Euro Pressure Subsides for the Moment

After extended yesterday's reversal to $1.2450 in pre-Asian activity, the euro has recover and near midday in London is at making session highs near $1.2525 and initial potential extends toward $1.2560-70 in the North American session.  The pace of yesterday's slide, even for the die hard euro bears, was surprising.   In order to keep the technical correction that we favored, last Friday's low near $1.2435 needs to remain intact. 

This applies to the other major currencies too. The dollar made a high at the end of last week near CHF0.9660. Though approached, this area has held today.  A comparable low was set in sterling just above $1.54. It may be a messy correction, but the correction seems still intact.

The corrective forces are more broadly evident.  After Asian equities followed the US lower, European bourses  are higher, though Italy's market is struggling lagging.  Spain's IBEX is leading the move, with telecoms setting the pace.  Financials are largely matching the overall 1% rise. 

Spanish and Italian debt are a different story.  Benchmark 10-year bond yields are 13 and 9 basis points higher respectively.  Note that Italian 5-year credit default swaps are rising faster than Spain's today, playing on the concern we sketched out here.   That said, European bonds as a whole are under more pressure than one may have expected given the equity market bounce.  Germany's 10-year is up 8 bp, the Dutch are up 9 bp and the French yield is up 10 bp.  

The fact that sterling is shrugging off an an unexpected 0.7% decline in April manufacturing output is also suggestive of corrective forces.  Overall industrial output was flat and the year-over-year pace moderated to a 1% contraction from -2.6% in March.  Of note mining and quarrying fell 5.7% on the month and oil/gas output was off 6.4%.   

The data may not be as poor as the optics would suggest.  There may some distortions caused by the Easter holiday and the decline contraction in manufacturing did not quite reverse the outsized 0.9% gain in March.  Nevertheless, the preponderance of data suggests that the economic stagnation may be giving way to contraction.  The BOE may have missed an opportunity to ease policy, either through interest rates or through asset purchases.  It will revisit the decision in a few weeks. 

Amid the doom and gloom, the Swiss government provided an unexpected piece of optimism.  It raised this years GDP forecast to 1.4% from the 0.8% estimate in March.  The inflation forecast was unchanged at -0.4%.  For next year, the government trimmed its growth forecast to 1.5% from 1.8%, with inflation at 0.5%.  Although the government emphasized the importance of domestic demand, our concern remains that through cap on the franc, the Swiss continue to block the adjustment process and are defecting from the "liberal" order.  If Japan, for example, would do this (successfully), there would be cries of alarm. 

That said, the IMF noted that the yen is "a bit" overvalued on a medium/longer terms basis.  The Deputy MD and former US Treasury official Lipton seemed to affirm that intervention may be appropriate in combat disorderly markets.  The IMF threw another bone to Japan's Noda may endorsing the controversial sales tax hike.   We have argued that taxing consumption in Japan may discourage a desirable activity.  On the other hand, savings, especially in the corporate sector, is less desirable and perhaps that is what ought to be taxed.  

Lastly, we note that the German government has failed to reach a deal with the opposition to support the fiscal pact.  The SPD and Greens are pressing for 1) the financial transaction tax, and 2) more steps to boost EU growth and jobs.  Tomorrow the head of the SPD Steinmeier is set to visit French President Hollande.  The SPD in Germany and the Socialists in France have not always gotten on very well, but the their self-interest and the larger political agenda may allow for greater cooperation.