Hopes of an Irish Rescue Package Reignite Dollar Weakness

Highlights
The US dollar is broadly lower in anticipation of a joint EU-IMF rescue for Ireland, reigniting risk appetite and demand for higher yielding currencies, along with commodities.  The euro continued to gain on the dollar, trading up to $1.365 highs while cable was boosted towards $1.60 as a result, with cable also benefiting from better-than-expected economic data.  Meanwhile, the yen is only currency down versus the dollar as the 2-year interest rate spread widened in the dollar’s favor by 2bp.  Otherwise, the Australian dollar extended overnight gains to trade just above $0.990, as the improvement in sentiment and hawkish tone of the Reserve Bank of Australia encouraged buying momentum. 

Global equity markets are broadly up, led by a rise in risk appetite, as Ireland is closer to accepting an aid package from the EU-IMF, and a continuation from yesterday’s performance in the US.   The MSCI Asia index is up 1.6% with a sharp rise in the Nikkei and the Shanghai. The 2% gain in the Nikkei is led by outperformance in financials and telecommunications with a 0.9% gain in the Shanghai index led by materials and consumer goods.  In Europe stocks continued to rally with the Euro Stoxx 600 up 1.0% driven, again, by materials and consumer goods.  Meanwhile, the Dax and FTSE were both up over a percent with gains with the FTSE making higher gains in consumer goods on the back of positive economic data.  And ahead of the jobs data, US futures are up over 1.0%.

European sovereign bonds yields continued to moderate as a rescue package for Ireland’s banks appears to be in the works.  Irish 10-year yields are down 11bp yet Portuguese yields are up 3bp on the day.  After today’s Spanish bond, one of the last three for the year, 10-year yields increased by 3bp.  Spain sold €2.586bln of 2020 bonds at an average yield of 4.615% and a bid to cover ratio of 1.84, up from 4.144% from the last auction on September 16.  The rise in the refinancing costs highlights the impact the latest flare-up in Irish yields has had on other eurozone members and highlights our view that despite rescue package euro strength may be short-lived as investors become more acute to the issues in Portugal and Spain, with nearly €1,000bln in government debt.  Meanwhile, 10-year German yields are up 8bp with the 10-year US Treasury up 5bp.   

Currency Markets

Officials from the EU, IMF and ECB are in Dublin today to assess the magnitude of the aid needed and to negotiate the terms.  Ireland does have a trump card, though it may lack the political will to use it.  It was among the first countries to guarantee bank debt.  It could find German Chancellor Merkel is right.  That burden sharing is necessary.  If the EU/IMF/ECB wants the fragile Irish government to renege on promises about more cuts in government work’s pay, that those same forces, might compel Ireland to re-think its guarantees.  Isn’t it because of the ramifications of such a move, a wider questioning of all guarantees, and through the euro zone into greater disarray, and hitting the weakened banking systems again?  Germany and other European countries also appear to have their sights set on their long-time nemesis, the low Irish corporate tax rate (12.5%), in the tax competition that takes place within the euro zone, which caps other countries ability to raise corporate taxes.  Irish officials argue that it is sanctioned in the Lisbon Treaty, despite the complaints.  It is not clear when the details will emerge but there are two aspects to watch for:  One, since it is about Irish banks, less the sovereign, will Ireland be required to increase the €6bln fiscal adjustment projected for next year and the €15bln savings it projects in the four-year plan now expected toward the middle of next week (but the situation of course is very fluid)? Two, can Ireland keep the aid to some kind of contingent funding rather than direct financial assistance.

Unlike the episode earlier this year, which was resolved largely through liquidity measures, the solvency dimensions are more on the forefront now.  We are suspicious about how long an aid package for Ireland, whatever the contours of the package, will keep the proverbial wolf away from the door.  The greater risk seems to lie with renewed pressure in the periphery after a short respite.   This also fits in with two factors we continue to monitor for insight into the euro-dollar direction.  First, 2-year interest rate differentials between the US and German have stopped moving in the US favor and the premium the market pays for euro puts over euro calls has stopped widening. Second, there are not the end-all or be-all, but offer helpful insight and that insight and the beginning of buy the rumor of a Irish package (with an eye toward selling on the fact ?) has lifted the euro 2 cents since Tuesday.  Technical corrective pressure could see the euro recover toward $1.3770 at least initially.  This could see sterling toward $1.6100 and the Australian dollar back toward parity.  Dollar-yen marches to its own tune, but the yen is likely to under-perform on the crosses. 

U.K. October retail sales came in largely in line with forecast, up 0.5% m/m and down 0.1% y/y, compared to the consensus for 0.4% and 0.0 %, though September figures were revised down from -0.2% m/m and 0.5% y/y. The ONS reported that sales were underpinned by fuel and non-store retailing in October, while household goods sales fell.  Excluding fuel, retail sales were up 0.3% m/m and 1.2% y/y.  Although October m/m retail sales data were better-than-expected, the annual reading still indicate soft consumer spending, stoking fears that may output contract.  Ahead of the 2011 austerity measures retail sales should see a nice boost, adding, as opposed, to subtracting to GDP.  But with government austerity measures setting in shortly, the outlook for 2011 remains bleak as consumer confidence will likely wane and with a negative wealth effect from housing, output will most likely shrink, stoking sterling weakness as BoE continues to contemplate QE.

Upcoming Economic Releases

At 08:30 EST / 12:30 GMT the US reports initial jobless claims.  The consensus is for a small uptick, although the 1 month moving average is at its lowest point since September of 2008.  Afterwards, October’s leading indicators is reported and the November reading of the Philadelphia Fed index. Both are expected to increase from the previous month.  At the same time Canada reports its October’s m/m leading indicators index which is expected to increase to 0.1% from -0.1% along with international security transactions.  Events: Fed’s Warsh (FOMC voter), Pianalto (FOMC voter), Kocherlakota (FOMC non-voter) and Plosser (FOMC non-voter) speak. Meanwhile, BoC publishes quarterly review.