Dollar Firm, Anxiety Still Running High

The US dollar continues to sport a firm profile, but largely within the ranges seen yesterday. The notable exception is its performance against the yen, where it rose to JPY95.75 in Tokyo, extending yesterday's recovery off the shock JPY93.60 area low yesterday. Asian equities mostly traded firmer and the MSCI Asia-Pacific Index gained about 0.3%.   

India equities tumbled about 1.5%, the most in three weeks. Although the central bank's 25 bp rate cut to 7.5% would have been expected to support the market, comments from the central bank indicating little support for additional easing, and more importantly, a key government ally pulled out of the coalition, leaving the Singh administration without a majority. 

European equities are broadly lower, with the Dow Jones Stoxx 600 off around 0.5% near midday in London, though here too, yesterday's ranges remain intact.  Core European bonds are firmer, while peripheral bonds are softer.   We note that the US-German 2-year interest rate differential continues to move in a dollar-supportive direction.  At 23 bp today it is the largest US premium since the start of the year.  The gap created by yesterday's sharply lower opening in the euro is found between yesterday's high ($1.2970) and last Friday's low ($1.3000).  This area is important technically, and all the more so given that it appears on  the weekly charts. 

 

In contrast, we note the US-Japanese 10-year spread, at 133 bp is near its 10-day low.   This would seem to have a more negative dollar factor than is reflected in prices.    The dollar filled its gap and more against the yen.  It surpassed retracement levels seen from the March 12 high near JPY96.70.  We now peg support for the greenback near JPY95.00.   

Cyprus developments remain front and center today.  The situation remains very fluid, to say the least.  It is not clear if there will be a vote today, which has previously been indicated for noon (EDT, 16:00 GMT).  The newly elected Cypriot President seemed to have been among the strongest advocates of taxing small depositors has been forced to reconsider.  Germany and other European countries have been quick to claim that they had not wanted to tax small depositors.  The Cypriot government and parliament are searching for alternatives to raise 5.8 bln euros.  The problem is that there are not many other places to turn in Cyprus and a narrower base for the wealth tax will require much higher taxes on the more limited number of larger deposits.  

Many, including the French Fiance Minister are claiming some taboo has been broken.  Others claim a Rubicon has been crossed.  We are less sanguine,.  First, the generic category of wealth tax in contrast to income and sales tax is not uncommon in Europe.  Second, a tax on deposits is also not unprecedented.  For example, recall that in July 1992, Italy's government under Prime Minister Amato took 0.6% of all bank deposits (imposed a 0.3% tax on all real estate).   It is not the amount of the tax or the moral justification that is the issue, but the principle and precedent.  Third, throughout this crisis, the burden of the adjustment has fallen on those who are generally less well off. .  Minimum wages have been cut.  Health care benefits have been cut.  Pensions have been cut.  All for the sake of keeping some investors whole.  

Each aid package has been tailored to the uniqueness of each country.  The role as an offshore tax haven is the unique feature in Cyrpus.  This means that the banks rely almost solely on deposits,  rather than funding in the wholesale market or by issuing bonds.   There are not many other places to turn to raise the 5.8 bln euros that the Troika is insisting upon, which as they say is why Willie Sutton robbed banks in the first place. 

We do not see the developments in Cyprus (any more than the developments in 1992 developments in Italy did) portending a massive wealth grab by European countries.  It is not a test case or the beginning of some process.  However, it does seem to signal a greater willingness of the officials to seek a broader involvement in assistance programs, perhaps emboldened by the ECB's OMT and extra time to reach fiscal targets by the EU, with a greater focus on the structural balances. 

Otherwise, there are four economic developments to note.  First the RBA minutes were much like last time.  The easing cycle may not be over, but the RBA shows no urgency to resume cutting rates.  No one was expecting a cut in April, but even a cut in the May-June period is being pushed out.  

Second,  the UK consumer inflation was in line with expectations (0.7%/2.8%), though producer prices rose more the expected (input 3.2%/2.5%) warning of potential squeeze on margins.  The budget presentation tomorrow is anxiously awaited.   

Third, the German ZEW survey should improvement especially in the assessment of the current situation (13.6 from 5.2).  The euro responded positively to the headline (~$1.2960), but just as quickly returned to where it was before.   

Fourth, in Italy Berlusconi has provided a path toward a new even if limited government by offering to support the PD's Bersani as prime minister in exchange for a PDL candidate becoming president.  The President in Italy is largely ceremonial but can appoint life time Senators (like Monti) and has an important role facilitating elections and new governments.  Separately, the EC indicated a willingness to allow Italy to borrow more to repay debts, especially to small and medium sized businesses, many on the verge of bankruptcy due to the uncollected funds from the government.  The EC comments suggest these new borrowings would be not counted against its fiscal targets.  Estimates of the governments arrears range between 50 and 80 bln euros.