Marc to Market

Cool Video: Time-Lapse of World Trade Center Building

noreply@blogger.com (Marc Chandler) — Sun, 19 May 2013 07:00:02 PDT

This Cool Video comes from The Guardian. See the tallest building in the western hemisphere rise in a little less then 2 minutes in the time-lapse video. The spire was completed at the start of the month.

Great Graphic: Diverging Growth--Is it the Euro's Fault?

noreply@blogger.com (Marc Chandler) — Sat, 18 May 2013 08:24:41 PDT

This Great Graphic was found on the Economist's blog Free Exchange in a post titled "What the euro has meant". Under the impression that the charts speak for themselves, with little analysis, the author concludes that most of the euro area would have been better off being the US or Great Britain, even in per capita terms. Seeing how obvious this is the author is stumped by the fact that there is not a bigger push to leave the monetary union.

While the charts are interesting, the inference is weak. First, there is an all too common logical fallacy on display here. Just because the charts begin with monetary union does not mean that the monetary union caused what came afterwards. Second, surely to make some assessment of what EMU has wrought, a review of the economic performance before EMU is required.

US growth, for example, generally outstripped European growth in the two decades before monetary union. Italy and Portugal's competitiveness problem, for example, was evident before monetary union. To lay the blame at the feet of EMU seems wrong and disingenuous, though plays into popular prejudices. Although monetary union was over-determined (Europe's own post-WWII strategy, the problems with the European Exchange Rate Mechanism--ERM-- and political factors related to the reunification of Germany when the Berlin Wall fell), one of the incentives was to boost the competitiveness of Europe to compete with what the French called the hyperpower (the US).

Any discussion of a country exiting the monetary union needs to come to some understanding of why the country joined in the first place. That the euro area is not an optimal currency zone was well known before it was launched. The US itself was clearly not an optimal currency zone for most of its history and some would argue that the continental economy is too diverse and is still not an optimal currency zone. It cannot be understood abstracted from the political and historical context.

In summary, we offer three corrective points to the Economist post. First, it is not clear that Europe's growth problems began with monetary union. Second, the problem of competitiveness would still bedevil countries if they left monetary union. Third, the reasons for monetary union cannot be simply reduced to a homo economicus calculation. This implies that the failure of EMU to resolve the economic challenges countries face is in itself insufficient to spur defection.

Currency Positioning and Technical Outlook: Dollar Bull Run

noreply@blogger.com (Marc Chandler) — Sat, 18 May 2013 04:42:13 PDT

The US dollar posted strong across the board gains. It is being driven by the anticipation of favorable developments in the US, in the form of a possible slowing of the Fed's asset purchases, and less favorable developments abroad.

While it is technically poised for additional gains, the biggest risk to the dollar comes from Fed Chairman Bernanke's midweek testimony. His commitment to QE and readiness to taper purchases, as others have suggested, will be closely scrutinized. The failure to confirm these growing market ideas, spurred in part by comments from two (non-voting) regional Fed presidents, could prompt some profit-taking on long dollar positions.

While speculation that the Fed may take one of its feet off the accelerator in the next week month helped lift the dollar, other countries are easing policy. There has been even more talk about the ECB adopting a negative deposit rate. Continued sub-50 readings in the flash PMI, due midweek, will heighten the sense that the euro zone continues to contract for the seventh consecutive quarter.

The ongoing decline in the yen is meeting little official resistance. Chinese officials, for example, seem more upset by comments by the mayor of Osaka (which the US also criticized for being "outrageous") then they about the depreciation of the yen. The US Dollar Index has risen 3.7% from the low on May 1 to its best level since 2010, and it recording its best two week run since in a year.

Euro: A large head and shoulders pattern is being carved out. The neckline is seen near the late March and early April lows around $1.2740. Below there is the low from last November near $1.2660, which is just below the $1.2680 retracement objective ($1.2680) of Draghi's OMT induced rally. The measuring objective of the head and shoulders pattern would carry the single currency below $1.20, our year-end target. The euro's 50-day moving average crossed below the 200-day (golden cross) for the first time since last October.

Yen: The pullbacks in the US dollar continue to be shallow. This is not giving the longs any pain and it gives many momentum and trend followers a sense that it is a one way bet, a mindset that often proves dangerous. Support now is seen in the JPY102.35-60 area. Although there are reports of option structures before, many have their sights set on JPY105.

Sterling: The upside correction from the mid-March low near $1.4830 has ended decisively. That correction had held a up trend line, which sterling closed below at the start of the week near $1.5350. A convincing break now of $1.5120 area suggests a return to, and likely a break of, this year's low. Sterling has also broken below a trend line connecting the lows of the past three years. This sours the longer-term outlook and warns of a move toward $1.42.

Canadian dollar: The US dollar is flirting with trend line resistance against the Canadian dollar going back to 2011. The year's high was set on March 1 near CAD1.0340. A break of it opens the door for a move toward CAD1.05-CAD1.06.

Australian dollar: The Aussie has fallen out of favor in a big way. It has been aggressively sold-off; the largest decline over a 10-day period in more than a year and a half. It has convincingly broken a trend line drawn off the 2011-2012 lows that came in just above $0.9800. An investment bank called for a move to $0.8000. This corresponds to the 2010 lows and a 61.8% retracment of the post-Lehman rally. It may be a reasonable longer-term objective, and by the OECD's purchasing power parity model, the Australian dollar is almost 30% over-valued. However, given the difficulty in forecasting exchange rates and the substantial risks that are involved, as well as mitigating factors like Australia's triple-A credit rating and a currency that is gaining recognition as a reserve asset, we suggest medium term investors should anticipate half of that move, or $0.8900-$0.9000 and place stops accordingly.

Mexican peso: Over the past year, the Mexican peso has appreciated by 11.5% against the US dollar; making it the strongest among the G7 and liquid emerging market currencies. While we recognize attractive underlying fundamentals, technical factors have made us more cautious. A dollar bottom has been carved out over the past month. The long peso position remains large and a move above MXN12.40 could spur a further dollar short squeeze. A correction could carry the greenback into a MXN12.60-MXN12.80 range.

Observations from the latest CFTC report of the CME currency futures:

1. Participation rose as new gross positions were established across the board, with two minor exceptions, short Canadian dollar and short Mexican peso positions were trimmed.

2. There were 4 substantial (more than 10k contracts) position adjustment and they were all adding to the gross short positions: euro, yen, Swiss franc, and Australian dollar.

3. The 36% rise in gross short Australian dollar positions to a record 75.1k contracts was sufficient to switch the net position to the short side for the first time since last June. Nevertheless, the gross long position remains the second largest among the currency futures, behind the Mexican peso.

4. The gross short euro position is just below 100k contracts. Last June, as the tensions were mounting that led to the Draghi's OMT offer, the gross short position was 250k contracts. The gross short sterling position is approaching the record from March of 105k contract. The price action and the increase in open interest since the CFTC period ended suggests new shorts have been established.

week ending May 14		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-46.9	-33.5	52.8	0.3	99.8	13.7
Yen	-88.4	-78.6	28.9	1.0	117.3	10.8
Sterling	-65.3	-63.1	37.0	5.4	102.3	7.7
Swiss Franc	-15.4	-6.2	9.6	2.3	25.0	11.4
C$	-44.4	-51.9	28.4	2.6	72.8	-4.9
A$	-13.4	6.6	61.7	0.2	75.1	20.2
Mexican Peso	140.0	138.0	145.3	1.3	5.0	-0.6

Great Graphic: Yen and the Nikkei

noreply@blogger.com (Marc Chandler) — Fri, 17 May 2013 16:52:01 PDT

This Great Graphic, made on Bloomberg, shows how well the dollar-yen and Nikkei have moved together in recent years. The dollar-yen rate is represented by the white line and the Nikkei by the yellow line.

