Marc to Market

Japanese Corporates Not Yen Bears (Any More)

noreply@blogger.com (Marc Chandler) — Thu, 23 May 2013 06:54:06 PDT

Japan's Economics Minister Amari had initially suggested a few days ago that the correction to the yen's strength had been corrected. Reports suggested that under criticism from his cabinet colleagues, he softened his comments, now indicating that correction was ongoing. The dollar proceeded to recover and made new multi-year highs yesterday.

Amari was not talking off the top of his head. A Reuters survey of 400 Japanese businesses, half of which were manufacturers, released on Tuesday, shows that almost half the businesses said the yen's decline has been sufficient and more than a third would like to see the yen recover somewhat. Only 15% of the respondents sought further yen depreciation.

The Reuters survey found 48% of Japanese businesses wanted to see the dollar-yen rate stabilize around JPY100. Seven percent of the companies wanted to see JPY105 and eight percent wanted to JPY110. Almost 30% want the dollar to ease back to JPY95 and nearly 10% prefer JPY90.

The results for just the manufacturing sector were similar. Many Japanese manufacturers import inputs and the depreciation of the yen boosts costs of these. In addition, Japanese companies, such as autos, consumer electronics and the like, have moved production facilities offshore, insulating themselves to some extent from the vagaries of the yen.

While Abenomics has enticed foreign investors to boost their exposure to Japanese equities by around $100 bln since the election was called in mid-November 2012, Japanese business and investors seem less enchanted. The Reuters survey found that only 13% of the corporate respondents planned to boost investment in response the government's initiatives and only 10% plan to boost wages or employment. These findings were in line with other recent surveys.

Japanese investors have not been spooked by the depreciation of the yen and BOJ's decision to purchase of the new issuance this year and next. They have not fled the land of the falling yen and low nominal interest rates. Instead they have been significant sellers of foreign bonds. The weekly MOF data indicates Japanese investors have sold JPY5.36 trillion (~$53.6 bln) of foreign bonds this year and another JPY4 trillion (~$40 bln) of foreign stocks.

They are essentially taking profit on the large stock of foreign assets they have acquired. This is not the behavior of investors who think the dollar-yen is going to infinity as one fund manager put it. This is the actions of investors who think the decline in the yen is an anomaly that will not be sustained.

The findings of the Reuters poll also say something about the so-called currency war that has captured the imagination of the media and blogosphere. Globalization has complicated corporate interests. A weaker currency is not always beneficial. A stronger currency is not always harmful.

The diversity of corporate strategies, the varying elasticities of demand and different competitive environments for their products mean that it is difficult to generalize the currency views of Japan Inc. Moreover, given turnover, corporate flows are swamped by financial flows. The 2010 BIS triennial survey of currency market turnover (the next one is due later this year) put the average daily turnover of dollar-yen near $565 bln and eur-yen at another $110 bln.

This means that while the corporate views of the dollar-yen rate are interesting, it is difficult to extrapolate from it to trade the yen. Short-term speculators, momentum players and trend followers may be more important for the day-to-day moves than Japanese businesses.

Market Responds Dramatically to Bernanke

noreply@blogger.com (Marc Chandler) — Thu, 23 May 2013 03:30:45 PDT

The global capital markets have been thrown into a tizzy by comments from Federal Reserve Chairman Bernanke. US bonds and equities sold off yesterday on ideas that Bernanke was signaling a tapering off of QE. The knock on effect was seen in Asia, even before the disappointing the flash China PMI from HSBC that showed the first sub-50 reading in seven months (49.6 vs 50.4 in April, with a fall in new orders and new export orders).

Japanese government yields, which have been rising in recent days, initially jumped to 1.0% on the 10-year yield, almost triple the rate seen on the day before the BOJ announced its massive easing operation in early April. The bond market recovered as the stock market tanked The Nikkei lost 7.3%, essentially cutting in half gains over the past month.

The rise in Japanese yields hurts financial sector as they are large holders of government bonds. The financial index within the Nikkei shed 10.4% today, leading the market lower. Regional markets also tumbled with the MSCI Asia-Pacific Index off about 3.3%.

The behavior of Japanese investors is interesting. The weekly MOF data shows that after three weeks of buying Japanese investors returned to selling foreign bonds. In fact, the JPY804.4 bln of foreign bonds sold in the most recent week offsets in full the almost JPY700 bln bought over the past three weeks. Japanese investors sold foreign equities snapping the two week mini-buying spree. The JPY136.9 bln sold is more than purchases made during the four weeks this year that Japanese investors did buy foreign stocks.

The foreign appetite for Japanese shares was unabated, with another JPY716 bln poured in. Foreign investors have bought roughly $79.5 bln of Japanese shares so far this year. Many have bought Japanese stocks on a currency-hedged basis. Given the fall in the prices, they have had to adjust some of the hedges (by buying dollars), but the dollar demand has been swamped by the powerful short squeeze in the yen. The The dollar had set a new high for the move yesterday near JPY103.75 and in early Europe had dipped below JPY101. The next level of technical support for the dollar is seen near JPY100.40-60 area, which corresponds to a retracement objective and the 20-day moving average, which caught the last dip below JPY9900 earlier this month.

