Dollar Races Higher

The US dollar is posting strong across the board gains. The sole exception is the Japanese yen, which is also benefiting from the heightened anxiety.

There are three main drivers today. First, there is fear that the European sovereign debt crisis is spreading, with banking issues front and center in Spain. Second, there is concern that some central banks may be shifting euro holdings into dollars. Third, tensions in the Korean peninsula continue to run high. The euro and sterling have thus far held above last week’s lows (~$1.2144 and $1.4231 respectively). However, the euro has fallen to its lowest level against the yen since Nov 2001.

Global equity markets have been hit hard. The MSCI Asia-Pacific Index was off 3% and is back to levels seen last July. Less than 60 companies in this index of nearly 1000 companies managed to rise. The financial sector was weakest. European bourses are off 2.5%-3.5%. Spain’s IBEX 35 is at a new 12 month low and the UK’s FTSE is at an 8 month low. As in Asia, the financial shares are the weakest sector in Europe, followed closely by basic materials.

Funds are fleeing to the fixed income market and sovereign bonds are generally higher. The 10-year bund yield is 8 bp lower at 2.56% while the 10-year US Treasury yield is 11 bp lower at 3.08%. Some modest strains are seen in the peripheral European bonds today with Italian yields up 3 bp and Spain up 6 bp. Portuguese and Greek 10-year yields are slightly lower on the day. Pressure is a little more acute in the 2-year sector, with Italian 2-year yield up 13 bp to 1.82% and the Spanish 2-year yield up 8 bp at 2.115%. Spain successfully auctioned three and six month bills today. The bid-cover ratio is healthy but it came at the price of higher yields. The weighted average yield of 3-month bills rose to 64.5 bp from 51.5 bp last month, while the weighted average yield on the 6-month bills rose to 1.24% from 0.736% in April.