Fragile Stability Tries To Emerge

The capital markets are stabilizing as it has now taken the Italian political quagmire on board. Italian yields have steadied after reaching 3-month highs yesterday, and the government, as it were, was able to sell new debt to the market, raising in full 6.5 bln euros. Yields were of course higher than month's sales, but demand was solid. Italy's stock market has also stabilized and 0.4% rise near midday in Milan is outperforming the Dow Jones 600, which was up marginally. 

For its part, the euro has been largely confined to yesterday's range and this is consistent with the signal coming from the 2-year differential between the US and Germany.  That spread rose to 17 bp yesterday, the highest US premium since Jan 9.  The driver of the spread is the German leg and today the Germany 2-year is flat.  The euro can rise into the $1.3130-50 range without really improving the technical tone.  

Sterling initially was sold in Asia after it was unable to sustain the momentum that took it to $1.5220 yesterday..  Bids were found ahead of Monday's mutli-month low near $1.5075.and they were sufficient to drive sterling to session highs near $1.5165.   It needs to establish a foothold above $1.5250 to give great assurance that a base is being formed.   

Meanwhile, the dollar was confined to relative narrow ranges against the yen, well within yesterday's range.  The generally firm tone of the yen spurred profit-taking in the Nikkei, which shed almost 1.3%, led by telecom, oil/gas, financials and consumer services.  

With the recent price developments, sterling has eclipsed the yen as the weakest major currency this year (-6.9% vs -5.3%).  While some may be tempted to say that the UK is winning the so-called currency war, the trade figures and economic performance suggest otherwise. 

While the news stream has been fairly light, there have been a few developments to note. Given the shock of the Italian elections, we suggest placing less importance than one might have on sentiment readings, but the euro area money supply figures are interesting.  Although the year-over-year pace of in January to 3.5% form 3.3%, the 3-month year-over-year pace slipped to 3.5% from 3.7%, suggesting no significance should be attributed to the increase in Jan.  More importantly, private loans continue to fall.  The 0.9% decline follows the 07% decline in December and was larger than the 0.6% decline the consensus forecast. 

Also noteworthy are the ECB's figures that show that 1) deposits in Italy fell 2% in January and 2) Italian banks bought 18.5 bln euro of government bonds in January.  The decline in deposits may be noise or precautionary measures ahead of the election.  The continued bank purchases of government  bonds underscores the link between sovereign and banks.  

The Japanese government has upgraded its assessment of the economy for the second consecutive month, but that will not translate to a retreat from Abenomics.  The government opined that the economy bottomed but pockets of weakness remain.  In particular, it increased its assessment of industrial output, corporate sentiment and consumer spending.  

Weaker than expected Q4 construction figures (-0.1 rather than +1.5 as consensus expected) has provided the latest excuse to cut Australian dollar exposure.  The Aussie has now trading at levels not seen since last October, below $1.02.   Tomorrow's capex and private sector credit are seen as more important.  The next area of support is seen in the $1.0150-70 area.  On the upside, offers will likely be seen on bounces toward $1.0240. 

 In the US, durable goods orders may get attention early, but Bernanke's testimony, even though his prepared remarks will be identical yesterday's, the Q&A will be different.   The looming sequester and the new risks from Europe give Bernanke additional fodder for his defense of the Fed's long-term asset purchases.