More Euro Weakness That Dollar Strength

The US dollar is edging higher against most of the major currencies in a session devoid of much news. The Canadian dollar and the Japanese yen are the exceptions. The euro is the weakest of the majors; off about 0.3% near $1.0650. After a strong advance yesterday, sterling just missed recording an outside up day and is consolidating yesterday’s gains in a narrow range.  

European politics is widely cited as an important driver. The most obvious metric is the premium being paid over Germany. Yet the premiums narrowed a little yesterday and are narrowing a little today. Moreover, on the one hand, some observers argue investors are not taking the political risk seriously enough, and on the other hand, other accounts emphasize how much the spreads have widened already. How can the Stiglitz scenario be discounted?  He suggests the monetary union could blow up this year.  

The US 10-year yield is holding below the 2.40% that was breached yesterday. Recall the yield peaked the day after the December 14 FOMC decision to hike rates near 2.64%. It fell to 2.30% on January 17 and recovered over the next week to 2.54%. It has been drifting lower. The March 10-year note futures peak on January 17 at 125-13. Yesterday, it reached 125-10. The 125-16 area is the 38.2% retracement of the sell-off since the US election. The BOJ targets the 10-year yield and has had to become more active in defending it as rising global rates exert some upward pressure on Japanese rates.  

Although the dollar-yen rate is sensitive to US rates and the differential with Japan, the greenback has been resilient in the face of the latest decline in the Treasury yield. The dollar remains within the roughly JPY111.65-JPY112.80 range established on Monday. Still, until the dollar resurfaces above JPY112.80, the technical tone is vulnerable.  

The correlation between the dollar-yen rate and the Topix (percent change, 60-day rolling) is about 0.37, which is the highest since last September. The correlation between dollar-yen and the S&P 500 is has slipped to 0.18. It was above 0.5 for most of the first nine months of 2016.