Talking Points

• US Dollar Corrects Lower in Asia as Markets Digest Yesterday’s Sharp Rally
• 10-Year Bund Auction Outcome Not as Ominous as Traders’ Reaction Suggests
• German IFO Unlikely to Prove Market-Moving Unless Data Surprises Higher
• ECB Role in EU Debt Fiasco Still in Focus as Sarkozy, Merkel and Monti Meet

TheUS Dollar (Ticker:USDollar) corrected a hair lower against its top counterparts in overnight trade, down as much as 0.4 percent. The move likely reflected profit-taking after the greenback recorded its strongest rally in 10 days over the preceding 24 hours, as well as a re-evaluation of yesterday’sundersubscribed German bond auction. While the markets’ knee-jerk reaction was to panic – fearing investors had lost confidence in what had been the sole pocket of sovereign stability in the Eurozone – the reality of what happened turned out to be more nuanced.

In fact, it is not unusual for a German bond auction to be undersubscribed, and yesterday’s offering marked the fifth such instance this year. A key difference in the way Germany conducts its bond auctions is that its Debt Agency (called “Finanzagentur”) typically retains as much as 20 percent of a new issuance to sell later into the secondary markets. In this case,Finanzagentur retained an uncharacteristically high 39 percent, which may reflect worries about thin liquidity and broad-based stress in the Eurozone fixed income space. While this is hardly encouraging, it is also not nearly as dramatic as a loss of confidence in German debt, which was the initial interpretation of the auction’s outcome and the reason du jour for risk aversion. As such, it is not surprising for investors to see yesterday’s selloff as overdone and backpedala bit.

Looking ahead, November’sGerman IFO Survey of business confidence headlines the economic calendar, with expectations calling for the overall Business Climate gauge print at the lowest in 20 months while the forward-looking Expectations component touches the weakest level since July 2009. Souring business sentiment bodes ill for the economic growth outlook, both in Germany and the wider Eurozone. As wediscussed yesterday, sluggish performance complicates deficit reduction, producing a vicious cycle of ever-rising borrowing costs coupled with ever-slowing output expansion. Needless to say, such an outcome bodes ill for theEuro, although the report’s ability to drive near term price action may be limited in that the implications of a dour outcome are well-known and at least to some extent priced into exchange rates already. Conversely, an upside surprise may prove market-moving, encouraging the profit-taking dynamic seemingly already underway in Asia.

Elsewhere, a meeting betweenFrench President Nicolas Sarkozy,German Chancellor Angela Merkel and newly-mintedItalian Prime Minister Mario Monti will be watched for any significant policy clues. The three leaders will hold a press conference after their sit-down and traders will keep a close eye on the evolution of the debate about the ECB’s role in managing the debt crisis, particularly as it relates to Italy since Europe’s third-largest economy is almost certainly too big to be bailed out with the current EFSF rescue fund but also undoubtedly too big to fail without unleashing utter mayhem across global financial markets.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

---Written byIlya Spivak, Currency Strategist forDailyfx.com

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