Dollar Bid as European Woes Dominate

News that the US super committee failed to reach an agreement has done little to eclipse the negative impulses coming from Europe.   Rajoy won no honeymoon in Spain despite achieving an outright majority in parliament.  Spain's 10-year bond yield is up around 15 bp today, the worst performer in the euro zone.  Moody's warned that rising debt costs and weaker GDP is negative for France and maintained its negative outlook for Irish banking system, despite its improved capital position. 

The euro has given back its pre-weekend gains and is holding in Europe just above last week's low near $1.3422.  A break of $1.3380-$1.3400 area is needed to signal the return to the early Oct low near $1.3150.  Note that net speculative short position at the IMM jumped to 76.1k from 54.2k in the prior period.  This leaves it little changed since the end of Oct, though the euro is off almost 3% thus far this month. 

The EU nows says that on Wednesday it will unveil new proposal for a European bond.  It is said to be developing three proposals.  The first is joint issuance of all bonds and seems dead on arrival as it would provide moral hazard issues that would be unacceptable. 

The second is limited guarantees to the nationally issued bonds.  This is similar to the scheme to leverage the EFSF and suffers the same defects.  European officials have corrupted the CDS market by seemingly structuring the Greek haircut in a way as not to become a credit event.  This raises questions about such guarantees going forward. 

Third is the limited joint bond issuance and parallel with a national issuance.  This is the red bond/blue bond proposal floated earlier this year. 

In exchange for these steps toward a fiscal union, the EU wants to tighten control on public finances, along the lines that Germany's Merkel has suggested.  EU regulatory power to send budget inspectors into government departments.  These commissioners would be able to address the national parliament to explain itself and can advise on changes to national budgets. 

It is true that in light of the failure of the super committee, the US rating could be cut, with Fitch a more likely candidate than Moody's.  However, note that since S&P cut the US rating, the dollar has appreciated against all the major currencies, but the Japanese yen.  The euro is off almost 6% and sterling is off 4.5%.  

 

If the fear was over the US rating outlook and fiscal outlook was a key driver today, it seems counter-intuitive for the US Treasuries to have rallied.  The 10-year yield is off 5 bp and the 30-year is off 6 bp.   

Separately. Japan reported a trade deficit in October of JPY273.8 bln.  The consensus had called for a small surplus of JPY40 bln.  Exports fell 10 times more than the market expected.  They fell 3.7% year-over-year.  Economists had expected a 0.3% decline.  It is the first decline in three months and arguably reflects two things:  yen strength and weaker foreign demand. 

Reasonable people may argue of which played a greater role.  Imports rose almost 18% from a year ago.  The market had expected around 15% increase.    Rising commodity prices and substituting domestic production with imports seems to offer the most likely explanations. 

The dollar is holding above the low set before the weekend near JPY76.60, but the high is below JPY77.  It is the first day, thus far, that the dollar has not traded above JPY77 since BOJ record intervention on Oct 31.  Today is the fifth consecutive session of lower highs.   The Commitment of Traders saw a small rise in net long yen positions among the non-commercials (speculators) in the most recent period.  Since the end of Oct, the net speculative position has been tripped by a little less than a third, though the yen is up about 1.7% month-to-date.