The euro hit was hard yesterday after moving to $1.32 on the initial reaction to Bernanke. However, despite the large sell-off in European equities (Dow Jones Stoxx 600 off 2.25% near midday in London), the unwinding of yen crosses, and flash PMI data suggesting the regional; economy is still in a bad way, the euro itself is trading firmer. The Swiss franc, though, like the yen has surged. The dollar was at a 10-month high against the franc yesterday near CHF0.9840 and was trading two centime lower in Europe.

The flash PMI composite rose to 47.7 in May from 46.9 in April. It is the fourth month below 48.0, let alone the 50-boom/bust level. Both manufacturing and service PMI readings edged up from German and France, but there is nothing suggesting a recovery in Q2.

Separately Spain's bond auction went off without a hitch, though slightly higher interest rates and it was able to raise a little more than it anticipated. Peripheral bond yields are generally facing some selling pressures. Italy, Spanish, and Portuguese 10-year bond yields are 7-8 bp higher. Bunds and gilt yields are a couple basis points lower. US Treasuries are also a bit firmer and the US S&P is called to open sharply lower (~-1.25%).

Bernanke did not seem to us to break new ground and we suspect that many have read too much into his responses to questions by the Joint Economic Committee of Congress. We know from past comments by Bernanke that the Fed can and will adjust the pace of its purchases depending on the flow of economic data. The FOMC included this in the last statement. Bernanke and Dudley and others have also reiterated this.

In essence, in response to some regional presidents' comments, like Plosser, who suggested maybe tapering off purchases as early June, the Fed's leadership, Bernanke, Yellen and Dudley (BYD), have said, they need a few more months of data before being able to assess the situation. This underscore the data dependency of the decision. But this is simply an agnostic stand. BYD have also noted the fiscal drag that is still unfolding and past episodes where the better economic data was not sustained.

In fact, there is some merit to the argument that Q1 and Q2 were ended prematurely as the economy did not enter a self-sustaining course. Bernanke's prepared remarks showed a clear, to us, desire not to three-peat the mistake. The economy has lost momentum in recent months. Non-farm payroll growth slowed in March and April well below the 200k+ needed to make some, like Evans, more comfortable that the economy is truly catching now.

The performance of the economy over the next 3-4 months is important, and until then the Fed is buying $85 bln a month of long-term assets and, even if its slows its purchases in September, it will be continuing to ease policy, at a slower pace.

Great Graphic: Five Different Measures of US Inflation

noreply@blogger.com (Marc Chandler) — Thu, 23 May 2013 01:36:15 PDT

This Great Graphic was posted on FT Alphaville and it comes from Credit Suisse. It shows different measures of inflation. The Fed's preferred measure is the core PCE (deflator). However, it is sensitive to other measures as well.

Perhaps it is like the different measures of unemployment. There is no true or right measure of unemployment. There are different measures and each has a different use. It turns out that the commonly used U3 measure follows the guidelines established by the International Labor Organization and allows for more meaningful international comparisons.

Fed officials have largely played down the drift lower in prices. Bernanke himself suggested that he was not worried as inflation expectations remain anchored near 2%. This is perhaps one of the benefits of QE--namely helping to underpin inflation expectations that is among the least commented consequence.

The Fed may be right to play down the decline in the measured inflation, though a couple more soft reports could make it become more salient. Given the monthly increases seen in Q2 12, it is possible that as these drop out of the year-over-year comparisons, core PCE still drifts lower. However, the second half will be a different story. In the second half of last year, core PCE rose by a cumulative 0.3%. Core PCE rose 1.1% on a year-over-year basis through March, the most recent data, but in Q1, the annualized pace was 1.6%.

Bernanke and the majority of the Federal Reserve say that a few more months of data is before deciding if it should taper of the long-term asset purchases. Because the economy did not enter a self-sustaining growth phase, it can be judged that QE1 and QE2 ended prematurely. Bernanke and Co don't want to make the same mistake a third time.

Two Misunderstandings about Japanese Trade

noreply@blogger.com (Marc Chandler) — Wed, 22 May 2013 14:20:58 PDT

Japan reported April trade figures earlier today. Given the decline in the yen and the positive contribution of exports to Q1 GDP, it is a closely watched report. However, there are two profound misunderstandings that distort how the media and some other observers comprehend the data.

First, the decline in the yen does not automatically translate into lower prices for foreign purchasers of Japanese goods. Second, Japan is not nearly as reliant on exports as many suggest. It services foreign demand primarily, though not exclusively of course, on building and selling locally. These foreign sales still bolster Japanese corporate earnings.

There have been a number of reports that have cited Japan's dependency on exports and even the Financial Times recently noted one of the similarities between Japan and Switzerland was the heavy reliance on exports. Despite the numerous repetitions, this is simply not factually true.

The most recent comparable data from the World Bank is for 2011. Japan exported 15% of its GDP and the US 14%. Switzerland exported 51% of GDP and Germany 50%. China exported 31% of GDP in 2011.

This is not a new development and has persisted for some time. Consider that in 2000, Japan exported 11% of GDP. The same as the US. Switzerland exported 45% of GDP and Germany 33%. China exported 23% of its GDP in 2000.

