Equity futures are trading higher this morning and currencies have recovered courtesy of the better than expected U.S. retail sales report. The U.S. numbers have helped to turn around risk appetite but investors are treading carefully because the rise in European bond yields suggest that Spain could be forced to request a bailout that will make Greece look like child's play. U.S. retail sales rose 0.8 percent in the month of March, more than 2 times stronger than expectations. Although there was a slight downward revision to the prior number, excluding autos and gas, spending still rose a firm 0.7 percent. Non-farm payrolls took a nosedive last month but the sharp rise in equities gave Americans the confidence to spend. The Federal Reserve will be relieved to see that consumers have not grown hesitant about spending but with income growth slowing, they will still eye the retail sales figures with caution. The reason is because there are plenty of signs that the U.S. recovery is losing momentum. All we need to do is look at the latest Empire State manufacturing report which showed a sharp pullback in manufacturing activity in the NY region. The index fell from 20.21 to 6.56, the weakest pace of growth in 5 months. If the Philly Fed and Chicago PMI reports follow suit, we could be looking at a very bad month for U.S. manufacturing activty. According to the latest Treasury International Capital flow report, foreign investors continue to be major buyers of U.S. dollars. The total demand for U.S. dollars topped 107 billion in the month of February, the strongest in nearly a year. Net long term TIC flows however rose a mere $10.1B and this tells us that demand was concentrated in the short end of the curve. Japan, China, Canada and HK were net buyers of dollars while the U.K. was a notable net seller.
Meanwhile Spain continues to be a source of trouble for the financial markets. Ten year Spanish bond yields are creeping dangerously close to 7 percent, the level that prompted Greece, Portugal and Ireland to turn their Eurozone neighbors for a bailout. Spain is a much larger economy than Greece and so a potential bailout would wreck far more havoc on the financial markets. After the abysmally weak Spanish bond auction that showed the market's lack of confidence in Spain's budget plan, rising borrowing costs could make it even more difficult for the new conservative government to acheive their goals. But we have been at these levels before in the 10 year Spanish bond yield. Back in December, the 10 year yield reached a high of 6.097% and less than 2 weeks before that, it was at 7.04%. Around that time, the EUR/USD was selling off agressively from a high of 1.42 down to a low of 1.2625. If the probabilities of Spain seeking a bailout continues to grow, the EUR/USD could not only break below 1.30 but could test its one year low at 1.2625.
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