Risk Assets Jump, Smell Something, See Nothing

Equities, most foreign currencies and commodities have rallied.  It is not as if there has been a great deal of clarity over the weekend.  There have been a number of press reports that have been suggestive, but some, like the report that the IMF was preparing a massive loan program to Italy, has been denied. 

Hopes that the Tue-Wed Eurogroup meeting could resolve the issue of leveraging the EFSF seem to have eased and the market does not appear convinced that it will decide to make the next aid payment to Greece as Greek yields are broadly higher today.   Moreover, the Italian auction raised just above the minimum amount though with a big jump in yields and addition supply is scheduled this week. 

The euro rallied about 1.5 cents to almost $1.3400.  Although there is nothing concrete, the market smells something.Last week, some argue was a wake-up call.  Spanish and Italian bill auctions produced yields greater than Greece.  Portugal (and Hungary) has their ratings cut to below investment grade.

And more importantly, the core appeared affected.  Germany's sale was the third consecutive one that was under-subscribed.  Belgium's credit rating was cut and France was warned.  On top of this the economic data was poor with the flash PMI composite below 50 for the third consecutive month and the collapse in Sept industrial orders. 

However, it is more a case of the participants smelling something than seeing something.  Germany and France appear to be working desperately to expedite changes in the agreements to tighten fiscal discipline and this is seen as a precondition for increased ECB/German support.   With the euro over-extend on a short-term technical basis, it would not be surprising to see North American operators somewhat more skeptical than Europe.   A break now of the $1.3350 area could see a return to $1.33. 

Sterling is benefiting from the dollar's setback and is holding its own against the euro.  Sterling resistance is seen near $1.56, previously support.   A convincing break can signal another cent advance, but as with the euro, short-term technical favor a move lower initially in North America with support seen in the $1.5530-50 area.   The news stream has not been favorable in the UK, where Hometrack house price index fell again, the seventh consecutive decline. 

The dollar-bloc currencies have participated fully in the risk-asset bounce.  This is important because even if this proves a false dawn, as I expect, it shows that when the pressure does ease, where biggest upside exists.  In this light, the Scandi currencies were also big losers in the heightened anxiety environment.  The Swedish krona was the worst performing major currency last week.  Stronger than expected retail sales helped boost the krona as it benefited from the changed tone.  However, OECD warnings  saw it trim the gains. 

Still the strains in the system are evident.  The 3-month cross currency swap rate--what is costs to swap from dollars to euros, a key metric of the interbank tensions, now is near 148 bp below 3-month Euribor, further slippage since the end of last week and the largest gap since late 2008.  Another sign of the tensions is that overnight deposits at the ECB continue to rise and now stand at around 256 bln euros.