Conventional wisdom would suggest that the weakening yen is good for Japanese stock prices through an increase in exports. This seems like an exaggeration.

The fact of the matter is that Japan is not nearly export-dependent as one would expect. For example, it exports about 15% of what it produces. This in line with US exports as a function of GDP and contrasts with the 40% of more that Germany, Finland, Sweden and Switzerland export.

Japanese producers increasingly service foreign demand the same way US companies do, primarily, though of course not exclusively, by building locally. It is not through exports as much as local sales through which the weaker yen boosts reported earnings. In addition, as we saw recently with Japan's current account figures, the weaker yen also translates into higher foreign investment income. It is that investment income that offsets Japan's trade deficit and allows it to run a current account surplus.

Lastly, we note too that financials and brokers also benefit from the rising stock market and during parts of the rally, that sector led exporters higher. The booming Japanese equity market, the first in five years, may encourage Japanese households to rediscover equities after shunning them, with fixed income yields miserably low at home and abroad.

Japanese institutions trying to allocate for the new fiscal year may too find that their own equities is the only game in town. Foreign investors who have already scooped up $72.6 bln worth this year alone may have beaten them to the punch.

Strong Finish to Week for US Dollar

noreply@blogger.com (Marc Chandler) — Fri, 17 May 2013 07:59:04 PDT

The US dollar is capping this week's strong performance with new gains and the Dollar Index is at new highs for the year. It was the dollar-bloc currencies that had the dubious honor of being the weakest currencies over the past week, taking the baton from the Japanese yen.

Although the US reported some soft economic data in recent days, including a backing up of weekly initial jobless claims, the second consecutive monthly decline in manufacturing output and softer than expected consumer prices, the market is going through one of its episodic periods where it flirts with the possibility that the QE, which some had disparaged for being infinite, might end earlier than previously anticipated.

The combination of comments by two Fed presidents, Plosser and Williams, and resilience of the labor market have fanned expectations that the FOMC could taper QE purchases around mid-year. This heightened expectation is crystallizing as European officials continue talk about the possibility of additional easing, including a negative deposit rate. Rumors made in the rounds in Europe today that at least one major bank was contacted by the ECB about preparations for a negative deposit rate.

We suspect the market is getting ahead of itself. Neither Plosser nor Williams are voting members of the FOMC. Williams is closer to the Fed's Troika of Bernanke, Yellen (who he replaced as the San Fran Fed President) and Dudley, but his remarks were conditioned on continued improvement.

Given what Bernanke called the "reach for yield" in a speech at the end of last week, it makes sense that the Fed officials address investor concerns that the QE is creating bubble of its own, or in Fed-speak, encouraging a level of risk-taking not justified by fundamental conditions. Indicating that QE is not infinite after all and that asset markets are being watched closely is one way deflect criticism. In this context, Bernanke's testimony on the economy in the middle of next week is more important than Plosser and Williams comments.

Moreover, the softness of inflation readings may be more important for Fed policy than the labor market in the coming months. What we mean by that is the decline in measured inflation gives the Fed more time to push for faster job creation.

Headline CPI, which in April was 1.1% above year ago levels, has a difficult comparison with a year ago. In May-July 2012, the month-over-month CPI changes were net-net flat. This suggest headline CPI may stabilize in the coming months. However, the 0.5% increase in both August and September will drop out and the risk is that headline CPI falls below 1%. Core CPI has been a bit stickier, it peaked a year ago at 2.3% and in April stood at 1.7%. Given base effects, it is likely to slip below 1.5% in the coming months.

Separately, we note that broad US money growth seems largely unaffected by the $85 bln purchases the Fed is making every month. M1, which is most impacted by QE has slowed to a 11.9% year-over-year pace in April from 13.2% pace at the end of last year. M2 has slowed from an 8.0% clip in December '12 to 7.1% in April. Bank loans rose 3.7% above a year ago. Last year they rose 4.2%.

US 2 and 10-year yields were largely flat over the past week. Japanese yields were higher and it is both the rise and volatility of the JGB market that will likely dominate the discussion when the BOJ meets early next week. Given the recent economic data, which includes the stronger than expected GDP and the 14.2% increase in March machinery orders (reported earlier today after the GDP figures shows that capital spending fell for the fifth consecutive quarter), there is some risk that the BOJ (and the Abe government) upgrade their economic assessment, even though the GDP deflator showed the most deflation in over a year. European and Australian/New Zealand interest rates were lower, with the UK, the notable exception.

With the G7 offering little resistance to yen weakness, the small rise in Japanese rates make little difference and many players are looking for JPY105 in the coming weeks. The yen is not match for the dollar currently, but it is for the euro. The euro-yen is little changed on the week The poor euro area growth, softening inflation, the increased risk of easier monetary policy (and potentially disruptive if the deposit rate is cut below zero) haven given the euro bears more fodder.

The fascination with the dollar-bloc has ended abruptly. Don't fight the central banks seemed like a key mantra for many investors and central banks were diversifying reserves into the dollar-bloc. The reach for yield favored them as well. The shortage of triple-A paper also was thought to offer protection especially for the Canadian and Australian dollars.

Perhaps the question is which central bankers one ought to pay attention to. Dollar-bloc central bankers themselves often expressed frustration with the strength of their currencies, but investors had largely ignored this in the recent past. In any event, softness of the Chinese economy, where recent import and export data is viewed with a jaded eye--not just by foreign investors, but by Chinese officials--and the decline in commodity prices, with implications for macro economic performance and investment plans ,have taken a toll. In particular, it is the pace of the Australian dollar's decline, pushed along by negative comments (which likely means short positions) from some high profile hedge funds, that is spurred the dramatic price action.

The US dollar is finishing the week firmly for two reasons. The first is positive developments for the dollar, though we are skeptical of how quick the Fed tapers off its purchases given the subdued price pressures and slow gains in non-farm payrolls. Bernanke's testimony will be important. The second is a deterioration of the macro-fundamentals in Europe and the dollar-bloc, with no major objection to continued yen weakness. Interest rate developments generally are consistent with price action.

Emerging Markets: What Has Changed?

noreply@blogger.com (Marc Chandler) — Thu, 16 May 2013 17:30:00 PDT

(From my colleague Dr. Win Thin)

This is what has changed in the EM space, in our view:

1) The Bank of Israel surprised with a 25 bp rate cut Monday, an intra-meeting move

2) EUR/CZK traded above 26 for the first time since November 2011, as Q1 GDP came in much worse than expected at -1.9% y/y vs. -1.7% y/y in Q4

3) On the other hand, EUR/HUF moved lower on better than expected Q1 GDP of -0.9% y/y vs. -2.7% y/y in Q4

4) PBOC is finally fixing USD/CNY higher after a prolonged bout of appreciation

1) The Bank of Israel surprised with a 25 bp rate cut to 1.5% Monday, an intra-meeting move. Next scheduled meeting is May 27. We've been looking for more cuts, especially as the shekel has strengthened, but found this week’s cut a bit strange in terms of timing. Israel has kept rates steady since the December 24 cut to 1.75%. It met in January, February, and March and kept rates steady. Why now? The next meeting was only two weeks away. It looks like the currency aspect drove this decision.

As it cut rates, the central bank noted that the shekel has been boosted by natural gas sales and global monetary easing, and announced a plan to buy $2.1 bln of foreign exchange this year in an effort to offset the money from gas sales. USD/ILS had already bottomed May 9 but we think the authorities are acting aggressively now to go WITH the market, instead of fighting it. The pair moved back above the 3.60 area for the first time since April 29. Resistance is seen near 3.70 and 3.75, support is seen near 3.60 and 3.56.

