The US dollar consolidated around Friday’s closing level with the Euro and Yen slightly stronger. The Australian dollar struggled to sustain the A$0.990 handle after a benign PPI release reinforced expectations that the Reserve Bank of Australia will continue to keep rates steady.
Global bonds were mixed with Asian bonds moving lower in price. In Europe, the increase in peripheral yields were led by Ireland, with the 10-year moving higher after Ireland’s Green Party withdrew from the government coalition on Sunday. The markets continue to focused on European inflation, a weak CPI print this week could lead to euro losses. Bonds in the US sold off as investors moved into riskier assets such as equities.
EMU composite PMI increased to 56.3 from 55.5 in December did not hurt or help the Euro. Most of the euro’s increase over the past two weeks has been driven by the increase of the 2-year yield spread between the US and German. Currently the spread is 60 basis points in Germany’s favor moving upward from 35 basis points 3 weeks ago. The currency pair has been highly correlated to movements in the spread during the past 12 months.
German January CPI figures are due Thursday and a downside surprise at this juncture would likely have more impact that a small increase. Expectations that German inflation is moving higher in conjunction with German growth is fueling speculation that the ECB is closer to raising interest rates and increasing liquidity to provide an opportunity for peripheral countries to fund their budgets.
The European Financial Stability Fund (EFSF) is planning its first issue this week. Talk was of a 3-5 billion euros of a 5-year issue. The large move in the Euro and the declining spread in interest rates between Germany and the peripheral was likely created by repositioning from portfolio managers with the outlook that the EFSF fund would succeed.
The Euro has pressed higher and is gaining momentum as a short squeeze in short positions is likely going to allow the currency pair to test the 1.3786 resistance level. A close above 1.38 will target 1.42 as the next resistance level.