The Ministry of Finance data shows that some time in the late 1990s, the sales by foreign owned subsidiaries of Japanese companies surpassed exports. Consider that Toyota sold about 2 mln vehicles in North America last year and a little more than 70% were made there. This compares with a 55% local production of the 2.21 mln vehicles sold in 2008. Nissan aims to produce 85% of the vehicles it sells in North America by 2015 from 69% now. Consider Panasonic. It has 189 production facilities abroad compared with 117 plants five years ago.

The yen has declined by 21% against the dollar since the election was called the middle of last November. It was clear from the start that Abe was going to lead the LDP to victory. This does not mean that the price of Japanese goods have fallen. The price of money adjusts considerably faster than the price of goods, producing what economists call the J-curve.

A weaker yen does not automatically translate into higher exports. Japan's exports to the US have risen 14.8% from a year ago. However, exports to China, where the yen has declined nearly 24% since mid-Nov '12 are up a mere 0.3%. Japan's exports to the euro area are off 3.5% from a year ago, even though the yen has declined 23% against the euro.

Note too that even for exports into the US, many costs are incurred locally. These costs include transportation, marketing and storage. These costs could amount to as much as the cost of the good itself.

A weaker yen still helps Japanese businesses, but not necessarily through increased sales volumes. Rather, the shift in foreign exchange prices means that the foreign currency revenue earned through foreign sales translates into more yen. Some estimates suggest that currency translation could be worth $2000 a vehicle. This is a key factor boosting earnings and earnings expectations for Japanese companies.

Observers often see what they want. In a survey of major new wires and papers, with few exceptions, the reporters cited unadjusted trade figures that showed that April deficit (~JPY880 bln) was much larger than the March deficit (~JPY362.5 bln). Abenomics is not working, they want to conclude. One reporter even argued that a weaker yen is needed, though an increasing number of Japanese businesses are content with it to stay around current levels. As Japan has moved production facilities offshore, imports cost more in a depreciating yen environment.

It is customary to look at the trade figures on a seasonally adjusted basis when comparing data to the previous month. The seasonally adjusted trade deficit stood near JPY764.5 bln in April, down from a revised (lower) March deficit of almost JPY919.9 bln, which is the smallest in three months. On a year-over-year basis, Japan's exports have risen 3.8% and are back to pre-Lehman levels. Imports are up 9.4% from a year ago, reflecting not only the dependency on foreign fuel but also food, clothing and other supplies.

Central Bankers' Day

noreply@blogger.com (Marc Chandler) — Wed, 22 May 2013 03:27:09 PDT

The US dollar is firmer against most of the major currencies, but is more mixed against the emerging market currencies. Although the US reports April existing home sales (consensus +1.4%), the focus is on Bernanke's testimony and then the FOMC minutes.

Essentially we expect the Federal Reserve Chairman to say essentially three things: First, that the Fed has made progress on its thinking of the QE exit strategy. Second, that there will be no imminent tapering off of purchases of long-term assets and that the decision is dependent on the trajectory of prices and the labor market. Third, that fiscal policy and weakness in Europe are headwinds for the US economy and that the Fed cannot yet be assured that economic growth is sustainable. We suspect some late dollar longs are vulnerable if Bernanke hits these points.

The Federal Reserve is not the only central bank in the news today. The BOJ meeting concluded. Although there were no changes in policy, the BOJ did upgrade its assessment of the economy, as the government did earlier this week. The BOJ pointed to the stabilization of exports, capex and stronger housing investment. Officials are still concerned with the volatility of the JGB market and will again meet with dealers next week (May 29) to see if it can be better understood and addressed.

The dollar has fully recovered from the Amari-induced drop. The post-Kuroda bounce took the dollar back to JPY103.00 where it ran out of steam. The key to the North American session may be how the US Treasuries respond to Bernanke. For the past two weeks the US 10-year yield has been mostly in a 1.88%-1.97% range. It is in the middle of that range now, but we think the market has gotten ahead of itself on the tapering off story and look for the yield to come off and this may weigh on the dollar against the yen. That said, dollar pullback will be bought as the market continues to press the underlying trend.

Minutes from the Bank of England's MPC were released. There were no real surprises. The vote remained 6-3 in terms of new gilt purchases. We had thought there was some chance that one of the doves would have switched sides given the recent economic data and the closing window before Carney takes the reins. The real weight on sterling, however, which drove it to $1.5075, its lowest level since early April, was the dismal retail sales.

The 1.3% decline in April, the biggest in a year, compared with Bloomberg consensus of a 0.1% increase. Soft PMI and BRC reports and weak pay growth figures, coupled with poor weather seemed to have signaled disappointing retail sales. A soft CBI soft trend report added to sterling's misery. The break of the $1.5120, is sustained on a closing basis, bodes ill for sterling's outlook. We look for it to return to and take out this year's low, set in March near $1.4830.

