Dollar Steady, Euro Hit

The euro experiencing independent weakness today. There are a number of considerations at work, nearly all of which are negative. Peripheral tensions are running high. Portugal's 10-year bond yield remains well above 7% for the seventh consecutive session and 12 of the past 15 sessions. A sustained rise through 7% seemed to have intensified the pressure on both Greece and Ireland to seek international assistance.

Meanwhile on Wednesday Portugal will try to buy back paper set to expire in April and June and the small Left Bloc is pushing for a vote of confidence on the minority government. Q4 GDP came in line with expectations, contracting 0.3%, offsetting the growth in Q3. It is a useful reminder too that the central bank expects the economy to contract 1.3% this year and the pro-cyclical nature of fiscal policy.

EU finance ministers meet and key differences do not appear to have narrowed over how to address the crisis. Increasing the size of the permanent mechanism to 500 bln euros is hardly sufficient to stem the crisis. There is bound to be much discussion over last week's surprise news that the BBK's Weber will step down at the end of April and not be a candidate to replace Trichet at the head of the ECB. Merkel's close economic advisor Jens Weidmann (previously headed up a monetary policy unit at the BBK) has been tipped to be announced Wednesday to succeed Weber at the BBK. Regling, the German head of the EFSF has reportedly indicated greater desire to head up successor to the EFSF rather than the ECB. A compromise candidate at the ECB will eventually be agreed upon, but the fact that it will not be the uber-hawk, it would seem that the risk of a ECB hike late this year has risen.

A major knock against the dollar has been that QEII is capping US rates and fiscal expansion continues with abandon. Both are worth challenging. The US 2-year yield has doubled from the 42 bp low seen on December 7 and remains near the highest level seen since last June. Over the past month, the US 2-year yield has risen and the 2-year differential, which tracks the euro-dollar has moved 17 bp in the US direction over the past 8 sessions. The unexpected compromise fiscal policy in the US seemed to be the last hurrah of the fiscal expansion phase today marks the turn of the debate. President Obama will outline his budget strategy, which reportedly will propose halving the deficit by the end of 2012 and cutting the (projected) deficit by $1.1 trillion over the next decade. His plans are said to be 2/3 spending cuts and 1/3 tax increases. This is the opening gambit and the Republicans are likely to seek greater spending cuts and less tax increases.

Japan's contraction in the Oct-Dec GDP (-0.3% on the quarter, -1.1% annualized) was a bit better than expected though the previous quarter was revised (0.8% from 1.1% Q/Q). However, tomorrow the BOJ is likely to revise up its economic assessment for the first time in nine months. China's trade surplus was much smaller than expected, but the focus is on tomorrow CPI figures. Although the market consensus is for a 5.4% rate, a local paper reports a sub-5% reading. There is some speculation that the "food" weighting in the measure may be re-jigged. Tomorrow also sees the UK CPI/RPI report ahead of the BOE's inflation report on Wednesday. Another jump in headline inflation is expected. The key to the policy outlook is whether there is some softening of the confidence of the majority that inflation pressures are transitory as they are not being picked up in wage growth or money supply.

Lastly, Sweden's Riksbank is widely anticipated to hike 25 bp tomorrow to 1.5%. The krona may be vulnerable to a "buy the rumor sell the fact" type of trading. Swedish officials seems to welcome the krona's strength, but businesses are increasingly pinched and the Stockholm market is one of the few European bourses that remain lower on the year.