out steam.  A break now below $1.5050 and especially a close below $1.5010 (20-day moving average) would sour the near-term tone.   Alternatively, a move above $1.5130 could spark another cent advance. 

Upcoming Economic Releases

The US and Canada report May trade figures at 8:30 EST/12:30 GMT.  The US trade deficit is expected to narrow about $1 bln to $39 bln.  The Canadian trade surplus is expected to slip to flat from C$200 mln surplus in April.