Turn Around Tuesday or Just a Pullback?

The major foreign currencies are broadly weaker, retracing part of the Friday-Monday rally.  The ostensible trigger were reports of military action in Beijing.  There was talk of a reaction to the dismissal of Bo Xilai last week.   Such speculation is likely to prove wide of the mark, but was sufficient to get the ball rolling. 

Late foreign currency longs, like my tactical call in the Australian dollar yesterday--were in weak hands and hence the unwind.   In  fact, the Australian and New Zealand dollars hare bearing the brunt of the correction among the majors.  Even though the dollar is gaining against the yen and is back knocking on the JPY84 area, unwinding of some carry trade positions, while Tokyo markets were on holiday. 

Provided the euro holds $1.3150-60 support area, another run to the upside either later today or tomorrow looks likely.  Some what firmer than expected UK inflation is seeing sterling marginally outperform.  Headline CPI rose 0.6% in February, compared with consensus forecasts for a 0.4% increase.  Base effects still help press the year-over-year rate down to 3.4%, which is the lowest since Nov 2011.  Sterling briefly dipped below $1.5840 but recovered after the data.  Tomorrow the UK presents its budget, which is the focus. 

The minutes from the Reserve Bank of Australia's recent meeting did not break new ground.  While I had identified the $1.0640 area as important resistance, I had expected this to be overcome.  It did not and once it became clear that it was holding, momentum traders cut and ran. 

Moody's warned that even though it has a more relaxed fiscal target, Spain's outlook is still challenging.  Peripheral spreads, including Spain, are a bit wider today.  Separately, Spain reported bad loans reached a 17 year high in January with 7.91% of all loans overdue, up from 7.61% in December.  Overall credit shrank 3.2% year-over-year in January.   This likely reflects both supply (reluctant lenders) and demand (reluctant borrowers, recession). 

Italy's Monti has won well-deserved praise since placing Berlusconi, but his most challenging test begins in earnest today as he meets with union leaders to work out a deal on labor reforms.  From a high level the problem is this:  because the legal framework (crystallized in "Article 18" from the 1970s) older workers have proprietary rights in their jobs.  This takes the air of rent-seeking behavior. 

Younger people either don't work or are regulated to more tenuous short-term contracts, for which banks are reluctant to lend.  Although Italy's unemployment rate is below the euro zone average, its employment rate is about 57%, among the lowest in the area.  In addition, due to the unfavorable demographics, Italian unions represent retirees more than workers. 

The thrust of Monti's reform is to make it relatively easier, though still far short of the employment-at-will seen in the US for example, to hire and fire and to link more benefits with shorter term contracts.  In some important ways, the social cost of the current system is born by the family, through which the inter-generational transfer is made.  

Labor reform has been in Italy what Social Security reform has been in the US--so controversial and antagonistic of various and conflicting vested interests that politicians typically avoid.  Already the metal workers union is protesting even the discussion with 2-hour intermittent slowdown today.    Labor reforms are so integral to Italy's structural reforms that the failure here would jeopardize Monti's legacy and could very well signal the end of Italy's "financial" outpeformance.