Europe Dominates

The US dollar is generally firmer as the European debt crisis escalates and dominates the global capital markets. As was the case in the post-Lehman environment, the demand for dollars is just as much a function of securing funding as it is a safe haven.

Ironically, sterling has been sold-off harder than the euro today. Investors continue to try to get their heads around the risk of a hung parliament, the length of time it may take to form a government, and whether the country can avoid a Greece-like debt crisis, which Vince Cable, a likely candidate for Chancellor of the Exchequer should the Lib-Dems be part of the next government. Unlike yesterday, the yen is trading a bit heavier against the dollar and most of the common crosses, except against sterling. It appears that its recent strength was more a reflection of unwinding cross positions than safe-haven demand.

Following the largest loss in the US S&P 500 since February, global equity prices have tumbled. The MSCI Asia-Pacific Index shed 1.6% and all of the industry groups posted losses, with financials a significant drag. The Nikkei lost the most in the region with a 2.6% decline, as exporters in the technology, telecom and industrial sectors suffered by the surge in the yen. Emerging market equities, which have seen significant inflows this year, have seen a reversal of fortunes. Yesterday’s 1.5% decline in the MSCI Emerging Market Index is off another 1.8% today. European bourses are broadly lower, with some declines approaching 2%. Financials, basic materials and consumer services the largest drags.

The bifurcation of the global debt market into those bond markets subject to contagion, as in the periphery of Europe and emerging market bonds, on one hand, and those sovereign bonds like US Treasuries and German bunds that are drawing safe haven demand. Note that despite the slightly higher than expect Australian CPI figures (0.9% in Q1 vs expectations of 0.8%) did not stand in the way of Australian bond rally, with 10-year yields sliding 7 bp after yesterday US Treasury rally yesterday.

Spreads in the periphery in Europe continue to blow-out today. The market is on edge amid speculation that other EMU members may be downgraded and/or that another rating agency cuts Greece’s rating, following S&P’s 3-notch slash yesterday. The FOMC meets, but with only minor tweaks in its economic assessment expected, the focus remains on the meltdown in Europe. We note that the demand to secure dollar funding may see upside pressure on the very short dollar rates, while further out rates may ease on safe haven demand.