2) EUR/CZK traded above 26 for the first time since November 2011, as Q1 GDP came in much worse than expected at -1.9% y/y vs. -1.7% y/y in Q4. In q/q terms, GDP was -0.8% vs. -0.2% in Q4 and we note that GDP has contracted q/q for 6 straight quarters. Indeed, the Q1 reading of -0.8% is the worst of them all. Things are getting worse, not better. If market keeps selling CZK, the central bank may not have to do anything. The November 2011 high near 26.12 isn't very far away, and we favor a move towards late 2009 highs near 26.50. For now, the market is doing the heavy lifting for the central bank.

3) On the other hand, EUR/HUF is moving lower on better than expected Q1 GDP of -0.9% y/y vs. -2.7% y/y in Q4. In q/q terms, Q1 GDP grew 0.7% vs. a revised -0.4% (was -0.9%) in Q4. It is the first positive q/q reading since Q4 2011 and the strongest since Q1 2011. Still, this is hardly any reason to break out the tokaj to celebrate, and it is certainly not strong enough to preclude another 25 bp rate cut at the next meeting May 28.

We think that current levels near 290 would be a good opportunity to go long EUR/HUF. 200-day MA comes in near 290 and should offer support. Break below would target support near 285. On the upside, resistance is seen near 295, 300, and 303. Separately, we note that the recent weakness of the Swiss franc may be supportive of Hungary insofar as it is easier to service the still substantial levels of franc denominated consumer debt.

4) PBOC is finally fixing USD/CNY higher. After a long string of CNY gains, it has finally started to weaken in line with the rest of the region. For 4 out of the 5 past days, USD/CNY has been fixed higher, and the Thursday fix was the highest since May 6. Next week will give markets the first glimpse of May data from China, with the HSBC flash manufacturing PMI due out next Wednesday. April data was mixed, with surveys (PMIs) weaker than expected and hard data (trade, new loans) stronger than expected.

We think that China data probably offers modest downside risks to markets rather than upside risks at this juncture. Between the broad based dollar rally under way and downside risks to the Chinese economy, we think that the yuan is likely to trade sideways to weaker in the coming weeks. Next week, we get the first glimpse of the economy with HSBC flash PMI on Thursday.

Aussie Smack Down

noreply@blogger.com (Marc Chandler) — Sat, 18 May 2013 06:00:46 PDT

The dramatic sell-off of the Australian dollar is the latest of a series of price developments that have surprised the market. The sell-off in JGBs, which appears to have stabilized, has seen 10-year yields in Japan nearly double, despite the BOJ's commitment to buy 70% of the new supply. The sharp decline in gold prices has taken place despite what was purported to be a debasement of paper money. In addition, there has not been a tsunami of capital flooding the emerging markets. Emerging market equities have under-performed the developed markets despite the stronger growth prospects.

The Australian dollar was the market's darling. It was an accessible, even if not perfect way, to get exposure to China and its vociferous demand for commodities. It was one of the few triple-A rated countries left standing after the financial crisis. Its interest rates were relatively higher in an environment in which there was a clear thrust toward securing yield. Central banks found the Australian dollar an interesting, albeit limited, candidate to help diversify reserve flows. Almost three dozen central banks reportedly have Australian dollar exposure in their reserve holdings.

The Australian dollar has fallen out of favor in dramatic fashion. It has eclipsed the yen as the weakest major currency this month, falling nearly 5.5% against the dollar. It briefly dipped below $0.9800 for the first time in eleven months.

In the falling market, the Aussie's negatives are highlighted. Softer Chinese data, weak commodity prices, official projections of a larger budget deficit, weaker domestic growth, expected lower inflation, and anticipation of future rate cuts may have all played a role in souring sentiment. Add in some bearish comments from hedge funds, you have a run of sorts on the Australian dollar.

Despite the Australian dollar's decline in recent weeks, there was still a substantial gross long position in the CME currency futures. The last CFTC report covered the week to May 7. The gross long Australian dollar position (61.5k contracts) was the largest among the currency futures, save the Mexican peso. In fact, this Aussie position was nearly as large as the gross long yen, sterling and Swiss franc positions combined.

What we have seen is a likely capitulation trade by stale longs. Hedge funds and momentum traders appear to have exerted the squeeze. Technical factors warn that the market is getting over-stretched. In addition, the Australian dollar has come down to test an important trend line. It is drawn off the October 2011 low and the June 2012 low. It is found now near $0.9815. While taken out on an intra-day basis, the Aussie is now back above it, with the help of soft US data, including a larger than expected decline in consumer prices.

To be sure, we expect the Australian dollar to trend lower over the coming months, ahead of the September election. The weakness of the Australian dollar takes some pressure off the RBA to cut rates in June. The most likely scenario, it seems, is another rate cut before the election and a rate cut afterwards (i.e., a rate cut in Q3 and Q4). Other central banks are unlikely to be deterred by the Australian dollar's weakness from diversifying reserves. Arguably, their purchases seem to affect the pace of the move not the underlying direction

Great Graphic: Euro Area GDP

noreply@blogger.com (Marc Chandler) — Thu, 16 May 2013 01:00:09 PDT

The euro area provided its first estimate of Q1. The 0.2% decline in GDP comes after a 0.6% contraction in Q4 and confirms the euro area as the weakest among the high income regions. It is the sixth consecutive quarterly contraction, a record of dubious distinction.

This Great Graphic was posted on lemasabachthani blog. The first chart shows how the PMI does a fairly good job tracking the region's GDP. The April PMI readings indicate Q2 is off to a soft start.

The second chart shows the changes in the overall levels of GDP, index to 2005 (=100). That German GDP has surpassed its pre-cycle peak is seems well appreciated. The magnitude of Italy's under-performance may be somewhat surprising, though its weakness is understood.

With such high (recorded) unemployment, one might have expected a worse performance by Spain, though it has begun more clearly under-performing. Perhaps most remarkable is how average (EMU level) that Franc's performance has been.

Japan: Stronger than Expected GDP and Bought Foreign Bonds for Third Week

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 21:20:07 PDT

Japan reported a stronger than expected Q1 GDP expansion, confirming it was the fastest growing economy in the G7. Separately, the Ministry of Finance reported the third consecutive weekly net purchases of foreign bonds.

Japan reported that the world's third largest economy grew at an annualized rate of 3.5%, faster than the 2.7% expected and follows the recent upwardly revised (due to a technical error)1% pace in the final quarter of 2012. The quarterly pace was 0.9%, rather than the consensus forecast of 0.7% and 0.3% in Q4 12.

Consumer spending and exports were the main contributors to GDP. The former alone accounted for 2.3 percentage points of growth and the latter, 0.4 percentage points. Business investment was the weakest since the tsunami and private non-residential investment took 0.3 percentage points from growth, while inventories took another 0.8 percentage points.

While growth offered an upside surprise, the GDP deflator was a downside surprise. This measure of prices was 1.2% lower than a year ago, the most deflation since Q4 2011.

Separately, the Ministry of Finance reported that Japanese investors bought foreign bond for third consecutive week. Many observers have been waiting for institutional investors to diversify away from the JGB market, where the BOJ is set to buy 70% of the new issuance. However, the sums involved remain quite small. During this three-week buying spree, Japanese investors have bought just shy of JPY700 bln of foreign bonds. In the prior three week period, they sold JPY2.3 trillion of foreign bonds.

Moreover, our diagnosis of the yen's recycling problem (not the traditional trade surplus, but the investment income and foreign capital inflows) does not mean that Japanese investors do not buy foreign assets; simply that they do not buy enough. Consider in the past three weeks, as Japan bought the equivalent of about $7 bln of foreign bonds, foreign investors bought a little more than $19 bln of Japanese stocks and bonds.

