President's Day Comment

Foreign Exchange: The US dollar is posting modest gains against most of the major currencies as geopolitical concerns blunt the impact of stronger than expected euro zone flash PMI and German IFO reports. The euro extended last week's gains to almost $1.3730 in this pre-Asia activity, retreated and then had another try at it in early Europe, but could not get above $1.3710. Support is seen near $1.3650.

Sterling, for its part was unable to extended last week's 2.5 cent rally, but profit-taking pressure has been kept in check by speculation that the BOE's Bean may have joined the hawkish dissents at the recent MPC meeting. The minutes from the meeting are slated for release on Wednesday. Initial support is seen in the $1.6180-$1.6200 band. The dollar has traded in about a 20 pip range against the yen, finding support near JPY83.00. Safe haven flows have not benefitted it or the Swiss franc very much at this point, though the market is monitoring developments in Libya, Bahrain and Yemen and gold has made a new high for the year and oil looks 3% higher.

Equities: Geopolitical concerns appear to be encouraging modest profit-taking in global equity markets. Asian equities traded heavily, with the MSCI Asia-Pacific Index posting its first decline in four sessions. The 0.1% loss slightly trims last week's 3% advance. That said, some of the region's largest markets, like Japan, China India all gained. Generally speaking, commodity producers were the weakest, with copper prices seeing some profit-taking as well. Bourses in Europe are under more pressure, with losses largely between 0.66% and 1%, with the Dow Jones Stoxx 600 off 0.60% near midday in London. Financials are the hardest hit in Europe, followed by technology. Heathcare, on the other hand, appears to be the best performing sector.

Fixed Income: European debt markets are firm as the pullback in equities and geopolitical concern underpins prices. Most peripheral bond market are holding their own, though unable to keep pace with the 5-6 bp decline in the core. Portuguese bonds are little changed, but the focus this week is on Ireland, where national elections will be held on Friday. The Irish 10-year yield is off 4 bp, but the 2-year yield is up 7 bp. The 2-year US-German spread that the euro-dollar exchange rate tends to track closely had been moving in the US favor, but reversed sharply at the end of last week on hawkish comments from an ECB board member and is consolidating today.

Political risk was the main reason behind S&P decision to cut Bahrain's rating to A-/A-2 and leave placing it on negative credit watch. Elsewhere, note that Hungary and Israel make rate announcements today. The former is expected to leave rates steady at 6% while the latter is expected to hike by 25 bp to 2.5%.

Important Developments
1. Strong sentiment readings in the euro zone. The flash PMI for manufacturing for Feb rose to 59.0 form 57.3 in Jan and represented a new cyclical high. The flash service sector reading rose to 57.2 from 55.9. The composite rose to 58.4 from 57.0 and is the highest in nearly 5 years. Although the Germany service sector PMI softened a bit, the news was overshadowed by the new record high in the IFO survey (111.2 from 110.3 in January.

2. Germany's Merkel was dealt another setback with a sharp defeat in the Hamburg election that say the CDU vote halved. She will lose another three seats in the upper house of parliament. The size of the loss sends an ominous sign about the other six state elections this year, beginning next month. Meanwhile the Bundesbank has more formally rejected ideas that the EFSF, or its successor, the ESM, be granted powers to buy bonds.

3. After much debate the G20 agreed upon a list of indicators that should be monitored to identify global imbalances. There are no surprises with the list, which we largely in media last week. The "optics" of imbalance are obvious. This has never really been in much doubt. The controversy is over the meaning and solution. Academic work suggest that demographics and terms of trade (the price of raw materials relative to manufactured goods) play an important role, in addition to macro-economic policy and such important factors were conspicuous in their absence from the debate.

4. The US House of Representatives approved a $61 bln cut in discretionary spending over the weekend. The Senate is not in session this week. The next key date is March 3-4 when the current temporary resolution expires. Brinkmanship political tactics risk injecting extra volatility into the financial markets.

5. IMM positioning showed that the next speculative yen position reversed sharply (from +36.7k to -18.5k contracts) for the first net short position since last June. The report covers the week through Feb 15. The net speculative sterling position more than doubled (to 52.5k contracts). This is the largest net long sterling position since late 2007. Net long Canadian dollar positions nearly doubly (to 72k contracts). This is the largest net long Canadian dollar position since last March. Euro, Swiss franc, and Australian dollar speculative positions were little changed over the reporting period
President's Day Comment President's Day Comment Reviewed by Marc Chandler on February 21, 2011 Rating: 5
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