Nervous Consolildation, Waiting for Other Shoe to Drop

The US dollar is trading within the ranges that were seen prior to the weekend as the market awaits fresh developments. The market remains apprehensive as additional rating fallout is expected, ahead of a resumption of Greek PSI talks and this week's European sovereign supply (estimated 17 bln euros of bonds).

Global equities are mostly lower. MSCI Asia-Pacific Index fell 1.2%, the largest in a month, led by financials. The re-election of Ma Ying-jeous in Taiwan was widely anticipated, but failed to bring relief to local shares which fell 1.1%. The Shanghai Composite fell 1.7%, the most in the region and now has given back almost 61.8% of the rally from Jan 6. China reports retail sales, investment and industrial production figures tomorrow.

Most European bourses are lower, though the German Dax is an exception, posting about a 0.3% increase in early afternoon turnover in Frankfurt. Consumer goods/services and technology are leading the way. Financials are the weakest sector in Germany and in the Dow Jones Stoxx 600. Following sovereign downgrades, bank downgrades are anticipated, given the linkages.

European bonds have mostly had a muted response to the S&P downgrades, which were mostly anticipated. Of note, however, Portugal, whose rating was cut below investment grade, has seen a large sell-off, pushing the benchmark 10-year yield up over 100 bp. Spanish and Italian bond yields are little changed.

That said, there is market talk that the ECB has been buying sovereign bonds today. Note the CDS market does appear to be picking up a bit more tension than the sovereign bond markets today. Portugal's 5-year CDS is up the most (49 bp), followed by Italy (+20 bp). Moody's, which 3-months ago put France credit outlook on watch warned of credit risks if its slips behind its austerity plans or if the euro zone crisis worsens. S&P decision on the rating of the EFSF, which issues bills later this week, now that it cut France and Austria's triple-A rating.

Japan surprised with a strong 14.8% jump in November core machinery orders, largely offsetting the Sept and Oct declines (6.9% and 8.2% respectively) and the corporate goods price index edged up 0.1% in Dec. The BOJ regional report showed 7 of the nine regions cutting their economic assessment. Japanese officials appear to be growing increasing uncomfortable with the appreciation of the yen against the euro and the euro fall to new multi-year lows against the yen earlier today (just above JPY97). Intervention on the cross does not seem imminent, but the risks are increasing.

The Bank of Canada meets on Tuesday. It is widely expected to stand pat. There are some observers who expect the central bank to upgrade its economic assessment after 3.5% growth (annualized ) Q3 after a 0.5% contraction in Q2. However, employment data has been weak and Oct GDP was flat. Dec CPI is due out at the end is expected to be 2.7% down from 2.9% on the headline, but the core rate could tick up to 2.2% from 2.1%.

At the IMM, speculative euro net short positions were extended to 155.2k from 138.9k and represents a new extreme. Yen longs were extended to a new multi-year high of 59.6k, up from 56.5k. Sterling, Swiss franc and Canadian dollar net shorts were extended marginally. Net long Australian dollar positions were expanded form 46.5k to 53.5k, a new multi-month high.

India reports a sharp fall in wholesale inflation (7.3% year-over-year in Dec from 9.1% in Nov). This is a two-year low and gives the central bank some breathing space. It is likely to leave rates on hold when it meets next week. This comes at a favorable time for the ruling Congress Party, as state election begin later this month. The rupee is the strongest Asian currency thus far in the new year, after having sold off hard into year-end. The rupee is up 3.25% this year.