Separately, the BOJ has pumped massive amounts of liquidity into the banking system and this is helping stabilize the JGB market after the worst sell-off in a decade. The BOJ injected JPY2 trillion of 1-year money at 0.1% (LTRO?) on top of the normal operation that provided JPY800 bln.

Japanese stocks initially rallied in Tokyo, with the Nikkei making new 5-year highs before reversing. The high flying JASDAQ was hit much harder by the wave of profit-taking, led by consumer goods and health care.

The dollar initially came off in early Tokyo trading, testing the JPY102 area. Turnover was quiet and the dollar was largely confined to a JPY102.00-40. The euro is also trading a bit heavier against the yen. Support is seen in the JPY131.00-20 range.

Cool Video: CNBC Squawk Box--Bearish Euro View

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 17:00:02 PDT

Thinking about Prices

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 09:06:09 PDT

Investors have a robust appetite for risk as financial assets remain strong, but there is a nervousness below the surface. The current trajectory cannot be sustained. The US equity market, for example, has gone nearly 180 days without a 5% correction.

With the central banks of the US and Japan buying a combined $160 bln a month in assets, the ECB providing as much liquidity as the banks want and have collateral for, and renewed reserve growth among the emerging markets, orthodoxy warns of the risk of inflation and higher commodity, especially gold prices.

This is not the case. The CRB Index is 6.5% off the January high and is 40% lower than the 2008 peak. Gold is trading more than 20% below its Q4 12 peak. The bounce after the dramatic sell-off in mid-April fizzled at Fibonacci retracement objective (~$1488). The break now of $1400 warns of a return to the panic low set near $1322. So much for buying claims on real "stuff" to protect one from the so-called financial repression of negative real interest rates.

The Fed and the ECB have recently noted the weakening of price pressures. If one excludes food prices, China's CPI is near euro area and US core levels, well below 2%. Japan, Switzerland and Sweden are experiencing outright deflation. On the European periphery, deflation is beginning to become evident in Greece and while disinflation is evident in Germany, France, Italy, Spain and that Netherlands.

The disinflationary environment is particularly hard on the periphery of Europe. In order for them to boost competitiveness, their prices have to rise slower than Germany's for an extended period. However, Germany CPI was up 1.1% from a year ago on an EU harmonized basis. Some observers have talked about the Fed's QE exporting inflation, though it is difficult to see where, surely not its biggest trading partners. More recently others have argued that Japan's QE will exporting deflation. Yet, Germany's low inflation forces deflation on the periphery, regardless of what the ECB does with the interest rates.

Japan's Prime Minister Abe has advocated higher wages as an essential part of efforts to restructure and revive the world's third largest economy. While corporate earnings and their outlook have been boosted by the weakness of the yen, businesses are still reluctant to share the spoils, though some bonus payments were raised.

It is a different story in Germany. IG Metall, the workers' union, and Gesamtmetall, the employers' union struck a wage deal earlier today. Some 770k workers covered by the agreement will get a 5.6% wage increase over the next 20-months. The union had sought a 1 year contract for a 5.5% pay increase.

IG Metall represents 3.7 mln workers and this deal will influence other wage negotiations, but there is greater regional and industry variation than before. Note that Bavarian IG Metall workers had previously won a 3.4% wage increase starting July 1 and another 2.2% increase next May 1. Bavarian labor market is tighter and unemployment lower than the national average.

Europe is only now appreciating the banker patriarch Mayer Rothschild, late 18th century insight, "allow me to issue and control a nation's currency and I care not who makes its laws". While this assessment appears right as rain, perhaps if Rothschild were alive today, he might amend this to say, "but let me divide the social product between labor and capital and I can protect myself from the vagaries of exchange rates".

Some US officials recognized that boosting Chinese wages, broadly understood, was the real key adjusting the competitive imbalance not the exchange rate. Higher German wages (unit labor costs) would do more good for France, Italy, Spain and for the cohesion of Europe than a 25 bp refi rate cut by the ECB.

The significance of the dramatic sell-off in Japanese government bond despite the fact that the BOJ is buying 70% of the new issuance is not fully appreciated. Media reports largely emphasize domestic funds reallocating away from the JGB market and into equities and foreign bonds. Some accounts suggest the backing up of US rates has helped drag Japanese yields higher.

There are two components to yield. There is the real rate and the risk premium. This risk premium in the high income economies is understood to be largely inflation risk. These are more difficult to measure, especially given the large bid by the central bank for JGBs, but it appears that the rise in the 10-year yield is largely a function of higher inflation expectations.

The 10-year JGB was yielding 75 bp before the election was announced last Nov. It had been trending lower and discounting the spikes in early April around the BOJ's announcement, it seemed to consolidate around 50 bp. Today it tested 90 bp a new 12-month high.

One way to try to get our hands around inflation expectations is to compare the yields of conventional bonds with the real yield of the bonds tied to inflation. The 5-year "break-even" was just above 70 bp last November and rose to 160 bp in early March. The uncertainty over the new BOJ governor nomination saw a period of consolidation, but today it made new multi-year highs of near 190 bp.

Ironically, Japan may have lower real interest rates despite the higher nominal yields and this will confuse many.

Great Graphic: Bearish Euro Pattern

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 06:21:35 PDT

This Great Graphic is a weekly bar chart of the euro on Bloomberg. It appears to be carving out a large head and shoulders pattern since last September.

The neckline is being approached near $1.2750, which is why we bring it to your attention now. The important point about technical patterns is the price projection.

The pattern, from head to neckline is about 9.5 cents, suggesting an initial target of around $1.18. This is not far from our year-end target of $1.20 and back toward the lower end of the euro's decade long range.

The neckline has a small upward slope, which is often seen in a topping pattern. A caveat is that usually the head and shoulders pattern is formed at the end of a large rally. In this case, the euro did rally off the $1.20 low seen last year before Draghi's OMT offer, but in the larger scheme of things, the euro spent little time above the middle of the $1.20-$1.50 that has confined the bulk of the price action over the past five years.

The Dollar Index is heavily weighted toward the euro and currencies that move in the euro's orbit, and can be sought for confirmation. First, it appears to have put in a double bottom (September 2012 and February 2013) near 78.60-80. The neckline is near 81.45, which projects toward 84.30. However, a convincingly break of the 84.00 area points to larger technical pattern that suggest scope toward 88.00. This is near the 2010 high. The euro bottomed in 2010 after falling briefly through $1.19.

Dollar Firms, Euro Area Contracts, Sterling Recovers and the Nikkei Soars

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 03:10:10 PDT

The Dollar Index is trading at new 2013 highs, encouraged by the continuing sell-off of the yen and the weaker than expected euro area GDP, which contracted by 0.2% in Q1. However, the dollar's upside momentum appears to be stalling a bit.

Japanese investors did not extend the yen's decline seen in North America yesterday. Europe did and managed to run the stops and barriers believed to have been struck near JPY102.50, but has since begun consolidating. Sterling edged below $1.52 briefly and has since recovered on the back of an optimistic BOE Quarterly Inflation Report. The euro is trading heavier, but may be finding a bid near $1.2880.

In terms of foreign exchange, Mr. Market does not fight Abe and Kuroda, but when it comes to government bond market it is a different story. We have argued that the net consequence of raising inflation expectations and a weaker yen, one would expect Japanese interest rates to rise. However, the move has been disorderly. JGBs initially extended their recent slide into a fourth session. The BOJ managed to calm the market and reverse the early losses by injected JPY2.8 trillion via money market operations. The Nikkei tacked on another 2.3%. led by telecoms, consumer goods and industrials, while financials and oil/gas sectors slipped.

