Dollar and Yen Bounce Back

As full liquidity returns to the markets for the first time in nearly a week, the US dollar and Japanese yen have rallied.  First though weak short euros and long yen cross positions were squeezed in early Asia, but by the time Europe entered the fray, the moves were well under way, with the euro and sterling coming off and the yen rallying. 

The BOJ defied political pressures and some market expectations that would take additional measures to fight deflation and support the economy.  We sketched out our reasons for not expecting this, especially given that the last move was mid-Feb and had not been fully implemented.  We also highlighted the importance the BOJ's economic assessment due later in the month. 

The dollar fell to new lows for the move against the yen and is testing the JPY81 area.  A break signals a test on JPY80.60 and then JPY80.  The euro also has fallen to new lows for the move, flirting with the JPY106 level.  A break signal a test on the early March lows near JPY105.65. 

To appreciate the challenge, however, note that before the euro and dollar fell through yesterday's lows against the yen, they first took out yesterday's highs.  The short-term market was caught leaning the wrong way and had to chase the market if they wanted to re-establish and this may have extenuated the break. 

The second key development is the pressure on the periphery.  Europe has returned from its extended holiday and continued where it let off last week, selling Spanish and Italian bonds and buying Germany bunds and gilts. As we argued at the time, the more Spanish officials talked about the 2012 budget and the more people examined it, the less credible it would seem.   Spain's economic minister was quoted refusing to rule out assistance, but this was hardly a policy cue.  If Spain is going to get assistance, it still seems some distance off. 

In addition, the Spain's Rajoy mis-handled the push against the EU 4.4% deficit target.   Spain's 10-year (generic) yield is approaching 6%, compared with the 4.83% seen at the start of March.  The 5-year CDs is at 472 bp and is approaching the high set last November near 492 bp.  

Italy's 10-year bond yield (generic) is up about 15 bp to 5.60%, which is the highest since mid-Feb.  Yields bottomed in early March near 4.68%.  The 5-year CDS is near 432 bp.  The peak from last Nov is still a distant 594 bp.  It bottomed at 350 bp in mid-March. 

While there is something to be said with the impact of the LTROs wearing off, there is also something to country-specific developments.  Since Rajoy's miscues on the budget, Spanish bonds have been selling off.  Since Monti's labor market reforms were unveiled, Italian bonds have been selling off.  Rajoy made new detaills available about cuts in health care and education but failed to instill confidence. 

There was some economic data but of little interest today.  French Feb industrial output rose 0.3%  and this was on the high side of expectations, but the year-over-year rate is -1.9% and manufacturing output fell a whopping 1.2% on the month.  German trade figures were in line with expectations.  Sweden reported unexpectedly weak industrial production and orders data.  The krona is a bit heavier than the euro, but not sufficiently to indicate a shift in expectations at next week's Riksbank meeting. 

China reported a trade surplus of $5.3 bln in March.  The consensus was for a deficit.  Imports were much slower than expected rising 5.3% year-over-year.  The consensus was for a 9.0% increase.  Exports were a bit stronger than expected at 8.9% rather than 7%.  The value of oil imports for 26% year-over-year.  Iron ore imports were off 9.1% and steel imports fell 20%.   This suggests weaker domestic demand.  In addition the value of goods imported for processing (and then likely re-exported) rose 2.6%.