EUR Requires Conviction

This EUR market is having a difficult time deciding what it wants to do in the short term as it gyrates around familiar prices levels. The initial reaction to the two notch Spanish downgrade by S&P was itself rather muted. The cut certainly was not a surprise, however, the timing was a bit unexpected and not a helping hand for the Italians who are paying a hefty premium to shift their own debt. While the Spanish out look is “negative” the country does remain three notches above “junk” status. Thus far, the single currency has avoided recording any dramatic losses and should probably be thanking the German bunds safe-haven status from preventing bigger losses.

The markets main focus this morning has been on Italian 10-year borrowing costs and investors appetite for periphery product. Last evening's Spanish downgrade was horrible timing for today's sale. Pre-sale, Italian benchmark yields climbed to +5.84%, 60bp above a comparable bond sale in March. Persistent high yields will only add to markets' concerns about the debt of weaker EZ countries. Despite this, the Italians did sell +5.95b euros bonds, near the top of a planned issue range of between +3.75b and +6.25b euros. It seems the immediate market reaction is one of relief, the EUR has managed to tick higher, Euro and periphery spreads are falling and even the dollar and cross yen currency pairs are rallying, confirming that some of the earlier Yen strength was on a safety bid.

By the law of percentages this market pessimism is unlikely to last. Market twitching between risk-on and off is not good for the heart or mind. Upbeat data could confirm a soft landing in China soon, US growth should remain comfortably above trend for this year, even technical positions are beginning to be supportive of riskier bets and risky assets such as the emerging markets, who are beginning to look cheap especially if an easing ECB policy prevails. The market has yet to decide the lead funding currency. Maybe the JPY? The BoJ seems willing to step up QE unlike the Fed.

JPY did happen to sell off after the expected BoJ announcement earlier this morning, however so far, its move remains rather muted. It was not a surprise to see the BoJ expand its asset purchase program (APP) by +JPY5t to +JPY70t and doing this by:

• Increasing JGB buying by +JPY10t
• Increasing equity index ETF's by +JPY200b
• Increasing J-REIT by +JPY10b and
• Decreasing fund supply operations by -JPY5t to +JPY30t.

The buying decision was unanimous and the increase in JGB's came in at the top of dealers expectations. The maturity on the JGBs and corporate bonds was extended from one to three years, up from one to two. Obviously, one of the BoJ's objectives is to weaken then Yen, however, policy makers accompanying statement this morning suggests that the BoJ believes that the changes would be enough to help achieve its medium-term +1% inflation target. This is not a strong conviction for a weaker yen, it implies a limited negative effect on the currency without further easing rhetoric.

The market now eyes US data for direction and support for investors conviction. The EUR continues to gravitate towards 1.32 expiry levels and seems capped temporarily by more strikes topside at 1.325. Despite the EUR crosses off their lows selling strength remains investors preferred choice. It's shaping up to be another range bound session into the weekly close.

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