Two Developments Push Euro Lower in Europe

Asia extended the euro's recovery, but developments in Europe have seen it surrender the earlier gains and move back toward the lows seen in North America yesterday near $1.3360.  The relatively light participation in the ECB's 84-day dollar auction and signs that even at this late date there are key disagreements among euro zone officials about key issues like private sector participation, EFSF/ESM, and role of IMF seemed to sour the mood. 

There were 34 bidders for the ECB's 84-day dollar auction, the first under the reduced rate (50 bp +7-day OIS).  They took down $50.7 bln.  This was at the lower end of expectations. It suggests that banks may still not be using the facility.  Extrapolating from the elevated LIBOR and cross currency swap rate, which slipped but is still wide compared with anything but the past few weeks, many observers suspect greater dollar demand.  If true this means that LIBOR will stay elevated and cross currency swap pressure intensify. 

  

Stigma may still be the biggest obstacle as there had been talk of as much as $130 bln demand.  Some observers are claiming "broad usage"  and "surge" in demand.  This is hyperbole.  The demand at the 7-day auction increased to $1.6 bln from a little more than $350 mln last week, but these sums seem to small relative to the pressure in the markets. 

Note that the BOJ auctioned 1-week dollars yesterday and saw demand "surge" 25-fold to a mere $25 mln from $1 mln. 

In any event, the euro came off quickly after the results, but this also coincided with conflicting comments about whether the EFSF and ESM would run concurrently as floated yesterday, the role of private sector investors in future sovereign bailouts and the role of the IMF.  A spokesperson for the German government was quoted expressing pessimism over the likely outcome, warning some do not appreciate the seriousness of the situation.  The comments seemed to be directed at non-euro zone members, possibly the UK. 

The UK and Italy reported worse than expected industrial production figures, while Germany's report beat expectations handily.  Industrial output fell 0.7% in Oct in the UK, twice the decline as expected.  Manufacturing fell 0.7% and this was thrice expectations.  Italy's industrial output fell 0.9% in Oct, twice the consensus.    Germany industrial output rose 0.8%, not the 0.3% the consensus forecast.  This like yesterday's orders data suggest that although the world's 4th largest economy slowed, it is still quite resilient. 

Separately, the German 5-year bond sale was over-subscribed and this helps ease concern, which we never shared, that there was beginning to be capital flight from Germany.  The 3 and 6 month bill yields remain negative in Germany. 

In terms of today's price action, the greenback will start the North American session a bit over-stretched after the run-up in the European morning.  The market may not extend positions much ahead of tomorrow's ECB meeting.  Initial support is seen in the euro now near $1.3360 and then yesterday's low near $1.3330.  Sterling seems comfortable within yesterday's $1.5560-$1.5660 range.  The dollar is is a 17 tick range against the yen.  Simply nothing there for short-term traders.    Australia's better than expected GDP report helped lift the A$.  Resistance near $1.03 was tested and it held.   A break above there would open up another 0.5-0.75%. Canada and Australia's ratings may draw some investment flows over time, given risks in Europe.