The real economic news today comes from Europe. German, French and Italian GDP reports were weaker than the consensus. Germany managed to eke out a 0.1% expansion, though the market had been looking for a 0.3% expansion Q4 contraction was 0.7% rather than 0.6%. France contracted by 0.2% rather than 0.1% and Q4 GDP was revised to -0.2% from -0.3%. Italy contracted by 0.5%. The consensus was for a 0.3% contraction. The Italian economy has contracted now for seven consecutive quarters and the eighth one appears to be under way.

The UK reported a somewhat better than expected employment report in the sense that the unemployment rolls fell by 7.3k, roughly twice what the market expected and the unemployment rate slipped to 4.5% from 4.6% in April. However, this was accomplished it appears with cheaper wages. Average earnings, reported with an additional month lag rose 0.4% in March on a 3-month year-over-year basis, which is the way it is reported. This is nearly half that pace that was expected and follows a 1.0% rise in February.

Even more important for sterling and gilts today was the Bank of England's Quarterly Inflation Report. It is last under Governor King's stewardship. King is going out on an optimistic note. Growth, he says, may be 0.5% this quarter, after a 0.3% expansion in Q1. King also brought forward when inflation peaks (Q3) and when the 2% medium term target is achieved. Sterling has been bolstered, while gilts have weakened in response.

He revealed that the May MPC meeting, a "modest and sustain" recovery was anticipated. This warns of the possibility that three members, including King, that has been advocating new gilt purchases, may have seen some defections. The minutes will be released May 22.

Great Graphic: What Japanese Investors Bought

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 01:30:02 PDT

Country specific data on Japanese portfolio capital outflows is lagged, like the US TIC data, by two months. The March data was recently released. This Great Graphic from Bloomberg shows Japanese investors bond purchases between US Treasuries (green), French bonds (red) and Australian bonds (blue).

One of the key take aways is the Japanese appetite for French bonds, of which they have been consistent buyers of over the last 16 months, adding another $2.3 bln worth in March. In contrast, Japanese investors have been sellers of US Treasuries and Australian bonds in in five of the past six months.

The fact that French bonds continue to trade like somewhat higher yielding bunds trumps the growing divergence between the two pillars of Europe The interest by Japanese investors helps explain why French bonds have fared so well and why French bonds not JGBs rallied the most when the BOJ announced its quantitative and qualitative easing in early April.

Cool Video: Yahoo Finance--Breakout with Jeff Macke--Japan

noreply@blogger.com (Marc Chandler) — Wed, 15 May 2013 06:47:36 PDT

Update: AUD-MXN Trade

noreply@blogger.com (Marc Chandler) — Tue, 14 May 2013 06:41:29 PDT

The Wall Street Journal's coverage of our "trade of the year" provides an timely opportunity to update our recommendation published in mid-December 2012 calling for a dramatic realignment of the Australian dollar against the Mexican peso.

Rationale: We argued both legs of the trade had much to recommend. We recognized that the positive terms of trade shock was going into reverse. This is true for many commodity producers more generally, including Brazil and South Africa, for example.

Even though there is a positive carry associated with the trade, we conceived of it as a mean reverting strategy. OECD's metrics had the Aussie as the most over-valued currency in its universe and the Mexican peso the most under-valued.

The trade also expressed a contrarian theme; namely the enhanced competitiveness of the Americas' side of the Pacific. The Asian Pacific region captured the imagination and investment flows. The story was over-bought and the Australian dollar was often seen by many investors as a liquid and accessible proxy for Asia.

But that oft told story is old. We have been anticipating an important shift in competitiveness that is in fact taking place. It is crystallized in the two themes. The first is the cheap US energy and is and will continue to encourage bringing manufacturing closer. Second, based on estimates of unit labor costs, it is cheaper to manufacture in Mexico than China. A combination of rising wages and inflation in China is changing the competitive landscape in ways we did not think enough investors appreciate.

The new reform minded government in Mexico adds an additional dimension to the attractiveness of Mexico. Mexico also benefits for the depth and breath of its credit markets and the international quest for yield. Price Action: In mid-December the Australian dollar was trading near MXN13.50. We anticipated a 10% move. In late March, we updated the view suggesting to sell the Aussie into an upside correction, which fizzled just shy of the MXN13.00 level, in anticipation of a MXN11.90.

Now What? The Australian dollar, which proved so sticky for so long has cracked. Our year end target was $0.9700 and we will be revising it down in the next quarterly forecasts by a few cents. Our year end target for the US dollar was MXN12.00 and we will be revising that down as well.

Fundamentally, there is scope for additional rate cuts by the RBA. We think one rate cut before the September election and one after it is a reasonable and modest assumption. We do see scope for a Mexican rate cut in H2, but price pressures need to ease first and more importantly, a rate cut may be seen as generally a favorable development.

This was the case with the surprise 50 bp rate cut in March. Investors will also likely reward Mexico for as the government's reform agenda makes its way into legislation. The relative strength of the US economy also lends support to Mexico.

Beyond our MXN11.90 target from March, we now see scope for MXN11.20. More difficult than managing a winning trade is where to get in or add-on. Immediate resistance is seen near MXN12.15. Bounces in the Australian dollar against the peso have been limited to about 1.5% Given that last Friday and yesterday's low was about MXN12.035, a bounce toward MXN12.20 area may offer a new low(er) risk entry level.

In terms of legging into the trade, note that the Australian dollar is more volatile and as the currency has weakened recently it has become more volatile. Peso volatility was goosed at the end last week, but has come back off and in any event remains at the lower end of what it has traded since Lehman.

Turn Around Tuesday or Not

noreply@blogger.com (Marc Chandler) — Tue, 14 May 2013 03:48:45 PDT

Some of the US dollar's recent gains had been pared after its upside momentum slowed yesterday in North America. However, by midday in London the dollar came back better bid. Although we anticipated this broader consolidation from a technical perspective, there are a couple fundamental developments that are encouraging the move.

Japanese government bonds have continued to sell-off sharply. The 10-year yield jumped 11 bp to 0.86%. Last Tuesday, after Japanese markets reopened from the Golden Week holidays, the 10-year yield was below 0.60%. The yield now stands at it highest level since last June. Reports suggest banks and funds are the main sellers. If this volatility is sustained, it risks a response by Japanese officials. The BOJ has reportedly already changed its tactics in terms of its asset purchases in line with what the dealers suggested, and this seemed to work for a little bit.

The dramatic rise in yields can has several repercussions, First, it would seem to run counter to the declared purpose of the aggressive monetary policy. A gradual increase in interest rates as inflation expectations increase is one thing, a 50% increase in the yield three days is completely different kettle of fish. Second, while US yields have also risen recently, the backing up in Japanese rates has been even more striking and this has resulting in a sharp compression in the spread. Now around 104 bp, it is the at the lower end this year's range. Third, the rise in domestic yields may deter life insurance companies and other institutional investors from aggressively implementing this year's international allocations. Fourth, these considerations saw the dollar pullback to about JPY101.25 were good bids were found. Additional support is seen near JPY100.80.

The euro zone March industrial output rose a much stronger than expected 1.0% and this trumped the disappointment over the German ZEW survey. The consensus forecast a 0.4% rise in industrial production and one important take away is that the surveys have been more pessimistic than the real data. Given the high levels of unemployment, generally, the erosion of confidence and sentiment is understandable.

The ZEW survey was released at the same time. The assessment of the current situation slipped to 8.9 from 9.2. The market had expected improvement. The economic sentiment gauge ticked up to 36.4 from 36.3 and, perhaps, encouraged by a 12.5% rally in the DAX over the past three weeks, the market had expected larger improvement.

