By Win Thin

U.S. durable goods orders came in much weaker than expected for June, and continue a string of disappointing economic data seen since early June. Citibank Economic Surprise Indices, CESI, are meant to encapsulate such trends. A positive reading for each index suggests that data releases for that country have on balance been beating consensus expectations as reported by Bloomberg, while a negative reading suggests worse-than-consensus data reports.

U.S. CESI has been in negative territory since the beginning of June, when May jobs data fell short of expectations. On the flip side, euro zone CESI has been in positive territory since mid-April, but eased back toward zero in June before turning sharply higher since mid-July. Subtracting U.S. CESI from euro zone CESI shows that data surprises have swung sharply in favor of the euro in recent weeks. Indeed, that has been one of the factors behind the euro's recovery.

However, we note that this "surprise difference" appears to be mean-reverting, and rarely stays at historical extremes for very long. As such, we would expect this difference to ease in the coming weeks. This would also fit into our belief that this euro rally remains a corrective move.

Perhaps as the CESIs move away from favoring the euro, that would also coincide with some topping action for the euro in the low 1.30s. We note some euro zone developments that have negative growth implications.

ECB's quarterly Bank Lending Survey showed that European banks continued to tighten credit standards in the second quarter, as the crisis impaired bank access to funding. It added that banks anticipate those standards to "tighten somewhat" in the third quarter as well. ECB also announced new collateral haircuts for its refi operations that differentiate between maturities and quality. Bigger haircuts make it more expensive for banks to borrow from the ECB, but the overall impact may not be so big, if those banks wean themselves off ECB money and go to other avenues for funding.

The euro continues to struggle to make headway above 1.30, but we acknowledge that there may still be some residual fuel left in the euro rally, given increasing optimism on the peripheral countries. Bond spread tightening accelerated on this week, though today is a mixed bag as 10-year Ireland yields tightened 17 bp to Germany, Portugal tightened 8 bp, and Greece tightened 5 bp.

On the other hand, Italy and Spain 10-year paper is underperforming today, with spreads widening 3 bp and 10 bp, respectively. This sort of mixed performance is being seen in the EM space today as well, with markets seeming a bit unsure of how far to push risk on trading in the current environment. Yen and Swiss franc are both largely firmer and equity markets softer today, suggesting that for now, risk-off trading is prevailing.
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