One Driver: European Crisis

There is one main driver in the capital markets today and that is the heightened anxiety coming from the European debt crisis.  It is not that a significant new development took place, but rather investors appear to be struck by the paralysis of policy makers.  The Greek and French elections are still a couple weeks away, Spain seems nearly rudderless as its banks and regional woes give it little breathing room with the depressed economy and demand for dramatic austerity.  Meanwhile, the second significant Italian earthquake in a month and poor environment made for a dismal auction today, as the Italian government seems likely to seek some adjustment in its fiscal target, which it already says it can't meet.  

The US dollar is broadly higher and the yen is gaining on the dollar, though thus far the rumored JPY79 barrier remains intact.  The euro slumped to about $1.2420.  Look for new selling to emerge on a bounce toward $1.25 now as previous support turns into resistance.  After finishing the New York session yesterday at $1.5640 closing support, it has been sold off sharply, even though the UK reported relatively constructive mortgage lending data and M4 money supply figures.  The next immediate target is near$1.55.  

There are seem to be three myths about the UK.  The first is that the British gilts are a safe haven.  Yields have indeed fallen sharply.    Over the past there months, the 10-year yield has fallen 46 bp, including 9  bp today.  The 10-year bund yield is off 51 bp and the US 10-year yield has fallen 29 bp.  However, the BOE data today indicated that foreign investors have been net sellers of gitls for three months through April, the longest streak in more than a decade.  

The second myth is that the UK austerity is a drag on the economy.  In Q1, the government sector was a net contributor to growth.  The third myth is that the drag from the euro zone has hurt the UK economy.  The two largest euro zone economies, Germany and France performed better than the UK economy in Q1. 

The note yesterday here  playing up the likelihood of an ECB rate cut next month was given additional ammunition by the unexpected weakness in the euro zone's M3 money supply figures today.  April M3 slowed to a 2.5% year-over-year rate from 3.1% in March.  Expectations were for an acceleration.  Private lending also slowed to a 0.3% pace from 0.6% in March and 0.8% in February. 

While the dollar has managed to hold above the JPY76 level, the tone is fragile.  As noted yesterday here the yen is inversely correlated with the S&P 500 by the most in a year.  This coupled with the narrowing of interest rate differentials, as Treasury yields fall, warns of additional yen strength.  A break of the JPY79 area could spur a move toward JPY78.30.  

For those who are following by long CAD short euro recommendation made on CNBC last Friday, the cross broke through the CAD1.28 level to record its lowest level since Jan 2011.  It bounced in Europe.  Look for the euro to run out of steam shortly around CAD1.28 again.