The euro neared our initial target of $1.3030, but the upticks were quickly sold. Nevertheless, it is not clear that the upside correction in the euro is over. The market may have gotten a bit ahead of itself in talk of another refi rate cut next month or a move to a negative deposit rate and the stronger than expected industrial production figures suggest the ECB staff may not alter its economic forecasts very much next month.

On the other hand, price pressures continue to subside, but the fact that Germany CPI (EU-harmonized) is at 1.1%, it sets a very difficult bar for other EMU members trying to boost their competitiveness. Germany may have acquiesced to a more protracted, less intense austerity drive, but it continues to force deflation on the EMU.

Although not a member of the euro zone, Sweden today reported it has deflation. The headline CPI is 0.5% lower than a year ago. While the doves will press their case, going forward, the month over month changes from last year that will drop out of the index going forward warn that the deflationary forces are unlikely to be sustained and the Riksbank core measure has held in better. The market anticipates the Riksbank being forced to and has taken the krone lower. It is as if the market is saying that if the Riksbank won't ease directly, it will through the exchange rate. The euro has been bid to its highest level against the krone since late January (~SEK8.65).

The Australian dollar has been sold to new lows following the somewhat larger projected budget deficit. The market had been prepared for a A$17 bln deficit, but it Gillard government forecast A$18 bln deficit. Recall that in mid-Oct last year it has forecast a A$2.2 bln surplus. Sentiment has turned against the Australian dollar as illustrated by recent high profile bearish comments from hedge fund managers.

The fundamentals have not changed as much or as quickly, though we had anticipated a weaker Australian dollar and have it as a "trade of the year" (short Australian dollars against the Mexican peso).. Moody's and S&PO have been quick to note that the budget does not effect their credit assessment or the country's sovereign rating. The next level of support is seen in the $0.9870.

Great Graphic: Euro Zone Members GDP Performance since 2007 in One Table

noreply@blogger.com (Marc Chandler) — Tue, 14 May 2013 01:00:10 PDT

This Great Graphic was spotted by a colleague Andrew Hofer. He saw it on the Nikos Tsafos' blog Greek Default Watch blog. It is a color-coded tracking of how the individual members of the euro have done in terms of GDP and its composition since 2007.

The first column shows GDP relative to 2007. Germany, third on the list, has grown a cumulative 3.6% since 2007, for example. The other columns simply subtract 2012 results from 2007 and is reported in real mlns of 2005 euros. The data comes from Eurostat

The columns represent the components of GDP (consumption, government spending, investment (capital formation), exports and imports of goods and services. Recall in GDP calculations imports subtract from GDP so a positive sign in the table is a decline in imports.

EM Preview for the Week Ahead

noreply@blogger.com (Marc Chandler) — Mon, 13 May 2013 08:50:00 PDT

(from my colleague Dr. Win Thin)

PBOC fixed USD/CNY higher for the second straight day today, as the string of CNY gains appears to be over for the time being. Spot USD/CNY moved higher as well, in sympathy with the rest of EM FX weakening. China April IP and retails sales rounded out the April data deluge, with the former rising 9.3% y/y vs. expected 9.4% y/y and 8.9% y/y in March and the latter right at the expected 12.8% y/y vs. 12.6% y/y in March. Overall, April data was mixed, with surveys (PMIs) weaker than expected and some hard data (trade, loans) a bit firmer than expected. We continue to believe that China growth will stabilize around the 8% level, but the risks are tilted more towards 7.5-8.0% than 8.0-8.5%.

On Friday, USD/BRL traded at its highest level since January 28 near 2.0296, just shy of 2.03. It has opened lower this week, trading near 2.0150 currently. Note that the central bank (BCB) last intervened via swap auctions on March 27 to limit currency weakness, when BRL was trading just below 2.03 (at a high that day near 2.0279). Before that, BCB intervened on January 28 and drove the pair lower from a high around 2.0366 down to a low of 1.9945 that day. Our point is simply that BCB may come in this week to help stabilize the real if weakness continues. However, predictability is not their strong point and so we don't have strong conviction on this. Brazil reports March retail sales Wednesday, and is expected to show some modest improvement. Support for USD/BRL likely near 2.00, resistance near 2.03 and then 2.05.

The Indonesian central bank holds a policy meeting Tuesday, with no change in policy expected. BI is one of the few central banks not in easing mode, as rates have remained at 5.75% since February 2012. Inflation has eased a bit but remains too elevated to consider cutting rates now. CPI rose 5.6% y/y in April, above the 3.5-5.5% target for the second straight month. GDP growth remains robust at 6.1% y/y in Q1, slightly slower than 6.2% y/y in Q4 but still fairly strong. USD/IDR remains in the 9600-9900 trading range that has held since Q4 2012. With little export overlap with Japan, Indonesia is not as vulnerable the weak yen as Korea, Taiwan, and others in EM, and so relatively high yield on IDR could help it hold up well in the current trading environment.

The Turkish central bank holds a policy meeting Thursday, and another 25 bp cut in policy rates is expected. Some are looking for a bigger 50 bp cut this month after the bank delivered a dovish surprise at its April meeting, when it cut policy rates by 50 bp across the board. Since then, average cost of funding (COF) for banks has dropped sharply to right around the 1-week repo rate of 5%. Because of this, it is likely that the repo rate will be cut this month in order to give the central bank more room to cut COF further. Inflation slowed sharply to 6.1% y/y in April, back within the 3-7% target range for the first time since December 2012. The deciding factor will likely be the exchange rate, as the REER stood at 121.10 in April and above the 120 level that has been identified as concerning. USD/TRY looks to have established a base near 1.79 for a move higher. On the upside, resistance is seen near 1.81 and then 1.83.

The Chilean central bank holds a policy meeting Thursday, with consensus for no change in the policy rate of 5.0%. We do, however, think the chances of a dovish surprise have risen. The real sector is slowing, and so we think a rate cut comes sooner rather than later. Q1 GDP will be reported next week, and monthly data suggest a slowdown to around 4.5% y/y from 5.7% y/y in Q4. This would be the slowest since Q3 2011. April CPI was much lower than expected at 1.0% y/y vs. 1.4% consensus and 1.5% y/y in March. Inflation has now been below the 2-4% target range for four straight months. If not on May 16, we think a rate cut on June 13 seems very likely. Support seen near 470 for USD/CLP, but upside is likely to be tested near-term. Resistance seen near 475, 480, and 486.

India reports April CPI and WPI this week. CPI was reported today at 9.4% y/y, lower than expected and the lowest since March 2012. This points to downside risk for WPI, which is due out tomorrow and expected at 5.45% y/y vs. 5.96% y/y in March. Inflation appears to have peaked in Q1, and will likely lead to more pressure on the RBI to continue easing. This will likely lead to some increased tension, as RBI Governor Subbarao said last week that the possibility of more easing is “practically non-existent.” The week before that, the RBI cut policy rates by 25 bp, as expected. RBI (and the market) was disappointed by the relatively meek budget for FY2013/14, which along with the wide current account deficit could keep the rupee under pressure. USD/INR is testing the 55 area. Break above targets 55.50 and then 5600, highs from the past six months. Support seen near 54.50 and then 54.00.

Hungary and Czech Republic both report Q1 GDP on Wednesday. Both are expected to show some improvement from Q4, but recession will likely continue well into 2013. Hungary and Poland report April CPI this week, and continued disinflation in both countries should allow for continued rate cuts ahead. All three CEE currencies should continue to under perform due to negative spillover from the euro zone recession and the resulting dovish policy response in these countries. For EUR/HUF, support seen near 292 and 290, resistance near 295, 300, and 303. For EUR/PLN, support seen near 4.12 and 4.10, resistance near 4.16, 4.18, and 4.20. For EUR/CZK, support seen near 25.60 and 25.40, resistance near 26.00 and then 26.12.

