Successful Auctions Lift Tone, but...

Better than expected reception to Spain's bond auction and Italy's bill sale have spurred "risk-on" with the euro moving into the range that appeared to have been broken yesterday and equity and emerging markets trading higher, though as discussed below, the gains may not be sustained through North America today.   It is too early to expect more action from the BOE or ECB.  

Spain in fact too advantage of unexpectedly strong demand to raise twice the upper end of its intended 4-5 bln euros and in doing so has completed a bit more than 10% of this year's projected funding needs.  Demand for Italy's bills were never really in doubt as retail may see them as an alternative to bank deposits.  The yield on the one-year bill sales fell to 2.73% from 5.95% last month.  Risk lies with the bond sale tomorrow, especially with the large increase in Italian bond prices today as the 5-year yield is off 60 bp and the 10-year yield has dropped about 40 bp.  

The year is long and the amount that the sovereigns and banks need to race is large.  It is worth reiterating three main points in our analysis.  First, amount of maturing bonds and coupon payments in January are roughly balanced.  This provides a supportive environment for this month's auctions.  This consideration deteriorates next month. 

Second, the 3-year facility by the ECB and the lower cost of accessing dollar funding reduces the extreme tail risks in the euro zone.  This was an important step in the crisis response. 

Third, there will continue to be "natural" buyers of European sovereign bonds.  Even if not all the foreign holders will roll-over their maturing issues, many domestic investors, like banks and pension funds, likely will.  The parallel we point is a year ago, many were asking who would rightly buy US Treasuries after the Fed's program ended.  Lo and behold, US yields fell more in the six months after the Fed finished than during its operation.  And now one of the largest fixed income managers in the world is reportedly recently increased his exposure to Treasuries.   This doesn't mean all auctions will go smoothly, but it supports our "muddle through" hypothesis. 

The relief rally in the euro is leaving short-term momentum indicators over-extended and North American operators seem to have been more aggressive about selling into euro upticks in recent days.  The euro approached a key band now in the $1.2680-$1.2720 and appears to be faltering ahead of the lower end of the that band.  The euro firmed to test the GBP0.8325 area, which is also an near-term important technical level.   It appears to be sufficient to stall the euro's upside progress now.

In terms of data, three reports are notable.  First, the UK reported a larger than expected decline in November industrial output figures.   The 0.6% decline compares with the consensus forecast of fall report after October's 1% decline.  Manufacturing declined by 0.2% after the 0.9% plunge in Oct.  Over the past three months through November, factory output fell 0.9%, the biggest decline in August 2009.  On a year-over-year basis, manufacturing is off 0.6%, the first decline since Jan 2010.  The recent survey data suggest some stabilization is likely in December.   Second, China reported a 4.1% year-over-year increase in CPI, the smallest in 15 months.   O)f note food prices accelerated.   The risk is that PBOC easing may not be as quick and smooth as the market hoped/anticipates may have been a weight on Chinese shares. 

Third, Sweden reported softer than expected CPI figures and this will likely weigh on the krona,which was trading near 2-year highs against the euro.    It also increases likelihood that the Riksbank eases policy.  Fourth, Japan reported a smaller than expected current account surplus for November, largely reflecting a larger trade deficit.  Note that the current account surplus is driven by the investment income balance not the trade account (any more).  Moreover, Japan reported the trade figures for the first 20 days in December and it ensures that Japan will report its first annual trade deficit in thirty years in 2011.  Dollar-yen--confined to a 16 tick range.