Update 1:05 p.m.:

Given the steep fall from the rally today in both the euro and stocks, I wonder if market pundits and traders will get on CNBC to declare the rally dead as quickly as they declared the pullback dead yesterday.  I kind of doubt it.  My bet is they will declare it another great buying opportunity. 

Update 11:05 a.m.:

Let me tell you up front that I don't understand why this is so negative, but here is the reason that the euro tanked and took stocks with it.  The story is that Germany will ban "naked" short sales on stocks and bonds.  This means speculators have to have located where they can borrow stocks or bonds for delivery that they want to sell in order to buy back at a lower price in the future.  "Naked" means there is selling with no intent to borrow.  Traders can still sell short, but they must be able to prove the borrowing is secure.  This rule to ban naked short selling was put in place here back in 2008 after naked short selling was partially blamed for the Lehman demise.  So I really don't know why Germany doing what we already did is such a negative.

Regardless, the euro plunged all the way down to 1.225 before hitting the ground.  It has recovered to 1.227.  The Dow fell to a low of -67 before rebounding to -56. 

Update 10:20 a.m.:

The Dow sank to -60 as the euro suddenly plunged to 1.228.  I haven't found any news related to the sagging euro.  As mentioned in the Morning Comment expectations were for a continued recovery in the euro.  The euro hit 1.244 early but it's been downhill ever since.  The Dow has recovered somewhat and is now down only 32 points. If the euro bounces back, which might come on some central bank currency intervention, stocks will follow. 

Perhaps the surprising early rally in bonds, despite the early rally in stocks, told us that some bond buyers had sniffed out some looming trouble.  The buying has picked up as stocks have fallen.  The 2-year is now .76%, the 5-year 2.12%, and the 10-year is higher by 22/32s to yield 3.41%.  The 30-year bond is 4.28%.

Update 7:55 a.m.:

Maybe there is more to the bond rally than I mentioned below.  Bond prices are continuing to move higher, and the short-end is participating along with the longer-term.  The 2-year is .78%, the 5-year 2.15%, and the 10-year is now higher by 17/32s to yield 3.43%.  The 30-year bond is up 1&1/4 point to yield 4.28%.

After performing according to script, the euro and stocks have turned around.  The euro seemed comfortable around 1.24, and the talk was that more shorts would cover and drive it higher.  But the euro has sagged back to 1.236.  The Dow peaked at +95 and is now +15. It's very early in the day.  More changes are likely.  Stay tuned.

Update 7:25 a.m.:

Stocks are trading as expected.  The Dow opened about 70 points higher and has traded there or above during this first hour.  The Dow is currently higher by 75 points.  Volume is light.  The euro is very stable this morning around 1.24. 

While the short-end of the bond yield curve is close to unchanged, longer-end prices are higher.  Most of this can be attributed to yield curve traders.  These traders are again betting the yield curve will flatten.  This means they sell short securities like the 2-year note and buy 10-year or 30-year bonds.  This was a popluar trade until the recent turmoil caused the yield curve to steepen.  With the recent calming of fears, those traders are putting those flattening trades back on.  The 2-year is .80%, the 5-year 2.18%, and the 10-year is higher by 10/32s to yield 3.45%.  The 30-year bond is higher by almost a full point to yield 4.31%. 

Morning Comment:

European stock indexes are much higher, the euro is back above 1.24, Dow futures are pointing toward a +65 opening, and all is right with the world again.  The market talk is that the euro is due for a big bounce after days of being pounded.  Yesterday’s reversal from 1.22 seems to be the key.  There have been huge short positions in euros, and conventional wisdom says at least some of these positions must be unwound.  This should lead to at least a few days of relief for the euro. Given a rebound in the euro, it follows that stocks should move higher.  Few people believe the euro won’t again come under pressure sometime soon, but the major move could be over. 

The European Union just made its first payment ($18 billion) for maturing Greek bonds.  Just $60 billion more this year and another $60 billion or so next year to go. Members of the EU are just praying it stops there.  One thing to note, we’re still not seeing LIBOR or swap spreads retreat to pre-crisis levels.  The three-month LIBOR is wider by 20 basis points than about six weeks ago.  Given the base rate of .25%, that’s a pretty significant jump in percentage terms.

The Producer Price Index came in about as expected.  PPI fell by .1% and the core rose by .2%.  We’ll get CPI tomorrow.  Housing Starts rose a bit more than expected as builders are re-stocking inventories depleted by the home tax credit crush.  But, it’s worth noting that building permits dropped by a very big 11.5%.  Starts rose to an annualized rate of 672k and permits dropped to a 606k annualized rate.  Keep in mind that 2.2 million was the peak rate in 2006, and something around 1.2-1.4 million is a “normal” historical rate.  Lots of room for improvement there.

One other thing the rally in the euro has done is cool off the rise in gold to some degree.  Gold closed Friday at $1,249.  The yellow metal is down another $19 this morning to $1209.  At least I think it’s lower on the euro.  Perhaps gold just got “Cramered.”  Early Monday morning Jim Cramer of CNBC and other infamy published an article explaining that everyone should own gold.  He still likes stocks, but believes that gold is an asset that absolutely everyone should own and that absolutely will go up in value over the long-term.  The pullback in gold might be more of a reaction to Cramer than the euro. 

Despite the expected rally in stocks, bond prices are unchanged to slightly higher.  The weak permits number seems to be the justification.  The 2-year is .81%, the 5-year 2.20%, and the 10-year is higher by 4/32s to yield 3.48%. If the stock market and the euro do continue to improve, I would certainly expect rates to move higher. 

I’ll be back with updates.

Dwight Johnston