The global capital markets continue to stabilize after the UK downgrade and Italian election results disrupted the start of the week. Investors appear to be finding consolation in assurances from the major central banks that the extraordinarily accommodative monetary policies will continue to for some time.
These new assurances, if you will, began last week with news that an increasing number of MPC members, including Governor King, wanted to resume gilt purchases. As we had anticipated, Bernanke corrected the less than dovish read to the recent FOMC minutes. Yes, a few regional presidents are opposed and would like an earlier exit. However, the leadership - BYD--Bernanke, Yellen and Dudley - remains committed to the efforts and continue to argue that benefits exceed the risks.
Draghi also provided assurances yesterday that there will be no early exit for its accommodative stance--providing as much funding as the banks want to borrow and have collateral for. In Japan, the Abe government just formally nominated the BOJ's new leadership team, which is committed to pursuing a more aggressive monetary policy.
Italy, the current bellwether, is also seeing more stable markets, even though there appears to be little progress resolving the political juggernaut. The Italian 10-year bond yield reached almost 5% yesterday and is now just below 4.8%. The 2-year yield rose to near 2.25% and is now below 2%. This is helping other peripheral bond markets today.
Of note, the Dutch debt market has shown little reaction to ideas on how the new deficit forecasts that show that without new measures, it will overshoot the 3% target this year and next, and may leave it vulnerable to a credit downgrade. The main reason for the overshoot, as elsewhere, the denominator (GDP) is falling faster than spending. The Dutch economy is expected to contract by 0.5% this year.
The Netherlands joins France as core European countries that are being caught on the sticky flypaper that has snagged the periphery. Earlier this week France reported new increases in its unemployment and as a consequence it should not be surprising that it reported a 0.8% decline in household consumption in January (the consensus was for a 0.2% decline). Tomorrow's PMI will confirm that the French economy is continuing to contract.
Early Asia built on yesterday's euro recovery but ran out of steam near $1.3160, just in front of the 50% retracement of the sell-off from the early Monday high above $1.33. On the pullback the euro briefly dipped below $1.3100, perhaps weighed down by sales against the yen, but there is a risk of a new run higher in North America today, with intra-day momentum indicators favoring turning higher now from over-extended territory. That said, with the US premium over Germany (on two-year notes) continuing to move back in the dollar's favor, we remain inclined to sell into euro bounces.
The Australian dollar has built on yesterday's recovery. The market seemed to focus more on the forward looking components to the capex report rather than the larger than expected 1.2% decline (the consensus was for a 1% increase). Capex intentions for 2013/2014 were stronger than expected. The risk of a rate cut next week has continued to be trimmed and now appears near a 20% chance vs 33%. Separately, the RBA estimated that the Aussie is 4-15% over-valued. The OECD estimate of PPP puts the Aussie at almost 36% over-valued, second only to the Norwegian krone (38.3% overvalued). The RBA also indicated that at least 34 central banks have bought Australian dollars for reserve purposes.
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