The Swiss franc has continued to weaken. The euro is at 2-year highs against the Swiss franc. Although the euro has been appreciating since mid-April, the trend has accelerated. Yesterday the IMF advocated that the SNB consider a negative deposit rate, if the franc came under new pressure. The market focused on this more than the IMF's other advice that the SNB should take advantage of franc weakness to unwind some of its balance sheet expansion. Today the SNB's Jordan indicated that a negative deposit rate and/or a shift in currency cap are still policy options. Many are talking about the euro rising toward CHF1.30 now that the CHF1.25 has been convincingly breached. The next big target for the dollar is CHF1.000.

Cool Video: How Tornadoes are Formed

noreply@blogger.com (Marc Chandler) — Tue, 21 May 2013 09:45:14 PDT

This Cool Video was posted on The Atlantic and originally comes from NASA. It explains the origins of tornadoes. In a little less than four minutes you will have a better understanding of complex weather phenomenon.

Two Issues for the Fed: How and When

noreply@blogger.com (Marc Chandler) — Tue, 21 May 2013 07:17:05 PDT

Federal Reserve Chairman Bernanke testifies before the Joint Economic Committee of Congress tomorrow. The market is anxious for the Chairman to weigh in on the recent comments suggesting that even some like-minded regional presidents like Chicago's Evans seems to be warming to the idea of tapering off purchases.

It is one thing for the more hawkish members, several of whom have never felt comfortable with the latest iteration of quantitative easing, to talk of slowing purchases, but it is another thing for some of the more dovish members to talk in this vein. Yet we suspect there is less than meets the eye. With the stock market extending its advancing streak to near 200 days without a 5% pullback and what Bernanke has called "the reach for yield" has driven the industry index of below investment grade yields below 5% for the first time; it is incumbent on Fed officials to demonstrate their vigilance.

To this end, the leadership needs discuss the conditions that would allow it to taper off its purchases. The Fed has been reluctant to provide much guidance in this regard, unlike the inflation and unemployment thresholds cited for interest rates. How the Fed exits from QE3+ is generally understood to be a slowing of purchases, probably of the mortgage-backed securities first. In a recent much-vaunted Wall Street Journal article, how the Fed exists QE3 was said to be "careful" with "potentially halting steps".

Arguably the more important issue is when and here the Wall Street Journal article was even less revealing, noting that it is still being debated. Although one non-voting Fed president talked about tapering off purchases as early as next month's meeting, this does not appear to be consensus. Instead, there is a consensus to wait for more economic data. More data seems to mean another quarter or so.

Some officials, including Chicago Fed's Evans, who was among the most dovish members, noted that the economy is "improving quite a lot", but wants to see if the economy sustains its momentum after having experienced other episodes of growth that proved temporary. Employment growth is understood to be among the most important real economy measures.

It is true that the 3-month and 6-month average non-farm payroll growth is just about the 200k threshold that Evans, among others, has cited. However, this overstates the strength of jobs growth. Consider that we have four months of data for this year. In three of the months, non-farm payrolls were 165k or lower. In one month, February, there was an outsized jump of 332k jobs, which skews the averages. However, with the May report on June 7, the February figures drop out of the 3-month moving average calculation.

Fed officials, and especially Bernanke who as a student of the Great Depression, is particularly sensitive to deflation risks, a few more months of data on inflation measures may also be helpful. The Fed's preferred inflation measure, the core PCE deflator stood at 1.1% in March. Only in two of the past nine months, has the deflator risen by more than 0.1%.

Some officials, like Evans, suggest that the decline in inflation may be transitory. Looking at the base effect for the year-over year measure, in Q2 last year, the monthly increase averaged 0.13%. As these drop out, the core PCE deflator will likely fall below 1%. Such a low inflation reading would risk deflation and would seem to argue for continued easing of monetary policy.

In addition to employment and prices, there is a third consideration: fiscal policy. Bernanke has commented previously on the fiscal drag. However, the US budget position is improving considerably faster than expected. Last week, the Congressional Budget Office updated its budget outlook.

Assuming no changes in the current laws and plans regarding taxes and spending, the FY13 budget deficit is expected to now shrink to about $642 bln, the smallest since 2008 around 4% of GDP. This is less than half the 2009 shortfall (~10.1%) and an impressive decline from the 7% shortfall in FY2012. To appreciate this consider that the UK government which has been committed to austerity since getting elected in 2010 has seen no change in public borrowing as a percentage of GDP (~7.5%).

The US public debt/GDP ratio is projected to begin falling next year. The CBO estimates that the FY2015 deficit will fall to almost 2% of GDP. The less accommodative fiscal stance may also encourage the Fed's leadership to take their time. The US economy remains fragile and reducing both monetary and fiscal accommodation at the same time may not be desired.

Bernanke's testimony tomorrow takes place before the FOMC minutes are released. Bernanke's comments are more important of the two events. However, recall that the FOMC statement released on May 1 contained one notable tweak and that is that "The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes." This symmetry contrasts with previous talk that focused on tapering off the purchases. In turn, this suggests some doves pushed back.

Data released since the meeting has generally been soft and/or disappointing. This includes non-farm payroll report, which included a decline in aggregate hours, surveys for May, softer auto sales, industrial production and manufacturing and housing starts. The resilience of consumer confidence and retail sales were the exception.

