The Euro-Bounce Continues – for How Long?

Government debt yields plunged across Europe again today, helping to pull EUR/USD back well back above 1.30 again, but for how long?. Meanwhile, core US CPI data pushes to a new 3-year high.

The after-effects of yesterday’s strong Spanish debt auction are seeing EU sovereign spreads tightening sharply again today, though to varying degrees. At the long end of the curve, the yield on Spanish 10-year debt as of this writing at close to a two-month low just above 5.00% (some 33 bps lower) while Italy’s 10-year yields have only come in 20 bps and are still a rather lofty 6.37%. Elsewhere, Belgian and Austrian 10-year yields were back toward two-month lows as well. At the shorter end of the curve, the moves were even more pronounced, and a Bloomberg article helps describe the likely dynamic here – sovereign spreads tightening as banks snap up sovereign debt at auctions in order to use it as collateral for the ECB 3-year LTRO’s next week – a move that will allow them to lock in rather fat, risk free spreads for a time. It appears for the moment that the ECB is enjoying the last laugh as its Dec 8 announcements are bearing fruit for now in calming debt fears. The question will be how well confidence is maintained on the other side of the 3-year LTRO set for next week – Tuesday for the “call for bids” and Wednesday sees the ECB announcing the allotment .. Another sign that all is not milk and honey is the yield on German 2-year debt, which has dropped to a record low sub 0.25% level today. On the other hand, Euro basis swaps leaped significantly higher today to -119.


Sweden - safe haven after all?

Sweden’s housing prices eased back higher according to the November data, but a market top-out and beginning of a down-trend appear rather clearly defined now with this second data point in a row below the 1.9M level, and the heady price gains of the last many years easily qualify as a bubble. It will be interesting to see in 2012 how well the Swedish krona performs relative to its past behavior, which has most often been very pro-cyclical (the 1000-day correlation of EURSEK with the US S&P500 is -0.87, for example). Further strain would be added from banking system difficulties in the event that the housing bubble goes into an ugly unwinding in the New Year. At the same time, the Swedish economy’s open-ness and export strength and low sovereign debt load make it look rather tempting as a relative safe haven when looking at the other basket cases around Europe, including the Euro Zone countries, the twin-deficit laden UK, and the bent-on-devaluation Switzerland. For more on the idea of the krona as a potential safe haven, please have a look at one of our Outrageous Predictions of the New Year – the idea that Sweden and Norway become the new Switzerland.


Chart: EUR/SEK

EUR/SEK has been powering lower and is now perched close to the psychologically significant 9.00 level. Could the pair be set for a try lower toward 8.90 and even 8.75 despite the direction in risk appetite, or will negative developments in Europe re-establish their gravity on the krona as they normally have in the past. The technical argument and marked new behavior of late would argue that the side of least resistance remains lower, particularly if 9.00 is taken out soon.




US CPI

The US headline CPI registered no change on a month-on-month basis and the year-on-year figure dropped for the second month in a row after peaking two months ago, but the core level rose more than expected and the year-on-year level rose to a new 3-year high, possibly delaying the Fed’s QE3, unless Bernanke and company would prefer to adopt the BoE’s attitude on inflation (ignore it and assume it will fade for years on end.)


Looking ahead

We’re heading into the heart of the Western holiday season next week and until the end of the year, so liquidity conditions will worsen for the next two weeks. This could either mean choppy, range-bound markets, or aggravated short-term directional moves on any dramatic new developments. The key pivot point appears to be next Tuesday and Wednesday with the ECB LTRO operations in sight, and resistance for the EUR/USD is up in the 1.3150-1.3210 area. Besides that, ad hoc political developments in the EU remain important and the noise coming out of China these days has been particularly disturbing and has received far too little focus relative to the Euro Zone’s latest woes. A column like this one yesterday (China’s epic hangover begins from the Telegraph’s Ambrose Evans-Pritchard) is hardly soothing for the nerves, though the latest hope is that the PBOC and the Chinese regime will begin a pronounced easing effort soon that was flagged with the recent lowering of the RRR for Chinese banks. Still, Mr. Evans-Pritchard’s column outlines some of the pitfalls of the regime’s palette of options here. Stay tuned.