Highlights
The US dollar was mostly firmer vs. the majors. EUR/USD made a marginal new low for the cycle at 1.2111, helped by rumors about France (see below) but then spiked higher during North American trading before closing lower on the day. With negative news stream likely to continue, we believe the euro bear trend remains intact. Yen was firmer too but kept up with the buck and so dollar/yen stayed around 91. EM FX was mostly softer. Only gainers on the day vs. USD were GBP, ILS, and JPY, while biggest losers vs. USD were INR, AUD, MYR, PLN, and CZK. US data was stronger than expected, with ISM PMI at 59.7 and construction spending surging 2.7% m/m. Czech political outlook cloudy as center-right parties hit a stumbling block to forming coalition. RBA left rates steady, BOC hiked rates 25 bp (see below). Head of EU Fin Min group Juncker expressed concern about pace of euro’s drop, not about the current level. We note that the pace of weakness has slowed since mid-May.
US equity markets were lower, as DJIA, S&P, and NASDAQ ended down 1.1%, 1.7%, and 1.5%, respectively. European markets were down too, with Euro Stoxx 50 falling 0.1%. Asian equities are likely to open down today as Asian ADRs were lower during N. American trading Tuesday. Nikkei futures point to a down open for Japan.
US bond market was higher, as 2- and 10-year yields were down 1 bp and 3 bp, respectively. European bond markets were mostly lower, as 10-year yields in UK, France, and Germany were down 1 bp, up 4 bp, and up 2 bp, respectively. Greek 10-year yields rose 14 bp, Portugal rose 10 bp, Ireland rose 11 bp, Italy rose 3 bp, and Spain rose 6 bp.
Currency Markets
The Bank of Canada hiked its overnight target 25 bp to 0.50%, as widely expected. A Reuters poll showed all primary dealers expected it and expect a hike at next month’s meeting as well (July 20). However, the Bank of Canada’s statement is somewhat more neutral. BOC also took measures to restore the normal operating band to 50 bp. The uneven economic recovery globally and what the BOC called "the possibility of renewed weakness in Europe" is one of the factors that might give the central bank pause. Given the substantial uncertainty surrounding the global outlook, the BOC cautioned "any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.” This would seem to suggest the bar for a July hike is an easing of the tensions in the global capital markets. The Canadian economic recovery is unfolding thus far in line with policy makers’ expectations. The Bank of Canada notes that policy is still accommodative. On a trade weighted measure, the 7% decline in the Canadian dollar since mid-April also imparts some degree of accommodation as well. Initial resistance for the US dollar is seen near CAD1.0550-60. A move above there could see CAD1.0720-40. Last week’s high was set on Tuesday near CAD1.0850. Support is seen near CAD1.0460.
The Reserve Bank of Australia met Tuesday and as widely expected kept the official rate steady at 4.5%. The tone of the statement was fairly neutral, as one might expect after 6 rates hikes since last October and increased uncertainty about the economic outlook of Europe and China. Australia reports Q1 GDP figures first thing in the Australian morning on Wednesday. The consensus expects a 0.6% quarter-over-quarter expansion; slower than the 0.9% pace seen in Q4 09, but near last year’s average quarterly pace (0.67%). Inventory rebuilding is likely to have contributed more to growth than in Q4 09. Foreign demand also looks promising as Australia reported a somewhat smaller trade deficit in Q1 10 than in Q4 09. Despite relatively healthy job creation, it has not spilled over to help consumption very much. Over the quarter, retail sales rose 0.5%. In Q4 09 retail sales rose 1%. The Australian dollar is not being driven by its high interest rates. The steep 13.5% loss recorded from April 30 through May 25 seems largely a function of the unwinding of risk trades, like long AUD short JPY. Within our constructive view of the dollar bloc in general, given that the Australian interest rate cycle is mature, we have suggested that the Canadian dollar, which hiked rates today for the first time, may out-perform. Some observers emphasize the pullback in China’s PMI today (though another PMI was firmer), but we think the China story is still a net positive for Australia. After falling to $0.8282 earlier, AUD bounced to $0.8437 in the North American morning, as the equity market recovered, illustrating the "real" driver of the Australian dollar.
France is coming under the spotlight after rumors of a downgrade made the rounds. This in turn may have been triggered an admission Monday by French Budget Minister Baroin that holding onto the AAA rating was a “tough objective.” He has since walked back that comment, but it’s clear nerves are frayed right now. French spreads and CDS prices did not move much today, but we note that French risk has been creeping higher of late. Our sovereign ratings model puts France as a borderline AAA/Aaa credit, so there is certainly a risk that France falls into AA/Aa territory in the coming quarters. However, we do not think there is an obvious case for a downgrade currently for France, which is more than we can say for many others in the euro zone. But recent ratings action underscores the fact that the agencies are on the warpath and unlikely to relent anytime soon and so even France is coming under market scrutiny. Given that most of the peripheral countries remain overrated, the downgrade story will remain in play for most of 2010. We saw this during the Asian crisis, when the agencies got caught wrong-footed and then slashed ratings with abandon across the entire region just as the situation was deteriorating further, adding more fuel to the fire. As we wrote several months ago, “To be clear, our model has been highlighting significant downgrade risk for Portugal, Ireland, Greece, and Spain since June 2009. The problems facing these peripheral countries are nothing new, and these problems are also not likely to be solved over the near-term. As such, we expect continued pressure on the bonds of the periphery, which likely will continue to weigh on the euro as well.” Here is our most recent ratings summary for the euro zone. 1. After the most recent downgrade to A- by S&P, we believe Portugal is still vulnerable to further moves given the negative outlook that remains in place. For sure, Moody’s Aa2 and Fitch’s AA- need to be adjusted downward as our model rates Portugal at A/A2/A 2. After losing its AAA status from all three agencies early last year, Ireland was downgraded further by all three later in 2009 as well. It still remains vulnerable to further downgrades as our model rates Ireland as A/A2/A vs. actual ratings of AA/Aa1/AA- 3. Despite the most recent downgrade to BB+ by S&P and the Apr downgrade to BBB- by Fitch, we believe Greece is still vulnerable to further downgrades 4. After losing its AAA status from S&P last year and now last week from Fitch, Spain still remains vulnerable to further downgrades. Our model rates Spain as A/A2/A compared to actual ratings of AA/Aaa/AA+, and there is no way it holds onto its Aaa status from Moody’s in this current environment 5. Italy has so far escaped rating action, but our model puts it at A/A2/A compared to actual ratings of A+/Aa2/AA- 6. For now, we see no ratings pressure on Germany, France, or Austria.
Upcoming Releases
Asia: Australia GDP; Thai central bank meeting; Singapore PMI Europe/EMEA: Swiss retail sales; Sweden current account Americas: US weekly mortgage applications, Challenger jobs cuts, pending home sales, vehicle sales; Brazil FIPE inflation. No US speakers of note.