On balance then, we suspect Bernanke will recognize, as the FOMC statement did, that the economy is growing at a moderate pace and that decisions on the pace of asset purchases is a function of changes in employment and inflation. It serves his interest to indicate it is data determined and that more data is needed. If this does in fact materialize, we suspect it would be supportive for US Treasuries while weighing on the dollar. To the extent that the FOMC minutes show that there are some at the Fed who think it should be doing more, it may also push the markets in the same direction.

Sterling and Yen Aren't Waiting for Tomorrow

noreply@blogger.com (Marc Chandler) — Tue, 21 May 2013 05:16:33 PDT

The US dollar remains largely in a consolidative phase, awaiting Federal Reserve Chairman Bernanke's testimony before the Joint Economic Committee of Congress tomorrow. There has been much talk about tapering asset purchases and Bernanke's views are critical.

However, comments by Japan's Amari, seemingly trying to soften yesterday's comments, after reportedly being criticized by cabinet colleagues helped lift the dollar back toward JPY103. Separately, soft UK inflation figures sent sterling back to the base it build last Friday and yesterday near $1.5165. Against the emerging market currencies, the greenback remains bid.

The BOJ's two-day meeting concludes tomorrow. No fresh initiatives are expected. The chief concern presently is the volatility of the government bond market--an unintended and seemingly unforeseen consequence of what it calls the qualitative and quantitative easing. The yield on the 10-year JGB rose 3 bp and continues to flirt with the 90 bp level. This compares with a yield of about 55 bp just before Kuroda announced the BOJ was going to buy 70% of the new issuance. The backing up of long-term yields in Japan did not bring in new buyers at the 40-year auction earlier today. The bid-cover was the lowest in almost 2 years.

While the market does not expect the Federal Reserve to stop its $85 bln a month in asset purchases at once and, like the Fed itself, continues to mull an exit strategy, few consider the same in terms of Japan. In some ways Amari's comments can be understood as tapping on the brakes, or blowing air under a parachute to help create the conditions of a soft landing to the yen. The decline of the yen may be one of the factors contributing to destabilization of the government bond market. A shortcoming of this interpretation is that it may attribute more intention and planning than may be the case.

The speed of the dollar's recovery against the yen will likely embolden the yen shorts. There is much talk of a JPY105 near-term target. Yet for the North American session, the JPY102.80-JPY103 may provide the cap.

The UK is one of the few high income countries in which measured inflation is still problematic. News that April inflation measures fell more than expected spurred ideas that guilt purchases may be resumed. Gilts rallied and sterling came off. April CPI slipped to 2.4% from 2.8% in March. The market expected a 2.6% pace. The drop in transportation and fuel prices accounted for almost half the improvement. Still, the core rate fell to 2% from 2.4%.

On the producer level, input prices fell more than expected (-2.3% vs consensus -1.3%) and this saw the year-over-year rate dip into negative territory (-0.1%) for the first time since last November. Output price slipped 0.1% in April rather than rise 0.2% as the consensus expected. This translates into a 1.1% year-over-year rise. Core output prices are up 0.8% on a year-over-year basis.

Separately, the UK reported the ONS house price measure rose 2.7% from a year ago. This is the second fastest pace since December 2010.

The minutes from the BOE's meeting earlier this month will be released tomorrow. There had been some thought that the relative strength of the recent data and the desire not to pre-commit Carney could have prompted one of the three dissenters (which includes Governor King) may have defected. Although the MPC did not know today's data when it made its decision, some observers now play down this possibility.

Sterling declined nearly a cent on the news, which has left the short-term technical indicators a bit stretched. Good bids have been seen in the last three session near the $1.5165 area. Immediate resistance is pegged near $1.5220.

The Australian dollar initially extended yesterday's upticks, but came off almost 2/3 a cent in Europe. The RBA minutes were not surprising and give no reason not to expect further easing. Yet the Australian dollar has fallen about 5.5% on a trade-weighted measure, tantamount to some degree of easing of monetary conditions and this might steady the RBA's hand next month. In addition, the minutes did reveal that some members thought that the past rate cuts are still making their way through the system. Near-term consolidation is the most likely scenario, awaiting tomorrow's busy session, with BOJ meeting, start of the EU summit, BOE minutes, Bernanke's testimony and FOMC minutes.

Emerging Market Highlights for the Week Ahead

noreply@blogger.com (Marc Chandler) — Tue, 21 May 2013 07:41:45 PDT

(from my colleagues Dr. Win Thin and Ilan Solot)

In the EM space, disinflation and slow growth remain major themes for most of the countries. Certainly, weaker Chinese readings have gotten the headlines but the malaise is spreading well beyond Asia.

Today, it was Chile that reported Q1 GDP growth at a much weaker than expected at 4.1% y/y, down sharply from 5.7% y/y in Q4. Others in EM are likely to report slower growth and disinflation this week, setting the stage for more stimulus ahead. Brazil is the major exception, and is discussed below.

South Africa April CPI is due out Wednesday, and is expected to ease to 5.7% y/y from 5.9% y/y in March. On Thursday, the SARB meets and is expected to keep rates steady at 5%. However, if disinflation continues as it is in the rest of the world, we think a rate cut by the SARB will be seen in Q3 in order to help address the slowdown.

