Big Move on 2-Year US-German Spreads

The euro-dollar exchange rate has done a fairly good job of tracking the movement in the US-Germany 2-year interest rate differential over the past several quarters.  There is a big move today.  The premium Germany offers over the US has narrowed sharply.  At 35 bp, it is the narrowest since Dec 7. 

The main driver seems to be flows out of the periphery.  Irish 2-year yield is up 65 bp now and Portugal, which some reports suggest China will support, is up 13 bp.  With the peripheral countries on credit watch, downgrades are likely in Q1 11 and this will likely take place as these Portugal and Spain have large funding needs.   Not only do the sovereigns faces funding pressures but so will the banks.   It is possible Portugal seeks EU/IMF assistance before the end of Q1.   At the same time, higher quality sovereigns, including Germany, will also be raising funds. 

Meanwhile, the Q2 10 US slowdown is a thing of the past.  Q3 near trend and Q4 possibly over trend.  Growth does not solve the US debt probelms, but it will make it easier to address.   I expect these developments will continue to underpin the greenback.