Dollar Softer Amid Consolidation

The US dollar is trading with a softer bias in what largely appears to be a consolidation.  The euro held support near $1.34, sterling near $1.56 and Aussie near $0.9800.  The news stream is light and corrective forces are seen in equities, which are mostly higher, and bond markets, which are mostly lower.  Emerging market currencies are also generally firmer. 

S&P and Moody's affirmed their sovereign US ratings, though Fitch will decide later this month.  Fitch appears to be moving toward putting its ratings on review.  The across the board cuts envisioned in the aromaticity hit the military and this what some in Congress will move to mitigate first.  Obama has signaled his refusal to play that game and threatens to veto any attempt to dodge the cuts without a larger solution.  

The real fiscal drag won't come from the automatic cuts, which do not come into effect until 2013, but the expiry of the payrolls savings tax holiday and

the emergency unemployment benefits.  Though it may not seem like it at the moment, there is still a reasonable chance that a last minute compromise is worked out to extend both another year.  It arguably makes good economics and politics. 

Spain went to the capital markets for the first time since the weekend election and as the markets have already indicated, the results have not eased Spain's predicament.   The yield on 3-month bills rose to 5.11% from about 2.29% a month ago and the 6-month bill yield rose to 5.22% from 3.30%. 

Spanish bonds are among the weakest performers today, with the 10-year yield rising 8 bp.  What is noteworthy about the European bonds today is that premiums over German bunds are increasing even in what appears to use the market's vernacular a risk on day.  Spreads typically decrease.    Also noteworthy is that the euro has seemed to track the periphery-German spreads.  This warns of downside risk in the euro, with the top end of the range seen near $1.3600. 

EU bond proposals are expected to be released tomorrow, but have already been largely leaked.  They do not seem to break new ground.  The signal by a Germany CDU official that Germany was not planning any big new initiative suggests slim chances for the kind of bold action some have begun talking up as opposed to muddle through approach.   

More important may be the EU discussion of the state guarantees to support bank credit.  This would in turn increase borrowings from the ECB, which could help ease some stress in the interbank market. 

However, developments on the ground may continue to outpace the official response.  Note that the power broker in Belgium trying to facilitate a compromise that would finally end the stalemate that has denied the country a government for almost 1 1/2 years already, appears to be resigning.  If that is confirmed, the risk seem to be high for a downgrade as it is already on credit watch.  Belgium bonds are among the hardest hit today with 10-year yields up 12 bp.  Greek 10-year yields are up 50 bp but the liquidity seems exceptionally poor.