Gold prices continue to fall, down 8 straight days and 10 out of past 11. Falling gold is part of the reason behind the ZAR selloff last week, along with labor unrest. Besides these usual themes hurting the rand, we got a bonus today with bearish bank news.

The biggest provider of unsecured loans saw its shares plunge after it increased H1 2013 credit impairment charges by 45%. This is most certainly reflecting rising bad loans from high unemployment and slow growth. USD/ZAR made a new high for this move today just shy of 9.50, a level not seen since April 29. Further rand losses appear likely as technicals point to a potential test of the March 2009 high near 10.73.

HSBC China flash PMI for May is due out Thursday, and stood at 50.4 final in April. This will be the first snapshot for May, and the risks are to the weak side. We note that in April, the surveys data (PMIs) were weaker than expected while the real sector data (loans, trade) were largely stronger than expected.

With the rest of the world slowing, we think it will be hard for China to defy gravity and we look for continued sluggishness in Q2 and Q3. Last week, the PBOC finally fixed USD/CNY higher after a long string of lower fixes. However, Friday saw a significantly lower fix followed by a virtually flat fix today and so the near-term direction is a bit cloudy.

Mexico mid-May CPI is due out Wednesday, and is expected steady at the 4.72% y/y pace reported for mid-April. Core is seen easing slightly to 2.85% y/y from 3.0% y/y in mid-April. The real sector data has been unequivocally soft in Q2, and this has fed into rate cut expectations. However, Carstens has for now ruled out any easing until inflation returns to the 2-4% target range.

Next Banxico meeting is June 7 and that is clearly too soon to act. Even the July 12 meeting is likely to soon, as we think officials will also want to gauge if the Q2 slowdown carries over into Q3. As such, we think the September 6 meeting offers the best chance of a rate cut, if the data continue to come in soft in Q3 as well. The peso has been hurt by a combination of generalized EM currency weakness coupled with weak local data and weak US data.

While we believe the US is only going through a soft patch, USD/MXN is likely to remain bid near-term, and a break above 12.40 would open up a test of the 12.60 area. Support seen near 12.20 and then strong support near 12.00.

Singapore reports April IP and CPI on Thursday. IP is seen at 1.2% y/y vs. -4.1% y/y in March, while CPI is seen at 3.0% y/y vs. 3.5% y/y in March. Real sector data has been coming in weak, while Singapore is experiencing disinflation just like the rest of the world. If these trends continue as we expect, we believe that the MAS will ease policy at its October meeting by shifting the slope of its undisclosed S$NEER to a neutral stance.

The MAS currently has a policy of “modest” appreciation. In light of the EM sell off last week, USD/SGD spiked to test the 1.26 area and traded at its highest since July 2012 before falling back a bit today. Despite strong fundamentals, SGD will remain subject to market forces that have hurt EM currencies across the board. The yen in particular has had a strong influence on regional Asian currencies, and we think that will continue. Break of the 1.2660 area would set up a test of the June 2012 high nears 1.2970. Support seen near 1.25.

Brazil is the major exception in EM with regards to disinflation. Mid-May IPCA inflation is due out Wednesday, and is expected at 6.49% y/y vs. 6.51% y/y in mid-April. Price pressures are slowly turning lower, with IGP-M wholesale measure at 7.3% y/y in April vs. the 8.3% y/y peak in February, and preview readings point to a May rate near 6.2% y/y. Consumer inflation still remains at the top of the 2.5-6.5% target band and is high enough for the central bank to have to act, however.

The next COPOM meeting is May 28/29, and another 25 bp rate hike to 7.75% is expected. USD/BRL traded with a 2.04 handle on Friday, the first time since January 23, before falling back a bit today. Still no intervention from BCB, which twice this year has offered swaps to support the real when USD/BRL was trading near current levels. If BRL weakness continues due to inflation concerns, it may be time to send a friendlier signal to the markets with a stronger accompanying statement on May 29. So far, officials have appeared quite reluctant to tighten.

Spanish Banks: New Look at Restructured Loans

noreply@blogger.com (Marc Chandler) — Mon, 20 May 2013 07:33:50 PDT

Germany, the tightfisted task master, is encouraging Spain to draw down more than the 40 bln euros it already has of the 100 bln euro line secured from the ESM to recapitalize its banks. Spain's budget minister denies there is a need. Germany does not typically encourage countries to take on more debt needlessly. We suspect by late Q3 or early Q4, Spain will, however reluctantly, take Germany's advice as it will likely need more funds for its banks.

The continued decline in house prices, the contracting economy and high unemployment point to the likely increase in bad loans. While this may be generally appreciated, another problem is emanating from loans to households and businesses that have already been restructured.

The issue is that the loans have been restructured mostly because the borrower cannot service their debt. Banks seem to be hiding the full extent of the damage by classifying the restructured loans as if they are performing normally, in an example of "extend and pretend" or "delay and pray".

According to official statistics, Spanish banks have restructured loans of about 208 bln euros. Over a month ago, the Bank of Spain told the banks to review the classification of the restructured loans immediately. Apparently, either the banks were moving to slowly or were finding serious problems, or a combination of both.

