Euro Winds Down

Includes: FXE, FXY, UDN, UUP
by: Marc Chandler

The relatively calm foreign exchange market and equity market in Asia ended abruptly in Europe. It is difficult to find the culprit, other than position squaring in thin markets, but the euro has come off a cent, dragging down the franc.

The MSCI Asia Pacific Index gained more than 0.5%, while European bourses are broadly lower, with the Dow Jones Stoxx 600 off 0.3% near midday in London, led by utilities and financials. Fixed income markets are subdued. Italy's bond auction was adequately received, especially during holiday conditions.

There have been a few developments to note. Japan's data was disappointing and this can only bolster the new government's attempt to stimulate the economy both monetarily and fiscally. Worker cash earnings fell a whopping 1.1% in November, nearly three times larger than the consensus. This may have been a factor behind the poor retail sales, which were flat. The consensus had expected a 0.4% increase. Weak incomes and domestic demand may have, in turn, weighed on output. In November, industrial production fell 1.7%, more than three times the decline expected.

In terms of the weekly MOF portfolio flows, they continue to be consistent with expectations of a weaker yen. With this assumption, Japanese investors would, all else being equal, prefer foreign bonds over foreign stocks and indeed that is exactly what they continued to do - buy foreign bonds and sell foreign shares. Foreign investors, in anticipation of further yen weakness, show a continued preference for Japanese stocks over bonds.

In Europe, the economic news, on the face of it, would seem positive. Spain, for example, reported a (small) current account surplus in October (~865 mln euros). This is the third surplus of the year and supports our expectation for reduced imbalances within Europe to ease the Target2 imbalances. Spain reported capital inflows of 12 .1 bln euros after 31 bln in September. Foreign portfolio inflows were 6.3 bln euros after 9.3 bln in September. Spain also reported retail sales that had only fallen 7.8% year-over-year rather than 10% the market expected.

France revised Q3 GDP to 0.1% from 0.2%, but November household consumption was a bit stronger at 0.2%.

In Germany, the first state to report December inflation figures, Hesse reported a large rise of 0.9% on the month, which lifted the year-over-year rate to 2.2% from 1.8%. Although following the last ECB's meeting and reports that a majority had favored a rate cut, what now appears to be a spike in German inflation would seem to reduce the odds of a rate cut in January.

Turning to the US, we note that any glimmer of hope that Washington will avoid the worst of the fiscal cliff sees risk-assets (e.g. equities) rally and the dollar weaken (except against the yen). The market sees the possibility of one last ditch effort. Today, Obama meets with the top two officials from both the House of Representatives (Boehner and Pelosi) and the Senate (Reid and McConnell). Reports suggest the key now turns not so much on tax increases as the $109 bln in automatic spending cuts. Most investors still seem to be looking past the near-term uncertainty and assume that one way or the other, the full impact of the cliff will be diminished.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.