German State CPI Figures Support ECB Rhetoric; Euro-Zone Current Account Slides

In the newspapers overnight, the New York Times wrote that talks between US Airways (LCC) and United Airlines appear to have collapsed. Following the publication a source said that the talks between the two airlines have not ended, but no deal is expected in time for review by the Bush administration. The source added that United is continuing alliance talks with Continental. The Wall Street Journal looked at problems that InBev [INB.BE] could have in its bid for Anheuser-Busch (BUD). According to the article obstacles for InBev include cultural differences, potential unrest from BUD's employees and distributors and protests from US politicians. Some analysts believe that BUD will resist any takeover approach from InBev and this could raise the price of any offer for BUD to as much as $70/share. Il Sole 24 Ore wrote that Telecom Italia (TI) will not merge with Telefonica (TEF) citing a company official.

In energy news overnight, Mexico’s Pemex said that protestors have blocked the water supply to one of its refineries. The company is now using water from a different source. According to wire reports several units have been shut down at Flint Hill's (private) Corpus Christi Texas Refinery (288K bpd). The units were shut after steam production was lost at the plant. The affected units include the gasoline producing fluidic catalytic cracking unit and the sulfur recovery unit. Sinopec (SNP) plans to suspend fuel exports in order to meet domestic demand, noting that it is facing "big pressure on oil supply and earnings. The company says that it is its priority to satisfy the demand for earthquake-related areas, the Olympics and summer oil demand. In an interview with the Guardian, UK PM Brown said that the top of the economic agenda for the G8 summit should be a global strategy for addressing the impact of higher oil prices. IEA Deputy Executive Ramsey said overnight that Russia is no longer the non-OPEC growth engine as government control of oil assets chills investors. Ramsey added that OECD demand is slowing, which may lead towards a revised demand forecast in November, adding that energy markets are stressed and undersupplied. Furthermore Ramsey said that oil markets are likely to remain tight with limited flexibility. Ramsey also said that peak oil is not imminent noting that carbon constraints are a bigger problem than peak oil.

In new supply overnight, Germany sold €5.64B in new 4.25% July 2018 bonds with an average yield of 4.26% and a bid-to-cover of 1.2x. The cover compared to 1.7x seen at the previous auction. S&P said in a report overnight that default risk remains despite market improvements. In the press release S&P said that "despite the recent market improvement, we maintain the same fundamental outlook as we did at the beginning of the year. We continue to expect deterioration in credit quality for the high-yield segment. Downgrade risks are elevated, and the pace of downgrades has accelerated in 2008. Firms will continue to face earnings pressure throughout 2009, as the economy is expected to grow at only 1.3% for both 2008 and 2009.” According to the Wall Street Journal investors in some types of mortgages are pressuring lenders to repurchase these assets. Investors who lost money by buying subprime mortgages are trying to force banks and mortgage companies to repurchase a rising number of troubled loans. The ECB announced overnight that it lent €177M on Tuesday via the marginal lending facility. Recall that the ECB lent €538M via the facility on Monday, raising speculation that perhaps another big European bank could be in trouble.

In currency news overnight, according to the Wall Street Journal, Vietnam has doubled its currency trading band, which will allow the dong to move 2% from its daily rate versus the USD. The Vietnam Central Bank later denied the report maintaining that the band is still 1%. According to an analyst at Goldman Sachs, the Korean Won and Taiwan dollar are among the most vulnerable currencies to higher oil prices. Emirates Business 24/7 wrote overnight that the UAE and the other members of the GCC will decide on whether or not to maintain the Dollar peg following the launch of their monetary union in 2010. In trading the USD remained locked in its mid-May trading range of 1.5660 to 1.5830 probing both sides throughout the session. The EUR/USD moved towards the 1.5760 area following continued hawkish ECB comments in regards to avoiding secondary effects of inflation. An ECB source reiterated that the ECB remains poised to tighten interest rates if inflation remains at elevated levels. The USD managed to muster up some positive momentum as commodities continued to move lower for the second straight session. Dealers noted that the decrease in the Euro-Zone current account data for month could be contributed by slowing growth factors, which helped to push crude prices lower in the aftermath. Dealers also citing a poor German Bund auction for additional softness in the EUR/USD pair

On the speaker front overnight the ECB's Trichet said in an interview with L’Express that US officials’ support of a strong USD is very important. Trichet said that we tell economic agents be careful to avoid second round effects, and noted that verbal discipline on the subject of forex is essential. According to a wire report released overnight an ECB source said that the ECB is ready to tighten if inflation remains elevated. The source added that Euro Zone inflation is likely to accelerate in coming months, pointing out that some ECB members see inflation back towards 2% in 2009. The source said that the ECB must avert second-round effects until HICP comes down. The comments were in line with recent ECB rhetoric, and were similar to source comments seen on April 22^nd.

The German import price index for the month of April was ahead of consensus expectations on the back of rising energy costs. While the import price index kicked off the data schedule overnight, the state CPI figures were the main focus in Germany. The first reading said it all; Saxony CPI rose to 0.6% M/M from -0.2% in April, and 3.1% Y/Y from 2.6%. While the Y/Y reading wasn’t as high as reading seen towards the end of 2007, it confirmed recent ECB rhetoric about possible short-term inflation spikes in mid-2008. The remainder of the state CPI readings followed in a similar fashion, breaking the 3.0% y/y handle, yet remaining below late 2007/early 2008 highs. In France consumer confidence posted a sharp decline with the May reading falling to -41, the lowest reading since records began in June of 1998. The indicator posted declines in just about every component and sub-component. As has been the case with many confidence/sentiment indicators as of late, analyst are citing record energy prices for the decline. Over in Sweden the April retail sales readings were much lower than expected falling to the lowest M/M level since April of 2005, and the lowest Y/Y reading since March of 1998. The poor reading was accompanied by downward revisions to March’s figures. Analysts are citing reduced spending as the result of inflationary pressures in the Swedish economy. Recall that twice over the past three months Sweden has posted Y/Y CPI readings at levels that haven’t been seen since the early 1990s. In line with the theme of out-of-wack data readings today the Euro-Zone current account declined to -€15.3B in March from an upwardly revised €7.5B in February, for its lowest reading on record.