Europe and Bernanke--Euro May Recover

The day after the LTRO, Europe has reported a mixed batch of PMI readings that underscore the multi-speed Europe that is emerging.  Germany, France, UK Norway and Sweden appear to be stabilizing.  However the rest seem to still be in difficult straits. 

A case can be made that Ireland, Italy and Switzerland are stagnating, while Greece and Spain are eroding.   For the euro area as a whole, the manufacturing PMI was left at the 49 reading of the flash report.  It is the seventh month below the 50 boom/bust.  New orders and backlog readings are still falling. 

The euro extended yesterday's downside reversal, but found a bid (talk of Asian official) in front of $1.33.  It needs to get above $1.3350 to stabilize the technical tone that had looked constructive before yesterday's action. 

A number of observers are claiming the euro has peaked.  While we had looked for the euro to peak in the $1.34-$1.36 area and the $1.35 cap looks solid, we are not convinced an important high is necessarily in place.  The euro has not even retraced "the minimum" 38.2% of its latest leg up from Feb 16 dip below $1.30 (comes in just below $1.33). 

In addition, to the extent Bernanke's testimony yesterday was construed as "less dovish" is vulnerable to a correction as the Chairman testifies before the Senate.  This testimony is not the venue for new policy.  We do not think he broke new ground yesterday. 

The purpose was to summarize the state of the economy and monetary policy.  There can really be no doubt that QE3 remains a policy option.  We have argued the bar is high, but to read Bernanke as "less dovish" seems to be error that the Chairman could very well correct today. 

ISDA decision on whether subordination of the private sector by the official sector is a credit event--trigger CDS-- is still awaited.  We expect ISDA's Determination Committee to not see it as a credit event and this could also be supportive for the euro. 

Yesterday's LTRO may have helped make for smooth auctions from Spain and France today.  Italian bonds have caught a strong bid as well.  Italy's 2-year is below 2% for the first time since Nov 2010, down 32 bp today.  Generally there is a bullish steepening in Europe, where the short end is rallying more than the long end.