Mexico reports April ANTAD retail sales Wednesday and Q1 GDP Friday. Both are expected to show significant weakness, and this will keep alive expectations for more rate cuts. GDP is seen slowing to 1.1% y/y from 3.2% y/y in Q4, and this would be the weakest since Q4 2009. Banxico minutes last week were less dovish than expected, which supports our view that the central bank is in no hurry to cut rates with inflation well above target. USD/MXN could not sustain last week’s move below 12, and appears to be back in the now-familiar 12.00-12.20 range.

Great Graphic: Asset Managers Embrace ETFs

noreply@blogger.com (Marc Chandler) — Mon, 13 May 2013 08:06:18 PDT

This Great Graphic was in a report by Chris Flood of the Financial Times. It shows the increased use of ETFs by asset managers. Flood reports that ETFS are now used by 18% of US institutional fund managers, up 4 percent points over the past year, based on figures from Greenwich Associates.

A study by Blackrock of the world's top 15 fund managers found that their ETF ownership increased on average by more than 30% a year over the three year period ending September 2012.

The use of ETFs has evolved as the market has matured and fund managers feel more comfortable in that space. Initially, ETFS were used for cash equitisation or transitions, but now are used to for more strategic purposes of gaining exposure to new asset classes or countries or regions.

Nothing Fails like Success

noreply@blogger.com (Marc Chandler) — Mon, 13 May 2013 05:23:42 PDT

(co-authored with my Tokyo-based colleague Masashi Murata)

Abenomics appears to be off to a fairly successful start, despite the volatility in the JGB market. The yen is sharply lower. Equities are dramatically higher. The Japanese economy itself is likely boast the best performance in the G7 in Q1, when the GDP estimate is released early on Thursday in Tokyo. Abe and his government are running strong in the opinion polls, putting it in a solid position to win 2/3 of the upper house in this summer's election.

The critics of Abenomics have generally focused on the risks involved. On the fiscal front, the high debt burden limits the government's ability to maneuver. This leaves the onus on monetary policy. Here the BOJ has been exceptionally aggressive. Consider the US economy is nearly three times bigger than Japan and the BOJ is buying roughly $75 bln a month in securities, while the Federal Reserve is buying $85 bln a month. Structural reform to boost the country's growth potential also seem limited, thus far.

However, what could be even worse for Japan than the failure of Abenomics is its success. The ultimate goal of Abenomics is revitalize the Japanese economy by freeing up the vast savings Japan has amassed (in the corporate sector). Savings in the household sector have generally fallen, as one would expect given the unfavorable demographic trends characterized by shrinking and aging population.

Far from a revolution that many observers have hyped, the Abe's diagnosis and medicine is not new, even if the dosage is. The problem, as we have argued before, is not too little investment in Japan but really the opposite; too much investment.

Consider that over the past decade, gross fixed investment in the US averaged about 10.5% of GDP. A comparable figure for Japan is almost 14%. Yet, US growth surpassed Japan's. As we have seen in China, so too with Japan, each new unit of investment generates less economic growth.

Data from Lombard Street Research shows that combined depreciation and retained earnings amount to 29.5% of Japan's 2011 GDP. In the US, where corporations also enjoy a financial surplus, it is closer to 16%. Boosting the wherewithal to invest would seem to compound the problem.

As Martin Wolf of the Financial Times argued in a recent column, corporate savings in Japan are too high relative to the plausible investment opportunities. This problem of surplus savings is incomprehensible to Japanese policy makers. They continue to insist on understanding the problem in traditional terms of boosting investment to increase employment and consumption.

In the early 1900s, a US journalist and presidential advisor, Charles Conant, was the first American to conceive of problem of surplus savings and he gave it a deep think. He argued there finite number of ways to address the issue the surplus. Wars destroy capital, but Conant argued against such a course. Redistribution was another strategy, but Conant was no socialism. Conant also realized that internal improvements (public works) or public investment could absorb some the surplus savings but not enough.

Conant concluded that exporting the saving to other countries, building infra-structure, laying the railroads and telegraph lines, the information highway of the day, was the way to alleviate the US savings congestion, which threatened profit-margins at home.

Japan can export some of its surplus savings, but typically, Japanese investors have been reluctant to do so on a sufficient scale. Japanese companies do invest in plant and production outside of Japan and since the late 1990s, the Ministry of Finance reports that the local sales of Japanese affiliates surpassed exports as the primary way Japanese businesses service foreign demand. For example, roughly 70% of the Japanese-brand cars in the US were produced in the US.

Portfolio capital flows are even bigger. Until very recently, Japanese investors have been net sellers of foreign financial assets this year. Moreover, Japan's past investments in foreign bonds (and equities) generate a large monthly capital stream that is the main driver of the country's current account surplus. The stock of that investment is so great that on a given month, the income it generates may be larger than the new portfolio outflows and that is with record low bond yields in the US, Germany, UK and France.

In the past when the private sector was unable to recycle Japan's current account surplus, the government would through intervention. Japan has accumulated more than $1 trillion of reserves. This route seems to have been effectively blocked by the G7/G20), given the sharp depreciation of the yen seen in past six months.

Japan does need to revolutionize its thinking, but Abenomics is not it. Japanese officials think their world is characterized by a shortage of investment. Instead it is plagued by a surplus of savings. It can boost consumption (what Conant saw as redistribution), but instead the Abe government is still poised to raise the retail sales tax next year and in 2015, as the DPJ legislated, with what appears to be its dying political breath. Abe said he wants wages to rise, but wanting and doing are not the same thing.

Lower real interest rates, even negative nominal rates, may not absorb the surplus savings as change their location by prompting a reallocation of portfolios to equities and real estate, for example. Instead, Japanese officials may be better served by addressing the corporate savings surplus directly.

There are many forms this could take, such as dramatically reducing the depreciation allowance applied to business investment. The tax on dividends could be cut, but this might not trickle down to households as their equity holdings tend to be a small part of their financial assets, and could end up simply redistributing the corporate surplus among businesses. Of their financial assets, the equity holdings of Japanese households as of March 2012, was about 6.5%, nearly half of what it was in March 2007. The comparable figures for the US households are 31.9% and 36.3% respectively.

Businesses are opposed to the suggestion that retained earnings should be taxed. Corporate governance reform could also force a reduction in corporate savings if shareholders had more power. A more politically palatable route seems to be tax based on the size of the business (pro forma basis).

In order to conceive of the solution, Japanese policy makers and investors need to perceive the problem. Yet, ideological blinders are preventing this and keeps Japan pushing on the same string, albeit somewhat harder, as it has for the better part of two decades.

Macro Overview

noreply@blogger.com (Marc Chandler) — Mon, 13 May 2013 03:24:06 PDT

The US dollar is consolidating the gains seen at the end of last week. The greenback briefly pushed through the JPY102 level in Tokyo, but this was not sustained. Meanwhile, the global equities are mostly lower, though the Nikkei tacked on another 1.2% to reach a new 5.5 year high.

Softer Chinese data may have weighed on emerging market stocks, which for the lower for the third consecutive session. In Europe, most bourses were lower the Dow Jones Stoxx 600 off about 0.4% near midday in London, led by a 1.3% decline in financial. A lower close today would break a four -day advance that had carried the index to new five year highs last week.

