The political theatre in Europe in recent weeks was a distraction. With it easing as new governments come to the fore in Greece and Italy, investors can return to the economic drivers. Investors appear to be focused on the vacuum and how the ECB is the only institution that can immediately address the situation, but is reluctant to do so. It refuses to offer unconditional or unlimited assistance.
This in turn means the financial stresses, like the continued widening of the cross currency basis swaps (cost to swap from dollars into euros) to a new three year high, the take up at the ECB’s regular refi operation, highest in a year, and the continued creep up of dollar and sterling LIBOR.
Greece, Spain, Belgium and Switzerland sold bills without much of a problem, but the bonds and CDS market is also under strain. Italian 10-year bond yields are poking through the 7% and Spanish 10-year yield is extending its breech of the 6% level and is approaching 6.5%. The Germany-French spread has gone ballistic and is up 21 bp on the day to 185. It began the year at 40 bp.
The safe haven flows are seeking refuge in Germany and the 2-year yield has fallen below 30 bp for the first time. This has pushed the US-German spread to 8 bp, the lowest in more than a year. The euro dollar exchange rate is correlated with this spread. The euro itself is off another cent plus today. The frequent pattern whereby Monday sees a marginal extension of Friday’s move before reversing is unfolding.
Technicals are poor and I note here that the 5 day is below the 20 day for the near-term trend and the 50 day is below the 200 day as a longer-term trend indicator. Another indicator, I often find useful is the 3-month risk reversal and the the premium the market is willing to pay for puts over calls is near the record set on Nov 10.
Euro zone economic data was poor. The euro zone economy expanded as expected 0.2% in Q3. There was great variance of course but of note the Dutch economy contracted. German and French growth kept the region as a whole positive, but growth is clearly slowing there as well. The ZEW survey from Germany shows deteriorating sentiment–which stands at a 3-year low.
UK CPI was slightly lower than expected, but at 5% year-over-year still sufficient for King to write a letter to the Chancellor. The BOE expects a large drop in inflation over the next six months and this will likely ease the obstacles to an extension of the asset purchase program. Sterling support near $1.5825 has help. A break could spur another another cent loss.
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