The US dollar and yen are continuing the rally that began earlier this week. The latest leg is more a function of poor developments in the euro zone rather than good news in the US. The US will report weekly initial jobless claims which are sitting at the lowest levels since the recovery began, but it is the continued sell-off in euro zone bonds (sans Germany) and European stocks (new 3-month low for the Dow Jones Stoxx 600, led by a further decline in financials) that is taking a toll today.
Rarely does the turn of the calendar mark a turn in the markets, but there has been a notable shift here as Q2 begins. The contrast between the US and the euro zone was driven home by the less dovish thrust of the FOMC and the continued expansion indicated by the ISM reports.
Whereas the US economy may have expanded around 2% at an annualized rate in Q1, the euro zone economy likely contracted. German Feb industrial orders (0.3% instead of the consensus 1.5% yesterday) and output (-1.3% instrad of -0.5% today)warns that it too is struggling, with the latter now down on a year-over-year basis.
The unresolved nature of the European debt crisis was also rose in significance as Spanish bond yields have now returned to levels seen around the time of the first LTRO, despite what has been advertised as the most austere budget since Franco. Italy’s 10-year benchmark yield is back to 5.50%, which completely unwinds the March rally. That this back up in yields comes within days of the European finance ministers’ agreement to increase the firewall must be particularly disappointing to officials.
Moreover, the heightened tension is also evident at the very heart of the core with the French premium over Germany widening to 125 bp, which has not been seen since late January. The shifting perceptions about the odds of QE3 in the US and relatively constructive data at the same time that Europe reports disappointing data and, not unrelated, a flare of up in tensions in the euro zone have seen the US-German 2-year spread move to a new wide since mid-2010 and the 10-year differential move to its widest level since early 2011.
The UK economy was more resilient than expected in Q1 and this week it reported stronger than expected manufacturing, service and construction PMIs. However, even though today's headline industrial output figures (0.4% instead of the consensus 0.3%), the manufacturing component was dismal. It fell 1.0% while the market expected around a 0.1% gain. This will raise the question of of whether the sentiment surveys overstated the resilience of the economy.
The increased tensions in the euro zone have encouraged players to test the resolve of the Swiss National Bank to defend the CHF1.20 level. It may have been the higher than expected Swiss inflation data that provided the spark. Swiss CPI rose 0.6% in March compared with a 0.4% consensus forecast and a 0.3% gain in February.
While it is true that in the past price pressures did end SNB efforts to prevent franc strength, that is most certainly not the case now. The central bank and private sector KOF expect deflation to persist this year with 2012 inflation expected to be -04%-0.6%.
There is some debate whether the market actually traded the below CHF1.20, though the central bank has made its intentions known. Thus far, it appears that the SNB’s attempt to prevent the franc’s appreciation has been fairly successful and relatively cheap. Ironically, the SNB’s intervention, to buy euros and sell francs may actually add to the pressure on the euro as it recycles the intervention proceeds. Market talk suggests large leveraged accounts joined the SNB on the cross.