Global bonds are mixed. Japanese government bonds extended last week's drop. The benchmark 10-year yield rose almost 6 bp and now near 75 bp, the yield is near a 3-month high. Spanish bond yields are extending last week's increase, while Italy's 10-year bond yield is up 5 bp, though little changed after the government's auction that raised 8 bln euros with 3, 5, and 13 year tranches. Core bonds are firmer, with yields 2-4 bp lower.

There are four developments at the end of last week are shaping the investment climate.

First, there was a sharp sell-off in US Treasuries and Japanese government bonds, albeit for different reasons. The US sell-off seems to be driven by renewed ideas that the Fed could taper of purchases earlier and by the move further out on the risk frontier, illustrated by the decline in the yield of an industry benchmark for junk bonds below 5% for the first time.

Some in the financial press give more emphasis to Philadelphia Fed President Plosser's comments that he favors reducing QE as early as next month than we would. Plosser is neither a voting member of the FOMC nor representative of a majority of Fed officials.

However, we did read with interest a speech that Federal Reserve Chairman Bernanke delivered before the weekend. Amid concern that QE is producing bubbles in other parts of the capital markets, Bernanke explained that the Federal Reserve was watching "particularly closely" investors "reaching for yield". He seemed sensitive to Minksy's insight that the relative stability of (ie, low volatility?) may encourage investors to take greater risks than the macro-economic conditions warrant. At this juncture, this seemed meant to reassure the market that the Fed is sensitive to the risks implicit in QE and not a signal of a near-term shift in policy.

The sharp dramatic decline JGBs appears to be a function of officials still wrestling with the implementation of its aggressive JGB purchase project and the kind of disruption it is causing. All else being equal, a sharp decline in the yen would tend to lift bond yields. In addition, competitive investments, like the equities, may also be drawing investors out of the fixed income.

Second, after first approaching it a month ago, the dollar finally broke through the JPY100 level. The move continues to appear largely driven by hedge funds and other speculators, though Ministry of Finance data did show Japanese investors bought about $5 bln in foreign bonds in a two-week period ending in early May. After breaking of key chart point the yen's decline accelerated and G7 meeting said nothing that poses an obstacle to additional losses.

The next key chart points are in the JPY104-JPY105 area. We suspect that by the end of the summer, perhaps after Abe would have secured a 2/3 majority in the upper house elections, the G7 may grow less accepting of additional yen weakness, especially if structural reforms are unconvincing.

Third, the US dollar staged a broader rally against the major and emerging market currencies. The Federal Reserve calculation of the dollar's value on a trade-weight weighted basis are only updated at month end, and of course, the Dollar Index is not reflective of US trade patterns, with two of the US main partners, Mexico and China not represented at all.

The Bank of England offers a real effective trade-weighted measure in real time. It finished last week at its highest level since July 2010. In the QE-era, more questions have been raised about the use of paper money to measure other paper money, but surely the 20% drop in gold prices from the peak in Q4 12, is not suggestive of a weak US dollar either.

Fourth, the extension of the Fed's QE program to $85 bln a month was announced in December and has been digested by market participants. Investors continue to grapple with the implications of Japan's aggressive QE (~$75 bln a month). As Japanese investors have purchased foreign bonds in two of the past three week, foreign investors, who had bought around $64 bln of Japanese equities this year have taken some profits in two of the past three weeks.

Over the past week or so, Australia cut rates and has made it clear that it has not exhausted it scope for additional rate cuts. In Asia, both India and South Korea lowered official rates. In Europe, Poland cut rates at the end of last week and the ECB, which cut rates earlier this month, is also holding out the possibility of addition conventional (refi rate cut) and unconventional (e.g., measures to boost the ABS market and some talk of directly buying distressed bank bonds, for which we are highly skeptical).

Turning to this week's data stream, the US is likely report the second consecutive decline in retail sales today, with the headline dragged down by a decline in gasoline prices and auto sales. The measure used for GDP calculations, which excludes these two components and building materials may eke out a small gain. The decline in factory employment and, more importantly, the reduction in the work week, points to a decline in manufacturing when the industrial production is reported at mid-week.

Both PPI and CPI will be reported this week. So-called pipeline inflation remains mild and CPI is likely to post its second consecutive monthly decline, which is something not seen in five years. Lastly, the both the Empire State and Philly Fed surveys will be released and they offer among the first readings of the US economy in May and both are expected to stabilize after the recent declines.

The data highlight from the euro area and Japan will be Q1 GDP estimates near midweek. The Japanese economy is expected to have been the strongest in the G7 in Q1 with a 0.7% quarterly expansion. After contracting by 0.6% in Q4 12, is expected to have contracted by a 0.1% in Q1 13, helped by a rebound in the Germany economy. In contrast, in the core, the French and Dutch economies are believed to have contracted in Q1.

The UK releases its April jobs report on Wednesday, but the BOE's quarterly inflation report the same day may garner more interest. In addition to an update on how the BOE sees the trajectory of prices before Carney takes the reins in July, the market is also keen on the official assessment of the Funding-for-Lending Scheme which does not appear to be bolstering lending to small and medium sized businesses very much, though encouraged to by the government's Help to Buy Scheme, mortgage lending may be supported.

Great Graphic: 10-Year Bond Yields (US, Japan and German)

noreply@blogger.com (Marc Chandler) — Mon, 13 May 2013 13:51:52 PDT

This Great Graphic was created on Bloomberg and shows the movement of 10-year bond yields in the US (white), Germany (green) and Japan (yellow) over the past six months.

Over this period, JGB yields peaked first, in early January, followed by bunds late in the month. US 10-year Treasury yields did not peak until early March.

On the other hand, JGB yields bottomed within days of the BOJ's announcement, detailing what it calls "quantitative and qualitative easing" in early April. The US Treasury yield bottomed on May 1, just above 1.61%, and at least one money manager proclaimed this was the end of the bull market. Bund yields bottomed the next day after dipping to almost 1.15%.

While the pace of moves may vary and the timing of bottoms and tops differ, the general trends, while not identical are similar and speaks to the global market for long-term capital, despite the emergence of other forces sparking a return of home-bias and the fragmentation of the capital markets.

Great Graphic: Can the Euro Area Look like Germany?

noreply@blogger.com (Marc Chandler) — Sun, 12 May 2013 08:05:08 PDT

This Great Graphic shows the current account performance and trajectory according to the IMF of selected euro area countries. It was posted by Alesandro Leipold, who found it through Gavyn Davies.

The graph depicts the significant adjustment in the external balance of a selected number of euro area countries. Part of this is a function of the contraction in domestic demand, which reduces the imports. It is also partly a function of improved exports. The pace of improvement of the current account positions is remarkable.

One of the consequences of the reduced external imbalances is that Target2 imbalances have also trended lower. Some observers had seen the Target2 imbalances as a sign that the monetary union experiment was not sustainable.

Projected a few years into the future, the IMF anticipates that largest euro zone members after Germany to be running external surpluses. France appears to laggard, but will largely be in balance. Spain shows impressive improvement and the IMF reckons it will have have a surplus by 2018 that comes close to Germany's. Moreover, it does not appear zero-sum within the euro area insofar as the modest decline in the projection of the German surplus is more than compensated for the improvement elsewhere.

What is less clear is that if the euro area surplus rises, where will the offset be globally? The energy story (and the knock-on impact on industry) in the US is a structural shift suggesting the US external account is also poised to improve. Does the projected improvement in the euro area external account mean deterioration of China's surplus? Emerging markets?

Cool Video: The Connection between Music, Movement and Feelings

noreply@blogger.com (Marc Chandler) — Sat, 11 May 2013 13:32:36 PDT

This cool video is from the PBS Digital Series. "Why Music Moves Us" is entertaining and educational and speaks to some cross-cultural similarities of experience. A hat tip to Maria Popova for spotting it.