Last week, the central bank gave banks until September to reclassify the restructured loans according to tougher guidelines. In particular, it shifted the onus of proof: restructured loans will be assumed to be substandard unless proven otherwise. The substandard classification requires greater loan loss reserves.

Overall Spanish banks have restructured about a seventh of their loan book (~208 bln euros) About a quarter are mortgage-related and another third or so are loans to non-real estate companies. Household and government loans account for about 40%.

Of these restructured loans, about 37% are considered "doubtful" and 21% are "substandard". The problem is with the 40% that are classified as performing normally, by which banks can avoid provisioning.

Spain's three largest banks account for a little less than 40% of the restructured loans. At the end of last year, Santander had almost 30 bln euros of restructured loans in its portfolio, BBVA had about 23 bln euros and Caixabank had almost 20.5 bln.

Some estimates suggest as much as 50-60% of the restructured loans should be classified as substandard or less. This will require greater provisioning. Some banks will be able to do so through retained earnings, but others, especially some of the smaller and weaker banks may find it more difficult.

Spanish banks have already transferred 50 bln euros of bad (toxic) assets to Sareb, the bad bank that has been established. Difficulties into valuing these assets continues and finding buyers is also proving challenging. In March, the government said Sareb was planning on selling 1.5 bln euros by the end of this year. Wilbur Ross, the US billionaire, has become more impressed with Spain's efforts and, seems to reversed his stance in October last year by telling Bloomberg TV today that he is considering investing in a Spanish bank or acquiring a Spanish loan portfolio.

The outlook is far from certain. House prices have fallen by 40% from their peak six years ago. S&P recently warned that prices can slide another 20% over the next four years. Moody's warned today that Spain's residential mortgage backed securities were continuing to deteriorate. On the other hand, Santander said last month that the real estate market was nearing a bottom.

In terms of non-performing loans, the government estimates that the ratio edged slightly higher in March to 10.3%. However, if one were to include the loans transferred to Sareb, part of the restructured loans discussed above, and the roughly 60 bln euros of foreclosed real estate assets, the non-performing loan ratio could rise toward 20% and nearly 30% of GDP.

Amari and Holidays Spur Consolidation in FX

noreply@blogger.com (Marc Chandler) — Mon, 20 May 2013 03:50:14 PDT

Most of continental European markets are closed today for Whit Monday and Canadian markets are closed for Victoria Day. With important data and central bank officials speaking later this week, the market is content to keep most of the major currencies within the ranges seen before the weekend.

The yen is an exception. Comments by Economic Minister Amari that the correction to the yen's weakness is nearly complete, and additional yen weakness may be harmful, hit a thin pre-Asia market that saw the dollar spike lower to just below JPY102 before recovering. This was seen as first attempt by the Abe government to slow the yen's descent. The motivation does not come from abroad as much as Japanese officials trying to stabilize the bond market.

Officials have tried changing the tactics of their QE purchases, making more frequent though smaller transactions, as the dealers wanted, but this appeared to have limited impact. At the end of last week,the BOJ injected a large amount of short-term liquidity and this seemed to help stabilize the tone, but the 10-year yield is up a few basis points today and almost 10 bp over the past week, making it the worst performing major bond market during that period.

The dollar has found support near JPY102.40 in the light European session. The JPY103 area may offer the immediate cap. The BOJ's two day meeting concludes tomorrow and some more guidance from Kuroda is expected. Earlier today the Abe government upgraded its assessment of the economy and the BOJ may do likewise tomorrow.

Despite the rise in the yen, Japanese equities extended their bull run, with the Nikkei gaining about 1.5%, led by oil and gas, utilities and telecoms. Financials and health care were the only two sectors showing weakness.

European developments are thin, but two developments seem noteworthy. First, Italy reported its first rise in industrial orders in five months. The 1.6% gain in March industrial orders was nearly three times more than the consensus expected. The premium Italy offers over Germany on 10-year money is near the lowest this year just above 250 bp.

Second, over the weekend, Bundesbank President Weidmann repeated his criticism of France, that it has a special responsibility to set and example and achieve its fiscal targets. This brings Weidmann in direct conflict with the Germany government, which he was once a part. Finance Minister Schaeuble has given his approval of giving France more time to achieve the 3% target. Nevertheless, Merkel and Schaeuble are likely to be pleased privately of the BBK's position.

However, it does raise some questions over what happens after the September election. Contacts in Frankfurt have been mulling the possibility that Weidmann moves over the finance ministry in the next government. While interesting, it never struck us as very likely. Yet given Weidmann's comments, his appointment would likely be both a cause and effect of a deteriorating relationship between the once two pillars of Europe.

While North American dealers may also be content to spend the session in a the consolidative mode, the dollar bullishness seems strongest here. They will likely take cues from the US Treasury market where the 10-year yield is again nearing the 2.0% level.

Central Banks Dominate Forces of Movement in the Week Ahead

noreply@blogger.com (Marc Chandler) — Mon, 20 May 2013 03:05:40 PDT

The most important force that has lifted the US dollar across the board is the sense, encouraged by official comments, of the potential divergence in the trajectory of monetary policy between the US and most of the other major high income countries.

