Dollar Firmer, Euro Worries

The US dollar was flat in Asia, but has rallied in Europe. The inability of the euro to establish a foothold above $1.23 was a sign of encouragement to the bears. Rumors of an Austrian downgrade and Merkel's comment expressing doubts about the European project have seen the euro drop more than half a cent in late morning turn-over in London. The slide in of the major foreign currencies appears to have exhausted itself and as North American dealers return, look for the dollar's gains to be initially pared.

The debt market does not seem to reflect much concern about Austria, despite the rumors or euro price action. Austria's 10-year yield is up 1 bp at pixel time, at 1.86%. The 2-year yield is up 4 bp but at a 3 bp annual yield, hardly evidence of anxiety. The five-year credit default swap is about 4 bp lower at 135.7 (below France, for example, quoted near 162).

With tensions running high, capital preservation remains key and that explains why German was able to against sell 2-year at negative yields (-6 bp), the first time a conventional auction has produced a negative yield. Note too that the bid-to-cover of 2 was higher than the last auction in late June). Peripheral yields are mostly higher.

Despite first close to US stock indices yesterday, Asia was lower, with the MSCI Asia-Pacific index off nearly 0.5%. Expectations for additional stimulus may have helped steady the Chinese stocks, but other growth sensitive markets, like Taiwan and South Korea lost over 1%. European bourses are mixed, but the Dow Jones Stoxx 600 is up about 0.25%, with utilities and industrials under-performing,. Spanish and Italian markets are lower and financials are an important drag.

There have been a few economic reports to be aware of:

1. UK employment report largely in line with expectations. The claimant count rose in June for the second month. The national measure of unemployment was unchanged at 4.9%, while the ILO measure eased to 8.1% from 8.2%.

2. The minutes from the recent BOE meeting showed 2 members dissented from the decision to resume gilt purchases. This was a bit a of a surprise, but given the subsequent news, which includes yesterday's report of a sharper decline in consumer prices weakens the hands of the hawks (dissenters). The MPC minutes recognize that the combination of QE and the funding-for-lending scheme (FLS) may take several months to show much impact. The door for a rate cut is kept ajar.

3. The New Zealand dollar is under-performing within the dollar bloc following news that Fonterra's auction for milk powder fell 5.8% after a 4.1% decline earlier this month. This will lead to a fall in farm income. Yet over time, given the drought in the US and higher feed costs, over the medium terms the US dairy output may be cut and this may help support prices.

4. China's home prices rose the most in 11 months. Of the 75 cities the government tracks, prices increased in 25 cities. There have been official hints at additional stimulus.

There are a couple features for today's North American session:

A. Bank of Canada's Monetary Policy Report. It should largely echo yesterday's statement following unchanged rates. Although the BoC maintained its rhetoric about eventually removing its considerable liquidity, the cut to this year's GDP forecasts and pushing out to H2 2013 when it reaches full capacity suggests we should not expect tightening this year. Its concerns about the global head winds will not abate any time soon.

B. June US housing starts are expected to have recovered fully from May's 4.8% decline. Permits, which were up large (7.9%) in May likely pulled back in June, bring permits and starts more into alignment. The data continues to support ideas that the housing market is stabilizing albeit at low levels. That said, housing starts are likely to be near their best level since late '08.

C. Bernanke goes to the House today for his semi-annual talk. While the Chairman has reiterated that the Fed stands ready to provide more support for the economy, he did not tip his hand toward a new round of QE. When outlining potential policy tools, in addition to QE and further guidance, he did put the interest on reserves back on the table and continues to indicate that the Fed is looking at other tools. He specifically mentioned using the discount window. The BOE's funding for lending scheme cannot be precisely duplicated, if for no other reason than Operation Twist means that the Fed is selling the short-term instruments that the BOE is providing in its collateral swap.