Turn Around Tuesday--Half Right

The euro and sterling did recover in late US yesterday and into the Asian session today.  The euro reached $1.3696, close to the initial objective of $1.37 and sterling rose to $1.5870, close but shy of the $1.59 initial target.  However, neither currency was able to sustain the gains through the European session. 

French bank shares have come under new pressure and the concerns are extended from a downgrade to perhaps the need for recapitalization.  That gets tricky because if the government has to bear the burden, it would risk its AAA status and this is important, not just for France, but for the potential knock-on impact on the EFSF AAA bond rating. 

Reports that Italy is seeking China's support did not help today's Italian bond auction.  The new 5-year benchmark auction saw a higher yield (5.59% vs 4.93% at the last sale in mid-Aug) and the bid-cover of 1.28 was off from 1.93% last and an average of about 1.5 for the 4 yr-10 yr auctions this year.  The reception of off-the-run issues were not much better.  On the other hand, a Italy also appears to be preparing to sell as much as 500 bln euros of state assets, including municipal utilities and real estate.   

Italy's 10-year premium over Germany reached a new record  as did the 5-year CDS.  The market is concerned that Italy has almost 44 bln euros in bonds maturing and it needs a high reinvestment rate, especially given that it had canceled Aug 12 and Aug 29 bond auctions, which drained its cash. 

Fears of an imminent default by Greece have not eased.  The 10-year generic bond yield rose briefly above 25% for the first time and the 2-year almost touched 75%.  It appears that the ECB bought some Greek bonds and the CDS is at a new record high above 4000.  These levels, for all practical purposes, mean that Greece is reaching a point where it is uninsurable.    

UK inflation remains stubborn.  The Aug CPI rose 0.6%, in line with expectations and the year-over-year pace ticked up to 4.5% from 4.4%.  Unlike the US and Europe, where there is a significant difference between the core and headline, in the UK the core is also elevated.  At 3.1% it is unchanged from July.  While the weakness of sterling may be playing a role in the UK inflation, it is not sufficient to help the external balance.  ONS reported today that the  merchandise trade deficit widened to GBP8.9 bln