Euro Softness Continues

from the BBH Currency Strategy Team

Dollar is mixed so far today, largely weaker against the majors and firmer against EM currencies. Euro is trading softer due to ongoing concerns regarding the crisis, with EUR/CHF making new lows near 1.27 and EUR/USD nearing support at the 200-day average today around 1.31.

Euro was hurt by report that the ECB has “serious concerns” about Ireland’s new banking law. ECB was specifically concerned about potential haircuts to bondholders, since it is fast becoming one of the major creditors due to its purchases of peripheral bonds. Last week’s purchases will be known later today when the ECB announces its liquidity operations that are meant to absorb the excess liquidity from those bond purchases.

Markets will be watching the ECB’s regular liquidity operations this week for signs of strain, as its last 12-month fixed rate operation is set to expire.

Bloomberg story speculates on potential French downgrade, but is not based on any rating agency statements. We have been highlighting downgrade risk for France since early 2010, as our model show’s it slipping into AA territory.

Peripheral bond yields are mostly higher, with 10-year Ireland up 13 bp, Portugal up 5 bp, Spain and Italy both up 1 bp, while Greece down 20 bp. With German 10-year yields lower by 2 bp, the peripheral spreads continue to widen.

Asian equity markets were largely down, but European equity markets have started the day higher. US futures are pointing to a modest up open.

Korean won was very volatile on news of South Korean military drills, as early losses were later erased after North Korea did not retaliate. While we like KRW fundamentals, we expect the won to underperform near-term on general EM softness as well as heightened tensions on the Korean peninsula.

BOJ began its policy meeting, no change expected tomorrow.

The Confederation of British Industry expects the Bank of England to start hiking interest rates within six months to curb inflation,

Hungary central bank meets today and is expected to remain on hold after last month’s surprise 25 bp hike to 5.5%.

Turkish lira continues to underperform after last week’s rate cut raised concerns about monetary policy.