Euro Punched Lower by Series of Jabs

What was to be a subdued period in the markets is turning into a rout.  There have been a number of poor developments that have sent the U.S. dollar broadly higher and has weighed on the highly correlated risk assets, equities, emerging market and commodities.

The combination of Belgium apparently wanting to renegotiate the Dexia bail out and the poor flash China PMI from HSBC’s flash reading (nearly a 3-year low of 48.0 from 51.0 in Oct) got the ball rolling initially, but this has been followed up by poor developments in Europe. 

The flash PMI showed continuing deterioration. The composite remained below the 50 boom/bust for the third month.  Manufacturing fell to 46.4 from 47.3 in Oct.  It is at the lowest since mid-09. The service sector was a bit more resilient at 47.8 from 47.2 in Oct.  

This was followed by news that industrial orders in the region collapsed in Sept. The 6.4% decline was more than twice the decline the market consensus had forecast and is the biggest decline in three years. 
And as if this was not sufficient, investors struck Germany, in the sense of not showing up for  the 10-year bund auction today.  Germany had intended on raising 6 bln euros by selling 10-year bonds, but there were only bids for 3.9 bln.  

This is not the first auction that has technically failed in the market’s parlance.  However, it is coming an important time, when the core has been assaulted. With hopes of a settlement to the political stalemate in Belgium diminishing, its bond market was already under pressure, as among other things it raises questions about the 2012 budget. French bonds have been under pressure especially as they are unable to keep pace with the bunds. Any increase in the the French obligation (presently 36.5% of the 90 bln euro package), would also be a negative development for it credit outlook. 

The risks are also evident on the euro-Swiss franc cross today, which reached nearly a two week low near CHF1.2285.  Against the dollar, there appears to be support near $1.3350, but the real objective now is the early Oct low near $1.3150.  The $1.3430-50 area should cap the upside near-term.  Sterling is trading at 6-week lows near $1.5555. $1.5620-50 will likely contain bounces if the downside momentum is to be sustained.  The BOE minutes do not change the likelihood that its asset purchase program is extended early next year. 

Lastly, the FOMC minutes underscore the argument presented previously in this space that the additional action that several Fed officials have advocated will be in the realm of communication and not the balance sheet. While the risk of QE3, or unorthodox policies in general, will continue to exist until the Fed can tighten monetary policy.  However, the risks of QE3 in the next period (six months?) looks slimmer now than before. 

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