Marking Time, Dollar Softer

The US dollar is softer against most of the major and emerging market currencies as players await for fresh incentives as month-end and quarter end approaches.  

Of note, the dollar has surrendered more of last week's gains against and has returned to the 20-day moving average around JPY79.25, after finishing last week above its Bollinger Band.  The short-term speculative market was leaning the wrong way.  That said, the dollar is approaching trend line support, drawn off the June 1 low near JPY76.65 and the June 18 low near JPY78.65 and the June 20 low near JPY78.80.  It comes in today near JPY79.11.  It may be toyed with, but the area is likely to hold initially. 

The retail sales tax hike was passed and the DPJ challenger Ozawa and his 57 allies that voted against the tax did not bolt, but remained in the party.  Prime Minister Noda's term as DPJ head expires at the end of September and he will likely face a leadership challenge then.   Recall that the first of two planned increases in the tax, which will double it from 5% to 10%, does not take place until late 2014.  Much can happen between now and then.  There does seem to be an "escape clause", under which the tax can be postponed if the economy is judged too weak. 

The euro is little changed; confined to yesterday's ranges against the dollar.  On one hand, one could say it is holding up fairly well, all things considered.  Among those considerations are Moody's ratings cut of 28 Spanish banks 1-4 notches in the second round of cuts since May 27.  The move was not limited to the old cajas, but BBVA was cut 3-notches to Baa3 and Santander was cut two notches to Baa2.  Spanish shares are flat, but financial are up about 0.25% near midday.    

After rallying last week, peripheral bonds are trading heavily (Portugal is the exception).  Spanish and Italian 10-year yields are around 7 bp higher.    Two year yields are up 15 and 11 bp respectively.  The bearish curve flattening is seen as a reflection of the intensity of anxiety.  The debt markets were under pressure prior to the debt auctions and remain so.  

Initial euro support is seen near yesterday's low near $1.2470.   A break of $1.2460 would likely bring in more selling and encourage ideas of a return to the sub-$1.23 area seen on June 1.  The $1.2530-40 area should provide a cap on upticks.  

To the extent there is a surprise today it is sterling.   It rose through yesterday's high (~$1.5595) to reach $1.5650 today.  The gains come despite the heavier tone to gilts and a lackluster stock market.  Moreover, the UK reported a larger than expected budget deficit.  The economic weakness is weighing on tax receipts (+1.6%). Income tax receipts were off 7.3%.  In addition, contrary to the austerity program, government spending surged (7.9%).  The deficit, excluding bank aid, was GBP17.9 bln vs GBP15.2 bln a year ago. 

On balance, the BOE has signaled action at next week's MPC meeting.  While a rate cut on gilt purchases were possible, today's official comments suggests a rate cut is less likely.  BOE King express some concern for the impact on small building societies.  

In the first two months of the fiscal year, the deficit was GBP28,4 bln.  During the same period a year ago, the deficit was GBP24.5 bln.  Although the UK economy contracted in Q1, the government sector was a net contributor to growth and it is likely to have been so again in Q2.  Counter-intuitively, without much of a plan to bring the government spending under control, the government sector in the US has been a drag on GDP.

Sterling faces initial resistance now near $1.5660.  A convincing move through $1.5680-$1.5700 would call into question the near-term bearish outlook and warn of the risk of another run at $1.58. 

Separately, Italy reported horrific retail sales for April.  The 1.6% decline was more than twice what the consensus expected and the March series was revised to -0.8% from -0.2% initially.   Monte dei Paschi that we noted was looking to issue state-guaranteed bond to meet EBA capital requirements by the end of of the month was limit down earlier.  Meanwhile, Monti is pushing for parliament approval of the labor reforms ahead of the EU Summit.  It will take several votes of confidence in the Chamber of Deputies today and tomorrow to ensure it does pass. 

Lastly, another surprise is that talk that Cyprus may need 6-10 bln euros.  Previously, it was thought to need around 3-4 bln.  Its GDP is just above 17 bln.  This is not just to cover the impact of the Greek default on Cyprus banks.  It looks like there is fiscal coverage here too.