Pessimism Grows, FX Consolidation Continues

The focus remains squarely on Europe. Concern that France and Germany are moving in two different directions undermines the already fragile sentiment and weakens expectations ahead of the weekend summit. This has kept the euro confined to the ranges carved out Monday-Tuesday--$1.3653-$1.3914. The lower end of the range seems more fragile today, but technical retracement level of $1.3621 allows a bit more slippage without doing more technical damage.

Sterling also appears confined to the ranges set at the start of the week--$1.5632-$1.5848. The higher than expected inflation report(5.2%) is slightly problematic for the central bank, which has already decided to push ahead with renewed asset purchases, but is more problematic for the government. State benefit increase (cost of living adjustment) will rise 5.2% now instead of the 4.3% the government had assumed. This is going to result in a wider deficit, all else being equal. UK retail sales figures due out late on Thursday are unlikely to change the general view of the UK economy as largely stagnant.

France is very much in the spot light. It is selling bonds today with and is likely to have to pay the largest premium over Germany since the advent of the EMU. Moreover, it comes on the heels of poor reception to a German auction . It is the first auction since Moody's warning that it will review the outlook of France's Aaa credit rating and worries that its guarantees under the EFSF ( 158.5 bln euros or 8.5% of GDP) and new ones for Dexia (guarantees 33 bln euros or 1.7% of GDP).

Admitted these are not on the balance sheet unless there is a default, but surely its strains are still evident. While there is much buzz about Europe needing to act to protect Spain and Italy, but the pressure is building on France. Also over the past three years, French banks have been slow to shrink their balance sheets and hence understood as more vulnerable.

S&P cut Slovenia's rating to AA- from AA with a stable outlook. This is hardly new news as Moody's and Fitch had essentially done the same thing last month. An election in slated for December. However, at stake seems to simply be who is going to implement the austerity.

Japan has underwhelmed the market with its new measures to blunt the impact of the yen's strength. Most of the measures announced have been leaked in recent days and the JPY2 trillion expansion to JPY10 trillion to help Japanese corporates acquire foreign companies is not sufficient to push the yen out of its doldrums. For the third day running, the dollar-yen has been confined to less than a 30 pip range (JPY76.63-JPY76.91).

Meanwhile, the wider Swiss trade surplus should help ease ideas in some quarters that the SNB was offer a higher peg for the euro-franc cross. The trade surplus widened to CHF!.85 bln in Sept. Exports rose 3.4%, recouping a good chunk of the 6.9% slide in August. The market may be reluctant to take the euro above CHF1.25 given the news backdrop.