Dollar Soft, New Insight into Euro Rise, Japan/China Tensions

News that the German Constitutional Court will indeed make its preliminary ruling tomorrow on the ESM and fiscal treaty has helped lift the euro. As noted yesterday, new charges in light of Draghi's plan threatened to delay the much awaited decision.  The euro made a marginal new high for the move, but quickly moved back into a consolidative mode.  Near-term support near $1.2750 has been established. Market contracts report some optionality in the $1.2850 may be slowing the momentum and some note the proximity of the 200-day moving average (~$1.2835), something that has not been violated since last October. 

Sterling has been trading above its 200-day moving average for more than 3 weeks.  The upside momentum has slowed as its straddles the $1.60 area.   The UK offered the data-surprise of the day with a much smaller than expected trade deficit.  The July deficit came in at GBP7.1 bln, down from a revised GBP10.1 deficit in June and expectations for a GBP9 bln deficit.  This is the smallest monthly deficit since February and reflects both arise in exports (8.5%) and a decline in imports (-2.5%).  The non-EU shortfall was almost halved to GBP2.9 bln from GBP5.1 bln. 

In our weekly review of the positioning in the CME currency futures, we have shown that the recovery in the euro off the multi-year near $1.2040 was partly a function of short covering by momentum traders and trend followers.  The gross short euro position has fallen from a record 251k contracts in early June to less than 150k contracts.  

In addition to this market segment, some asset managers also appear to be reducing core  under-weight European exposure.  Here in Q3, generally speaking, European has outperformed the US asset markets.  Given the opportunity presented by changed perceptions of the tail-risk initiated by the ECB, corporations and banks have seized the opportunity.  

One interesting development has been US corporates and banks issuing euro denominated debt; by some measures, could be the most in a couple of years.  Spanish and Italian banks and corporations have also issued more debt into the rally.  A large Italian and Spanish bank issued senior, unsecured bonds yesterday, following on the heels of last week's successful reception to the fellow bank offerings.  

Yesterday, two Spanish banks issued covered bonds for the first time in six months.  Good foreign demand was reported.  Banesto's 5-year offering, for example, at 395 bp above mid-swap rates saw strong interest, with foreign investors reportedly taking 80% of the issue.  The ECB of course has not bought a single bond under its program and sovereign bonds appear to be consolidating their recent gains, but the private sector has seized the window of opportunity. 

We again draw your attention to the tensions in the East China Sea.  Japan has bought 3 of the uninhabited yet contested islands from a Japanese family for about $26 mln.  The Japanese government owns a fourth island and is leasing the fifth.  The purchase, however, can only escalate the tension.  China has responded by sending petrol ships to the area, but reports suggested these may be law enforcement rather than military vessels.    

Taiwan has also protested Japanese action.  It is not clear the kind of economic linkages to these unresolved territorial disputes, but China has seemingly retaliated in the past, such as with the rare earth metals.  Japan also has a separate dispute with South Korea over a different sent of islands.  Tensions have escalated since the South Korean President visited them last month.  That dispute appears to be stalling negotiations of a free trade agreement.