Capital Market Developments

The ECB’s refi operations this week are being scrutinized for insight into the health of European banks. The 132 bln euro 3-month refi operation yesterday was generally heralded as favorable news. Recall that the market had been expecting between 200-300 bln euros would be needed to help smooth the expiry of the 12-month LTRO.

Today, banks took another 111 bln of six day funding. The combined total is not far from the mid-point of expectations. Moreover, upon closer scrutiny, yesterday’s refi results may not have been unambiguously good. Consider that a year ago, 1121 banks participated in the LTRO, which generated an average of 394 mln euros apiece. At the time, some suspected that even some banks that did not need the funding took it. Some 171 banks participated in yesterday’s operation and that produced an average of 771 mln euros apiece.

The purchasing managers’ surveys were generally softer, though only South Africa’s seemed to fall below the 50 boom/bust level. Norway is the exception in the other direction, with a 51.2 reading compared with consensus of 50.5 and an upwardly revised 504 in May (from 50.1). The manufacturing PIM for the euro zone was in line with the flash reading of 55.6, down slightly from the 55.8 reading in May. It is a four-month low. There are a few interesting details from the national readings. It Italy, exports rose to 4-year high. In Spain, output fell and, particularly worrisome, the employment reading below 50. The French reading was a touch below the flash report and the 54.8 reading is a six month low.

Japan seemed to buck the trend of generally soft economic data, with the better than expected Tankan survey that showed sentiment among the large manufacturers turned positive for the first time in 2-years. Sentiment generally improved for other business segments as well. It was the fifth consecutive quarter of improvement with expected gains in output and exports. Capital expenditure plans for the current fiscal year call for an increase of 4.4%, while profits are projected to rise 21.6%. It terms of currency expectations, the large manufacturers now expect the dollar to average JPY90.18 in the year ending 31 March 2011, down from JPY91 in the last survey. While the yen is firmer today, it is only slightly so and appears to be benefiting from the risk averse environment more than the economic data itself.

Sweden’s Riskbank delivered a 25 bp rate hike as was widely expected. However, nearly everything else about the Riksbank seemed dovish. First, there were two dissents to the decision (Ekholm—deputy governor and Svensson). Second, while the Riksbank revised up this year’s growth forecast to 3.8% form 2.2%, it seemed to merely incorporate the much stronger than Q1 GDP figures, and more telling it shaved its growth forecasts for 2011 and 2012. The same general pattern was seen in the CPI forecasts: 2010 tweaked higher, 2011 and 2012 adjusted lower. Third, the Riksbank was explicit that the repo rate does not need to rise as much over the longer term as previously assumed. The euro recorded session highs against the krona just above SEK9.60 in response, from SEK9.49 low seen yesterday. Riksbank Governor Ingues tried to play down the dissents, saying it was essentially a difference over timing. That seems disingenuous in the sense that isn’t that what the dissents are usually over. In the UK, Sentence’s dissent was on also on timing. The single dissent in the US was not based on timing but on the characterization of the guidance (extended period). The euro may re-test the SEK9.60 area and maybe even rise toward SEK9.65, near where we suspect a better selling opportunity may be found.

The euro initially slumped to CHF1.3074, a new record low. The stronger than expected KOF leading economic indicator yesterday coupled with the slightly stronger than expected PMI today and the lack of official protests were behind the continued Swiss franc gains. The June manufacturing PMI came in at 65.7 compared with expectations of 65.5. It was 66.4 in May. Many momentum traders had been targeting CHF1.30 since the break of CHF1.40. Some players appeared to turn cautious on the break of CHF1.31 today and the euro bounced above CHF1.32. If the euro cannot get back above CHF1.3250, sellers are likely to return.