In particular, the pendulum of market psychology has swung back toward speculation of tapering off of QE-related asset purchases by the Federal Reserve. At the same time, ECB officials continue to indicate they are carefully considering a negative deposit rate. Many still expect the Bank of England to resume its gilt purchases program and new initiatives on its forward guidance in Q3 after Carney takes the helm.

Meanwhile, Carney and the Bank of Canada continue to push further out when they anticipate full capacity will be reached and when it will remove some accommodation by increasing interest rates. The recent string of economic data, including prices, has been generally softer than expected and the forward guidance the central bank has offered is becoming less credible. Additional easing by the Reserve Bank of Australia is expected, though the recent sharp drop in the Australian dollar appears to be tempering expectations of a rate cut as early as next month.

Japan’s quantitative and qualitative easing is not even two months old. It is far too early to suggest a reassessment, though Q4 12 GDP was revised up and Q1 13 GDP came in stronger than expected and may be revised after Japan releases the latest capex figures in early June. Capital investment was an unexpected drag on Q1 GDP and may be adjusted higher.

Although there are several important pieces of economic data in the days ahead, including UK inflation and retail sales reports, euro area flash PMI readings, German IFO, Japan’s latest trade figures, US durable goods orders, the focus is on the central banks.

The Fed’s Dudley and Bollard speak on Tuesday, but the real interest is on Bernanke’s testimony on the economic outlook on Wednesday. Comments by regional Fed presidents who do not vote this year on the FOMC has helped fan speculation of tapering off of Fed purchases in Q3. Bernanke is likely to reiterate that the Fed is vigilantly watching the impact of QE on the financial markets and risk-taking generally. However suspect it is too early for Bernanke to signal a shift in the pace of QE. Not only has the full impact of the fiscal tightening this year not yet been fully transmitted, but also the decline in core inflation readings suggests no strong urgency to alter the pace of the asset purchases.

There are at least eight ECB officials that speak in the coming days, including Draghi and Weidmann on Thursday. The official line is that the ECB is technically prepared to adopt a negative deposit rate, and there were rumors last week that it had contacted at least one bank to discuss.

Most analyses seem to focus on the potential unintended consequences. More problematic, we suspect are the unforeseeable consequences to financial disintermediaries of policies that frankly have not been tried by other major central banks. In addition, shrinking margins and attempts to secure deposits may become more challenging, for example, and could lead to new borrowing from the ECB or ELA (emergency lending assistance).

Moreover, the intended benefits—to bolster lending, especially to small and medium size businesses-- may be elusive in the face of soft demand and recessionary conditions in much of the euro area, including several core countries. We expected that when the cost/benefits have been analyzed, the ECB will decide to refrain from pushing the deposit rate below zero.

The BOJ is the only major central bank meeting this week. Its two day meeting concludes Tuesday. For the most part BOJ Governor Kuroda must be fairly pleased. The growth is sufficient that the BOJ is likely to revise up its assessment of the economy. Inflation expectations, as revealed in the break-even rates of its inflation linked bonds have increased. The yen has weakened and the Nikkei has rallied. International resistance has been quite modest despite the traditional and social media playing up the “currency war” metaphor.

The main problem has been the Japanese government bond market. The increase in yields seems considerably earlier and more dramatic than officials anticipated. The marked increase in volatility is poses a significant threat to some market segments whose investment strategies that are particularly sensitive to shifts in value-at-risk models.

Just like the low vol environment encouraged investors such as banks and leveraged accounts to trade large size, the increase in volatility is forcing them to reduce exposures. This aggravates the lack of liquidity and tends to reinforce the increase in volatility. The BOJ has already tried to alter is asset purchases, making smaller and more frequent transactions.

Officials may steps up their verbal assurances and large scale injections of short-term liquidity did help stabilize the JGB market at the end of last week. Economic Minister Amari's comment that the yen's weakness has been corrected and additional weakness may be counter-productive, suggests heightened concern about the bond market.

Minutes from the recent Reserve Bank of Australia’s meeting that resulted in a 25 bp rate cut will be released. We look for the minutes to reiterate the statement issued after the rate cut. Previously, the RBA had identified scope to ease and they used part of that scope. This still leaves the door open to additional rate cuts. Concerns about the impact of the strength of the Australian dollar may seem a bit dated given the recent slide in the Australian dollar, though by most measures, it remains significantly over-valued.

The BOE publishes minutes from the recent MPC meeting on Wednesday. The minutes will likely echo the sentiments of the latest quarterly inflation report in which the BOE shaved its inflation forecast and lifted its growth forecast. In April, three MPC members, including the governor, voted to resume gilt purchases. They have failed to persuade a majority. With stronger economic data and the proximity of Carney’s ascension, it will be interesting to see if there were defections from the minority.

At the BOJ, Kuroda was able to secure a majority in favor of new and more aggressive quantitative easing, even though some similar measures had been previously rejected by the same board. The Bank of England is horse of a different color. The thinking seems to be more independent. Critics have harangued about Governor King’s management style, but he is a rare species of central bank heads that has allow himself to be outvoted on several occasions. Carney may find it more difficult than Kuroda in bending the central bank's monetary policy to his will.

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.