Healthy German Bund Auction, Little Support for Euro

Germany managed to draw a good reception to its 10-year bund auction. Despite a lower yield compared with last month, the bid-to-cover was higher and this despite the improvement in the performance of the weaker credits, which was supposed to erode the safe haven bid for bunds.

Today's auction produced an average yield of 3.13% compared with 3.2% at last month's sale. The bid to cover was 2.0 vs 1.7x in February. If there was a weka spot it might be that the Bundesbank retained a little more than 900 mln euros of the issue vs 767 mln euros at last month's auction.

The successful German auction comes on the heels of a favorable reception to Ireland's sale yesterday and indications that Greece avoided a downgrade by S&P.

The euro managed to poke through the $1.38 level for the first time since Feb 11, but failed to make much headway and now in early North American activity is little changed from levels that prevailed late yesterday. Immediate support is seen near $1.3750.

That said, the near-term tide appears to have turn in a more supportive direction for the euro, but a move above $1.3850 is needed to signal a test on the $1.40 area. The euro has been trading in fairly well defined ranges for the past several weeks and this has alleviated much of the over extended technical condition that was a result of the euro's decline from late Nov through early March.

A major weight on the euro had been the situation in Greece and the ramifications. Over the past month, the premium the market demand from Greece over Germany has eased by about 20 bp on the 10 year and about 80 bp on the 2-year. We estimate that Greece has raised about 10 bln euros or about half of what it needs to face maturities and coupon payments in the April-May period. The case we painted a couple of weeks ago by which Greece could muddle through this year seems increasingly plausible. However, we share the concern of others that the economic contraction in Greece may be greater than officials expect and this could undermine revenues just as the higher tax burden may encourage some capital flight.

Medium term investors who share our view that the risk on/off driver is gradually breaking down and may be replaced with a return to growth differentials, output gaps, etc, may want to let the euro correction run its course and anticipate better selling opportunities in the weeks ahead.