Euro Rebounds, China Hikes

Highlights
The US dollar is trading on a softer footing versus the majors and most EMs, consolidating some of yesterday’s gains, with the New Zealand dollar and the euro leading the move higher. The euro is enjoying early strength, trading near sessions highs above $1.365 amid talks of Asian sovereign fund demand. German December IP slumped 1.5% m/m but was largely shrugged off by the euro after yesterday’s weak orders led to lower expectations. Cable, meanwhile, pulled back from early highs near $1.616 and remains flat against the dollar amid UK Chancellor’s decision to raise an extra £800bln from a bigger than expected bank levy and uncertainty over UK policy decisions. The dollar continued to trade above the ¥82.00 handle, while the pair was unable to sustain a move near ¥82.50, hampered by talk of repatriation. The Australian dollar, meanwhile,is trailing gains in the G10 following China’s announcement of a 25bps rate hike.

Global equity markets are mixed with Asian stocks posting broad gains, while European bourses are showing signs of fatigue. In Asia, the MSCI Asia Pacific index advanced 0.2%, while Japan’s Nikkei rose 0.4%, reflecting the rally across US stocks and ongoing signs that the global economic recovery is gaining momentum. European shares, on the other hand, dropped, with the Euro Stoxx 600 off from the highest levels since September 2008. The regional decline was led by softness in banks, miners and energy groups, although the Spanish Ibex was the one index to buck the trend in losses. Commodities are broadly lower with copper off recent highs, while oil is down -1.3%.

Global bond markets are weaker as growth hopes and inflation concerns continue to pressure yields. Euro zone spreads continue to widen after officials failed to agree to a rescue package, with the generic 10-year Portuguese yield now sitting uncomfortably at 7.192%. Greek 10-year yields are up 10bps with the 2-year yield up 14bps despite Greece’s €390mln successful bill auction. Elsewhere in Europe, 2-year German yields are up 3bps, while 2-year gilts yields are down 3bps, suggesting that markets expectations of a BOE rate hike this week are diminishing. 10-year Treasuries remain flat but remain near their highest level since April 2010 amid the optimistic growth outlook. Elsewhere, Jordan’s local currency rating cut to junk (BB+) by S&P, which noted the outlook was moved to negative.

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The ECB’s hawkish stance is underpinning the euro. Not only was the market reminded that rates can be hiked before the ECB finishes normalizing monetary policy, but that Trichet was explicit that restructuring of Greek and Irish debt. The ECB’s stance was reinforced by its market operations, where it had a net drain of about 66 bln euros. EONIA and 2-year German (and French) jumped as well. The real test for the euro bulls comes in the $1.3700-$1.3725. The weaker than expected German industrial production figures (-1.5% vs consensus of 0.3%), like yesterday’s disappointing industrial orders report, took the steam from the euro’s advance. The $1.3580 should near-term support. Meanwhile, the ECB should draw some comfort from the wage settlement at Volkswagen, given their recent heightened warnings about the "secondary impact" of higher headline inflation. Reports indicate that 100k workers agreed to a 3.2% pay increase on a 16-month contract and a 1-off 1% of base salary cash payment. IG Metall initially wanted a 6% hike in a 12-month contract, while the company offered a 2.9% pay hike for a 2- month agreement and a 1-off 300 euro lump payment.

The successful place of yesterday’s 5-year syndicated bond in Portugal should be understood as preparing for the 9.5 bln euros of maturities coming due in Q2, but it has not relieved pressure on Portugal’s long-term rates. The 10-year (generic) bond yield is near 7.2%, likely making today the third consecutive session it will close above the 7% threshold. Pressure on Greece and Ireland to seek assistance as when their yields rose through the 7% level on a sustained basis. Separately, Greek held a successful bill auction, raising more funds than it initially intended (390 mln euros vs 300 mln), at a lower yield (4.64$ vs 4.90%) and strong bid-cover (4.5 vs 3.4).

China announced a 25 bp hike in key rates. The 1-year lending rate will now stand at 6.06% and the 1-year deposit rate will rise to 3%. The direction of the move is hardly surprising. The money market conditions were exceptionally volatile in the run-up to the New Year holiday. This may have prevented the PBOC from tightening. Yet we recognized that the tightening was likely to prevent a complete return to the status quo ante after the holiday. Today’s rate hike is unlikely to be the last. The fact that the deposit rate is still below the inflation, that is negative real rates, would seem, all else being equal, encourage spending and lending. That said, interest rate policy is only one set of tools Chinese officials are using to stem price pressures. Others include tapping strategic food reserves, threats of price controls and there have been reports of efforts to rein in hoarding.

There were two US reports out yesterday that we think are revealing. First, the US reported a $6.1 bln rise in December consumer credit, which was more than twice what economists had expected. Yet the real news was that revolving credit (credit cards) rose $2.3 bln, the first increase since Aug 08. Non-revolving credit, largely auto loans, rose $3.8 bln in December after $5.4 bln rise in Nov. As we noted last week, the recovery of the auto sector has important knock-on effects on a number of time series, from the strength of the manufacturing sector and trade, to the revival of the ABS market and sales, consumption and inventories. Second, consumer credit has averaged $5.26 bln a month in the last quarter of 2010 compared with a contraction of $1.6 bln month average for all of last year. This report should also been seen in the context of last week’s senior loan officer survey that showed an increase in credit availability and demand. It should also be seen in the context of yesterday’s report from the NYSE that margin debt in December rose $2.5 bln to $276.6 bln, a new post-Lehman high. It is shy of the June 07 record high of $381 bln, but this may very well be breached. While there are signs of continued, these two reports taken together, suggest some evidence that re-leveraging has begun.

Upcoming Economic Releases

At 7:30 EST / 12:30 GMT US reports January’s NFIB small business optimism (94 expected vs. 92.6 prior), while February’s IBD economic optimism is expected to decline (50.3 vs. 51.9 prior). January Canadian housing starts at 8:15 EST / 13:15 GMT Events: US to auction $32bln in 3-year notes at 1:00 EST / 18:00 GMT, Fed Speakers include Lacker (FOMC non-voter) Lockhart and Fisher (FOMC voter).

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