Capital Market Overview

The US dollar is little changed against the major foreign currencies as the consolidation seen at the end of last week continue. Holidays in Japan, Canada and the United States contributes to the subdued tone. The euro made a brief run above the $1.40 level in early Asia, but it was not sustained. Support is seen in the $1.3880-$1.3900 area. A break would indicate the consolidation is morphing into a correction.

The dollar spiked down to JPY81.40 in thin early Asian activity, but snapped back quickly. The JPY82.20-40 band may cap upticks. Sterling continues to under-perform.

There is increased talk that the BOE may also be moving closer to new asset purchases, though the CBI seemed to weigh in against it. Emerging Asian currencies were generally stronger, but EMEA were mostly softer.

Global equities are higher after the US S&P 500 posted its best close since May before the weekend. The MSCI Asia-Pacific Index, excluding Japan rose 0.5%, led by the raw material sector and consumer stocks. Weakness in Korea (-0.4%) and Taiwan (-0.8%) was offset elsewhere, including a 2.5% rise in the Shanghai Composite and the 1.5% rise in Thailand's main index. European bourses are mostly slightly higher, but Spain's IBEX is off 0.5%, lead by financials and basic materials. The Dow Jones Stoxx 600 is up about 0.25% near midday in London, after rising 1.2% last week. Technology and industrials are leading the way.

There are three important developments in the fixed income space today. First, Thailand has indicated it is considering measures to control capital inflows and the local press has focused on a 15% withholding tax on bonds. More details are expected from the cabinet meeting tomorrow. Earlier rumors that South Korea was considering a similar move were denied. Second, rumors circulating before the weekend turned out to have some merit in China, where the reserve ratio for the six large banks was raised to 0.5% to 17.5%. Note the the 12-month NDF rose 0.7% and now is discounting 3.5% appreciation of the yuan over the next year. Third, ECB's Bini Smaghi suggested that the IMF could shift Greece's aid into a long-term loan if Athens continues to adhere to its fiscal consolidation program. German officials were quick to argue that such talk was premature, but Greek bonds rallied on the suggestion.

The main driver in the foreign exchange market remains the prospects of new long-term asset purchases by the Federal Reserve. The US 1-year bill yield has fallen below 20 bp and the 2-year yield is below 35 bp. A large extent of the the expect impact from QEII appears to have largely been discounted. This has undermined the dollar. At the same time, a secondary force has also been operative, pushing the same direction. That is the less liquidity in Europe and this has seen short-term euro rates. For example, 3-month Euribor has risen to almost 98 bp today, the highest since July 2009.

The weekend multilateral meetings did not appear to resolve ongoing tension created by the unwillingness of many emerging market countries to allow their currencies to appreciate fully in response to the increased capital flows. There are two sources of the capital inflows. The first is from the diversification of savings from the US, Europe and Japan. This may in part be a reflection of the weak domestic economic outlook, but there may also be a structural component the diversification. The second source of inflows are the emerging market countries and companies themselves who are taking advantage of lower interest rates in the global capital markets, were they issuing stocks and bonds and repatriating the proceeds. The World Bank seemed more sympathetic to measures to contain capital inflows than the IMF.