Corrective Pressures Unfold, Lift Equities and Commodities, Weigh on Dollar

The market misread the Fitch downgrade of Italy and Spain before the weekend. The rating agency was largely lagging the other rating agencies and the market. With Tokyo markets closed, it was fairly easy to extend the pre-weekend euro losses, but with talk of European bank recapitalization, Merkel and Sarkozy's pledge for new and bolder action by November 3 helped the corrective forces regain control of the euro and tend it through the $1.3500-25 resistance area encountered Friday.

When I first identified the risk of an upside correction earlier last week, I highlighted the $1.3600-$1.3700 area. This still seems like a reasonable initial target. Market positioning using the Commitment of Traders as a proxy warns that the short-term trend following, momentum traders stretched--very short euros and sterling. The corrective forces are also seen in the commodity prices, which in general are up for the fourth consecutive session, as are European shares (Dow Jones Stoxx 600). The cost of swapping from euros into dollars is lower for the third session.

A series of US economic reports, including last week's jobs report is encouraging economists to revise up growth forecasts. China's two official purchasing managers surveys also eased hard landing fears in many quarters. Japan's Tankan survey found improved sentiment as the recovery from the March tragedy continues, even though weak aggregate demand is may limit the expansion. German data softened but Q3 growth in the 0.3%-0.5% range still seems likely and near trend. This macro back drop appears somewhat better than many had feared a month or so ago.

Facing increased internal and international pressures, European officials have created a new window of opportunity. The EFSF reform legislation has been approved by all the countries by Malta and Slovakia and this is expected to happen shortly. Merkel and Sarkozy have indicated that they are working on a plan to be unveiled in a few weeks to shore up the banks and to put some closure on the Greek crisis. There are no details available but short-term market was positioning for a drift toward the abyss. Reports suggested Russia was interested in buying Spanish bonds when EU debt strategy was in place. The improved news flow spurs an adjustment of market positioning.

The Troika (EU, ECB, IMF) are to finish up their review of Greece today and a statement is expected on Tuesday. Although there have been conflicting reports, the latest word from the Greek finance minister is that it has sufficient funds on hand until mid-Nov. This means that the Troika can seek more concessions from the Greek government. Greek financials are off nearly 11% today as Greece tapped bank rescue funds to one of Proton Bank, according to reports. This underscores why the focus has shifted to European bank recapitalization efforts.

Poor UK confidence report and ideas that the new gilt purchases announced last week (GBP75 bln) could be extended has seen sterling lag behind the euro's advance. I had initially suggested sterling could rise toward $1.57. A break of $1.57 could see $1.5800-$1.5950 as the corrective move unfolds.

Soft landing in China, stabilization of copper prices and corrective forces in general have help lift the Australian dollar. It is moving above its 20-day moving average (~$0.9926) for the first time since Sept 8. A move above $1.00 now would see a quick advance toward $1.0080 maybe toward $1.02 if Thursday's jobs data is stronger than the 10k expected. If the Australian dollar may be a leader, the Scandi bloc may under perform. While Sweden's orders data were strong (9% year-over-year), output figures were disappointing (5.6% year-over-year vs 10% consensus and 8.2% , -3.1% on the month vs -1.5% consensus). This poses a risk to Q3 GDP estimates. Norway reported higher CPI (1.6% Sept vs 1.3% Aug) and higher core rate, but the central bank may still ease expected rate hike trajectory at its Oct 19 monetary policy review.