Dollar Softens to Start Week

The US dollar has softened to start the week amid a light news stream. The price action seems to be a continuation of what was seen last week.  Expect a consolidative tone for the remainder of the North American session.  

Recall that the major currencies tended to consolidate within broad ranges established July 10-11 in response to Bernanke's comments, which helped the market understand better the conditional nature of the tapering talk. The euro, yen and the Australian and Canadian dollars remain within that range still. Sterling and the Swiss franc are above the best levels they saw then.

The euro has approached the $1.3200 level and a break of its would suggest potential toward $1.34. Sterling has absorbed offers in the $1.5280-$1.5300 area and now looks set to test $1.5400 near-term. While Japanese shares posted modest gains in the wake of the largely expected election results, the yen strengthened and is the strongest of the major currencies today. 

For the eighth consecutive session, it is flirting with the 20-day moving average that comes in near JPY99.70. The dollar remains well within the JPY98.90-JPY100.90 range seen last week. While the Aussie has been largely confined to its pre-weekend range, the Canadian dollar is showing some independent strength, with the greenback slipping through last week's lows.

US 10-year yields slip further below the 2.50% level, having peaked near 2.75% on July 8. The adjustment to interest rate expectations and positioning is also evident in the Eurodollar futures strip where the implied yield of the Dec 2014 contract is 20 bp lower than seen on July 8 and the Dec 2015 implied yield is nearly 50 bp lower.  Existing homes sales is the main economic report for the US today and analysts will scrutinize any weakness for signs that the rise in mortgage rates is having a cooling effect on activity.  

There are two developments in Europe that seem noteworthy.  The Portuguese bond market is continuing to recover from the recent slide.  The failure of the President's initiative to form a cross-party unity platform failed.  The opposition Socialists wanted to renegotiate the terms of its aid package, while the governing coalition remains committed to it made for strained talks at best.  The President accepting the political reality has endorsed the government, which appears to put closure around this mini-political crisis and Portuguese bonds have continued the recovery seen last week.  The 10-year yield is off 40 bp to around 6.20%, the lowest in a month.  Portugal shares are also among the strongest performers today with the local bourse up about 1.3%, led by a 5.2% rally among financial and underscoring the link that remains between the sovereign bond market and domestic banks.  

Italian bonds and stocks are also among the best performers today.  The 10-year benchmark yield is off 6 bp and the equity market is up about 0.75% in later afternoon activity. Press reports suggest the government may have reached a compromise on the controversial real estate tax that the Monti government had approved.  Recall that Berlusconi's center right wanted to abolish it entirely, but the making up the anticipated revenues was difficult.  The compromise appears to not include first homes, unless they are luxurious.  This will eliminate the burden on most households.  

Lastly, we note that China reported a CNY41.2 bln decline in bank foreign exchange holdings, the first decline in seven months in June, which is seen as a sign of capital outflows.  This raised fears to a new liquidity squeeze and sparked an increase in various money market rates.  After a poor start, the Shanghai Composite recovered to close about 0.6% higher.  The only sector that failed to close higher were financials.  After the removal of the interest rate floor for loans, Moody's said is was negative for banks.  The yuan softened slightly.