FX: Little Movement, Much to Digest

The US dollar continues to sport a soft profile as market position adjustments ahead of the Greek election continues to dominate.  As anticipated, the market has mostly looked beyond Moody's three step downgrade of Spain's creditworthiness to Baa3.  Spanish 10-year yields pushed through 7% briefly, but rumors that ECB officials may have "checked prices" helped stabilize the situation. 

In North America today, euro has potential to test the $1.2610 area seen yesterday, but strong gains through there are unlikely.  Similarly the dollar could test the CHF0.9520 area, but a break of CHF0.9480-CHF0.9500 is unlikely.   Sterling had finished the NY session yesterday on its lows and saw some follow through selling in Asia.  It has stabilized and there is scope toward $1.5570 today.  The Australian dollar brief and shallowly penetrated $1.00 level yesterday as we warned was likely.  Provided the $0.9920 area continues to hold, another test may be forthcoming.   The Canadian dollar is comfortable within yesterday's ranges.  Support for the US dollar continues to be seen near CAD1.0240.  Lastly, support in the JPY79.20-30 area is being tested as the North American session gets under way.  Look for this area to hold.  

The economic data calendar has been light, but there were several noteworthy developments.  First the news from Greece and Spain continues to be disappointing, even if unsurprising.  Greece reported its unemployment rose to 22.6% in Q1 from 20.7% in Q4 11.  

Spain reported housing prices continue to fall.  The 12.6% year-over-year pace in Q1 was the steepest since the time series began in 2007 and compares with an 11.2% decline in Q4.  The ECB's financial stability report forecast a 15% decline in Spanish house prices this year.  Meanwhile, the Bank of Spain also reported that even after the LTROs, Spanish banks continue to increase their borrowing from the ECB.  

In May, Spanish bank borrowings rose to 324.6 bln euros from 316.9 bln in April.   As we noted Moody's downgrade now means Spanish collateral falls into a bucket requiring an extra 5% haircut.  More of Spanish banks limited collateral will become encumbered or if Spanish banks cannot make the margin call, funds will have to be returned to the ECB. 

Second, Italy's bill auction yesterday was followed by a bond auction today. Italy was able to raise the amount of money it sought, but of course the price was higher yields.  Owing to the large stock of outstanding data and the average maturity of about 7 years, Italy can cope with somewhat higher yields for a short-period of time.    While Italy' economic challenges are clear enough, what many do not appear to be fully appreciating is the risk of policy paralysis.  Prime Minister Monti's support has fallen in half to 40% from when he first took office last November.  The calls from an early election appear to be heating up.  

German Finance Minister Schaeuble's comment yesterday that "If Italy continues along Monti's path, there will be no risks", may sound good, but logic dictates the contra-positive is also true.  There are risks if there is deviation from Monti's path.  We see Monti's efforts already running into resistance and dilution.  Moreover, the full impact of the structural reforms and austerity measures have yet to be felt, but we do know the more dramatic and reform and austerity measures are, there one finds increasing political and social resistance.  

Third, both the Reserve Bank of New Zealand and the Swiss National Bank held policy making meetings.  Neither signaled a shift in policy.  The New Zealand dollar is among the stronger performers today.  Officials do not appear to be in a hurry to change rates, while additional Australian rate cuts are expected.  The SNB revealed very little.  It will maintain its franc cap and continue to increase the size of its balance sheet, though few are calling it a form of quantitative easing.  Other unspecified measures were threatened.  The suspicion is that other measures, such as capital controls, or negative interest rates on foreign deposits may be contemplated to reduce the pressure (risks) associated with a increasing balance sheet.  

Lastly, there a couple of other stories worth being aware of.  A UK paper is claiming that Merkel is softening her stance on redemption bonds. While it may be true, after all it was her advisers that proposed this late last year.  However,  I would feel more comfortable with it if the story originated in Germany.  There is also talk that Cyprus may be preparing a formal request for 2.5 bln euros form the EFSF.  Recall its banking assets are 9-times larger than GDP and one bank is facing a bond maturity that is equivalent to nearly 10% of the country's GDP before the end of the month.  Moody's yesterday cut Cyprus' rating two notches to Baa3, citing the likelihood it would need international assistance.