Euro Pares Gains Ahead of US Employment Data

The US dollar is generally little changed against most of the major currencies, with the notable exception of the euro and Swiss franc, against which the greenback is recouping some of yesterday's losses. 

The word cues in Trichet provided yesterday is suggestive of another rate hike in Q4.  The issue is whether Trichet delivers it at his last meeting or Draghi delivers it early in his tenure. 

The euro's recovery yesterday appeared to have coincided with Trichet's announcement that it was suspending its collateral rules for Portugal.    This should not have been surprising.  The ECB had done the same for Greece and, following Moody's decision to slash Portugal's debt rating below investment grade, it had little choice but to do the same for Lisbon. 

Of course many European officials have complained about Moody's decision and feel hemmed in by the indication by the rating agencies that the French plan for private sector participation in Greece would risk selective default rating.  However, on substantive grounds, they do not seem to really disagree.   The question seems straight forward---do investment grade countries need IMF/EU assistance ?  The premium the market demands from Portugal over Germany and the pricing of the credit default swaps--suggest the market did not believe it was investment grade either. 

One theme I discussed earlier this week at some length was that it was not so much an issue of contagion now in Europe as the inability to contain the crisis to the small periphery.  I noted how pressures are mounting in Italy.  As has been the pattern this week, Italian bonds are under performing Spain.  The 10-year Italian benchmark bond yields rose 47 bp over the past five sessions and while the Spanish benchmark yield is up 32 bp.  While mild compared to the out sized moves in Portugal (+183 bp) and Ireland (+129 bp), the move above the 5% threshold by Italy is noteworthy. The Italian bond has sold off every day this week and the yield now stands at a 9-year high and the spread over Germany near 230 bp is a record. 

One key point I make is about the growth deficiency in the periphery and this applies to Italy as well.  The average annual growth rate has been about 0.25% over the past decade.  I have suggested that Italy's economy may have contracted in Q2.  Today it reported that industrial production fell 0.6% in May.  The consensus had been fro a 0.1% decline. 

US employment is the main feature of the North American session.  May's 83k rise in private sector payrolls was a bit of a fluke.  The average of the previous three months was 243k, which was the highest since March '06.    Many economists seemed to have revised up estimates for the non-farm payroll figure after ADP's upside surprise.  Over the last three months, the government's initial estimate of private sector employment was 54k higher than ADP's initial estimate.  In the previous three months, the government's estimate was 105k below ADP's,

The euro has returned to yesterday's lows.  Reports that Italian banks are passing the stress tests helped the euro bounce off those lows.  Recall that on Monday it closed above the key downtrend line drawn off the early May and early June highs.  This was a false break, which is not unusual for triangle patterns, which seems to be the dominant pattern currently,  and now the euro is approaching the uptrend line drawn off May 23, June 16, and June 27 low.  That line comes in near $1.4160. 

Turning to sterling, the performance this week is notable for medium term traders.  Sterling broken below its 200-day moving average for the first time this year in late June but recovered and managed to finish last week above that important psychological average.  It was soundly turned back and is most likely going to close below that average, which comes in today just below $1.6050. 

Lastly, the dollar remains firm against the yen.  Japanese exporter offers are thought to be slowing the grind higher.  Some in the media are claiming that the fact that China bought JPY497.1 bln of Japanese government bonds in May is evidence of reserve diversification.  Color me skeptical.  China sold 707 bln of Japanese bills during the same period.   Net-net China has less exposure to Japan than before.  It was rolling a portion of its bills into longer maturities.