Calmer Tone Ahead of the Weekend

A nervous and fragile calm has settled over the global capital markets.   The dollar has been thus far confined to yesterday's ranges against sterling and the euro, and attempts to push the dollar higher faltered against the yen and Swiss franc, leaving the greenback is narrowly mixed on the day.  European equities are mostly slightly firmer, though of note the financials are outperforming the broader market.  Most bond markets are firmer as well.  

 

As German rate have collapsed--illustrated by the 2-year offering this week with a zero coupon that was oversubscribed--there has been increased talk of fund managers moving into Belgium, France and Austria markets to secure somewhat better yields.  Ironically the divergence in the periphery is produced a type of convergence in the "core",  The French premium over Germany in 10-year yields has come in from about 146 bp on May 17 to 101 bp earlier today.  While hardly his doing, Hollande must be quite pleased with this market development.  

The fundamental news stream from Europe remains poor, but the technical tone and extreme market positioning suggests a more cautious stance.  The break to new lows yesterday in the euro failed to be confirmed by the relative strength index.  This divergence suggests short-term participants will have a better opportunity to sell the euro.  The same is true of the Swiss franc, where the dollar pushed through the CHF0.9600 level for the first time in a year briefly earlier in the session.  Against the yen, the dollar faltered at the 20-day moving average (~JPY79.80).  It has not closed above this average since March 30. 

 

Last Friday, Spain's Bankia shares were up nearly 25%. Today the shares have been suspended amid reports suggesting that it is preparing to request 15 bln euros in aid. Recall the sequence of events. On May 9, the Bank of Spain announced the formal nationalization of this bank that was a combination of seven savings banks. The central bank converted 4.5 bln euros of preferred shares into common to give it a 45% stake. Earlier this week, the government warned the rescue costs could be 9 bln euros. The price tag seem to keep rising. 

This is reminiscent of what happened in Ireland. Officials terribly underestimate the cost of taking over the banks. We have argued this is particularly true of countries that experience asset bubbles. Real estate prices have not stopped falling in Spain and "troubled" loan ratios continue to rise and with it, the cost of cleaning up Spain's banking system. Stay tuned.

Some of the funds leaving the euro zone appear to be headed to Switzerland and this is challenging the SNB's commitment to prevent the euro from falling through the CHF1.20 level. There has been talk of large scale intervention this week, but often the market has exaggerated the size of SNB operations, judging from the highly opaque reserve figures.  There are many ways that a central bank can disguise its operations.  It can intervene in the swaps market, for example, and the forward market. 

 Intervention is not the only tool that Swiss officials can deploy. There was reportedly a meeting in Italy yesterday, where Swiss officials suggested the possibility of retroactively taxing undeclared Italian funds in Swiss accounts. There is also some concern that France's Hollande's pledge to impose a 75% tax on income over one million euros will lead to some French funds fleeing to Switzerland too.

Moody's cut the long-term and deposit ratings of two Swedish banks (Nordea and Svenska) by one notch (to Aa3)and an agriculture bank (Landshypotek) by two notches (to Baa2), and reverted to stable outlooks for all. It confirmed the rating of SEB and Swedbank. The rating agency expressed concern about funding, asset quality and modest profitability. The market appeared to take Moody's announcement in stride and Swedish bank shares traded mostly firmer and the krona is firmer in the foreign exchange market. 

Earlier Japan reported national consumer prices that were largely in line with market expectations.  April CPI rose 0.4% year-over-year after a 0.5% increase in March.  Excluding fresh food and energy, Japan remains stuck deflation; prices are 0.3% lower than a year ago. Tokyo CPI which is for May shows no relief.  Tokyo deflation deepened to -0.5% from -0.3% in April.  The measure excluding food and energy stands at -1.3% compared with -1.0% in April.  

As noted here yesterday, the sell-off in energy prices and the nearly 8% appreciation of the yen on a trade-weighted basis since mid-March will only add to the deflationary pressure.   The BOJ seems reluctant to expand its asset purchase program.  Political pressure on it will likely mount, especially if the economy begins faltering again.