The angst that characterized the first several weeks of the year continues to dissipate.  Major equity markets are extending their two-week recovery into a third week. Immediate concerns about the US falling into a recession have eased. 

The market have withstood some downward pressure on the Chinese yuan.  Late yesterday Moody’s cut its outlook for China’s credit rating to negative from stable, and this did not cause much of a ripple in the capital markets.  In fact, the Shanghai and Shenzhen Composites rallied a more than 4% today, fully participating the global advance.  The MSCI Asia-Pacific Index advanced 3.4% today to reach its best level since January 13.  

Moody’s cited rising government debt, falling foreign currency reserves, and uncertainty about the reform agenda.  The rating agency expressed concern about the weakening of China’s fiscal strength and saw a growing risk that some of the government’s contingent liabilities materialize, such as aid to local governments, policy banks and/or state-owned enterprises.  At the same time, Moody’s affirmed It Aa2 sovereign rating. 

The US dollar is little changed against most of the majors.  There are two exceptions today.  The first is the Japanese yen.  The sharp rise in US yields and the equity market advance are weighing on the yen.  The dollar has risen to almost JPY114.50, its highest level since February 17. Above there, the dollar races resistance in the JPY115.00 area.  

We note that interest rate differentials are moving in the US dollar’s favor.  The US premium over Japan on two-year money is near 106 bp today, the best level for the year.  The 10-year premium is a little bel0w 180 bp today, up from 163 at the low point on February 11 when the dollar briefly dipped below JPY111 to record the low since October 14.  

Although the euro is little changed against the dollar today, its recent drop back to a $1.08 handle has also coincided with a widening of the US premium over Germany.  The premium today is pushing through 140 bp.  This is up from 117 bp on February 11 when the euro peaked near $1.1375.  It reached its cyclical high at the end of last year near 142 bp.