Waiting for LTRO

The consolidative tone that was seen yesterday in the foreign exchange market has largely carried over into today's session as the market awaits tomorrow's 3-year funding operation by the ECB. The major currencies are largely confined to yesterday's trading ranges.  

The market took that S&P downgrade of Greece to "selective default" in stride as it was expected once the PSI got underway.  In addition the negative outlook for the EFSF follows S&P's decision to put France and Austria, triple-A countries, on negative watch.  

There have been several developments today that while not having much impact on prices are still noteworthy. The first developments are on procedural issues. The German Constitutional Court has ruled that the budget committee set up to expedite parliamentary approval is limited in scope to decide only secondary market bond purchases by the EFSF. The committee is not a sufficient mechanism for other EMU aid issues.  

The decision can only be seen as the third blow to Merkel in the past several days. She was forced by her own coalition partner the FDP to select Gauck as president.  Merkel failed to carry the majority of her coalition in yesterday's vote on Greek 2.0. And now this constitutional setback that can only slow the process further.  

Another procedural development has been the ECB's decision not to accept Greek government bonds as collateral for the LTRO tomorrow. This is a function of the bond swap and that the national central bank assist banks in the transition period. This adds a new wrinkle into estimate the take down of the LTRO. There is another procedural development that may have substantive impact.  The determination committee of ISDA is to meet around GMT.  It may poses headline risk.  

There have been several substantive developments as well.  First, it appears that German inflation is stickier than expected as the preliminary state reports suggest a 2.3% pace rather than 2.1%., which is what was expected and also was the January print.  

Second, Italy's run of well received bond auctions continues. Today it raised about 6.25 bln euro in 5 and 10-year paper, the latter being a new benchmark. Yields fell compared with the past auctions and the bid-cover were largely steady. The auctions for these tenors resulted in the lowest yields since May and August 2011 respectively.  There was follow through in the secondary market.  

Third, in contrast, Spanish bonds are under pressure following the Spanish finance minister admission that the deficit blow out last year was more than initially claimed. Last year's deficit was 8.5% of GDP, up from initial estimates of 8.2% and the 6% target. Note that this month, the Italian 10-year yield has fallen a little more than 50 bp, while the Spanish 10-year yield is up about 10 bp.

Fourth, French Socialist presidential candidate Hollande has been pressing his case harder, calling for a 75% income tax on top earners and insisting on renegotiating the fiscal compact. Sarkozy has been unable to capitalize as appears to backtrack from promise to put the issue before a public referendum.  

The Japanese equity market has shrugged off one of the largest bankruptcies in modern times, with Elipida's default yesterday, as others seem to be positioned to pick up market share. The Nikkei gained almost 1%, led by telecoms. In fact, the only sectors that lost today were basic materials and oil/gas. Separately, Japan reported a much stronger than expected January retail sales report. The 4.1% gain on the month contrasts with the consensus 1% rise.  Car sales were up 24% on a year-over-year basis. The rise seemed to be fueled by new government subsidies for car purchases (up to JPY100,000).   

The dollar tested support near JPY80 and it held. Similarly, the euro tested its 200-day moving average against the yen just above JPY107.  A convincing break of either of these levels will likely fuel stops.