Dollar Softer

One of the most important developments in recent days has been the sharp backing up of global interest rates, spurred primarily by indications that contrary to expectations, US fiscal policy is in play again beyond simply preventing the expiration of the 2001 and 2003 tax cuts. While the rise in US rates has helped keep the dollar supported, we are concerned that two-year German rates have risen even faster than 2-year U.S. interest rates and that this may serve to dampen the ability for the dollar to extend gains against the euro significantly without continued poor news stream from Europe.

The this interest rate spread has tracked the euro-dollar exchange rate very closely throughout the year. The US-German 2-year yield differential is the most in Germany favor since before Thanksgiving. It is testing its 20-day average for the first time since Nov 21. Neither Fitch's 3-notch downgrade of Ireland nor Moody's review of 10 Portuguese banks for possible downgrade, nor Fitch's downgrade today of several Irish banks and some of their bonds, including the guaranteed debt of several institutions have managed to keep the euro below the low seen before the release of the disappointing jobs data at the end of last week.

Given that thew news stream for Europe is not likely to improve markedly, the benefit for the wider interest rate differential may be more muted to limited to limiting the downside of the euro than truly lifting it significantly. Initial resistance in the euro is seen around $1.3300-$1.3325. It may take a move above $1.3350 really squeeze the euro bears.

Elsewhere, China reported a larger than expected trade surplus on the back of a jump in both imports and exports.  While this is likely to raise the hackles of US Senators, threatening to introduce bill to threaten retaliation for the low yuan, the real story is on the financial variables including the jump in money supply and bank loans.  This spurred the PBOC to hike reserve requirements by 50 bp.   The key question now is whether the required reserve increase is instead of or in addition to a rate hike.  For medium term investors it might not make much of a difference.  The take away is that interest rates are likely to rise even if not imminently.

Sweden's somewhat disappointing industrial output figures are not sufficient to alter my expectation that the Riksbank hikes rates 25 bp next week. 

Disappointing French industrial production and manufacturing data points to weaker Q4 GDP.  The consensus was for a 0.3% rise in industrial output and a 0.4% rise in manufacturing output.  Instead both fell 0.8%.  It was second consecutive month that manufacturing output fell in France.  Italy's industrial output fell  by 0.1%, which was actually a smaller decline than the market expected.  It had fallen 2.1% in September.