Dollar on Back Foot

The ECB's hawkish stance has underpinned the euro. Not only was the market reminded that rates can be hiked before the ECB finishes normalizing monetary policy, but Trichet was explicit that restructuring of Greek and Irish debt. The ECB's stance was reinforced by its market operations, where it had a net drain of about 66 bln euros. EONIA and 2-year German (and French) jumped as well. The real test for the euro bulls comes in the $1.3700-$1.3725.

The weaker than expected German industrial production figures (-1.5% vs consensus of 0.3%), like yesterday's disappointing industrial orders report, took the steam from the euro's advance. The $1.3580 should near-term support.

Meanwhile, the ECB should draw some comfort from the wage settlement at Volkswagen, given their recent heightened warnings about the "secondary impact" of higher headline inflation. Reports indicate that 100k workers agreed to a 3.2% pay increase on a 16-month contract and a 1-off 1% of base salary cash payment. IG Metall initially wanted a 6% hike in a 12-month contract, while the company offered a 2.9% pay hike for a 2- month agreement and a 1-off 300 euro lump payment.

The successful place of yesterday's 5-year syndicated bond in Portugal should be understood as preparing for the 9.5 bln euros of maturities coming due in Q2, but it has not relieved pressure on Portugal's long-term rates. The 10-year (generic) bond yield is near 7.2%, likely making today the third consecutive session it will close above the 7% threshold. Pressure on Greece and Ireland to seek assistance as when their yields rose through the 7% level on a sustained basis. Separately, Greek held a successful bill auction, raising more funds than it initially intended (390 mln euros vs 300 mln), at a lower yield (4.64$ vs 4.90%) and strong bid-cover (4.5 vs 3.4).

China announced a 25 bp hike in key rates. The 1-year lending rate will now stand at 6.06% and the 1-year deposit rate will rise to 3%. The direction of the move is hardly surprising. The money market conditions were exceptionally volatile in the run-up to the New Year holiday. This may have prevented the PBOC from tightening.

Yet we recognized that the tightening was likely to prevent a complete return to the status quo ante after the holiday. Today's rate hike is unlikely to be the last. The fact that the deposit rate is still below the inflation, that is negative real rates, would seem, all else being equal, encourage spending and lending. That said, interest rate policy is only one set of tools Chinese officials are using to stem price pressures. Others include tapping strategic food reserves, threats of price controls and there have been reports of efforts to rein in hoarding.

There were two US reports out yesterday that we think are revealing: consumer credit and margin debt. The US reported a $6.1 bln rise in December consumer credit, which was more than twice what economists had expected. Yet the real news was that revolving credit (credit cards) rose $2.3 bln, the first increase since Aug 08. Non-revolving credit, largely auto loans, rose $3.8 bln in December after $5.4 bln rise in Nov. As we noted last week, the recovery of the auto sector has important knock-on effects on a number of time series, from the strength of the manufacturing sector and trade, to the revival of the ABS market and sales, consumption and inventories. Consumer credit has averaged $5.26 bln a month in the last quarter of 2010 compared with a contraction of $1.6 bln month average for all of last year. This report should also been seen in the context of last week's senior loan officer survey that showed an increase in credit availability and demand.

It should also be seen in the context of yesterday's report from the NYSE that margin debt in December rose $2.5 bln to $276.6 bln, a new post-Lehman high. It is shy of the June 07 record high of $381 bln, but this may very well be breached. While there are signs of continued, these two reports taken together, suggest some evidence that re-leveraging has begun.