Marc to Market

Greece: The Unvarnished Truth

noreply@blogger.com (Marc Chandler) — Mon, 28 May 2012 10:04:29 PDT

A series of weekend polls in Greece showed some movement in the electorate and put the New Democracy ahead of Syrzia. This is important because which ever party comes in first gets an extra 50 seats in the 300-seat chamber. The polls suggest the New Democracy and PASOK could retain the reins of government.

Yet a false dilemma has been presented. It is most assuredly not Schaeuble's way or the highway. It is not a choice of austerity or leaving monetary union. It is not adherence to the memorandum of understanding or being isolated in Europe.

The fact of the matter is even if New Democracy's Samaras becomes the next prime minister of Greece the terms of its aid must and therefore will be renegotiated. Two recent reports confirm that Greece's trajectory is well off the agreed path.

First, tourist revenues fell 15% year-over-year in Q1 and the news appears even worse in Q2. The controversy following the election saw 50,000 booking canceled, according to press reports. Some are estimating that Q2 tourist revenues may have fallen 20%. Tourism accounts for almost a fifth of Greece's economy.

Second, tax revenue fell 10% in May. This is not simply a function of tax avoidance, but it also reflects the imploding economy. In 2011, some 20% Greece's small and medium sized businesses lost money. This year estimates suggest as much as 60% will lose money.

The memorandum of understanding assumed that more efficient tax gathering efforts would boost revenue. It also assumed tourist revenues would be flat. On both counts, terms need to be adjusted.

Although Tsipras' style may be objectionable, his underlying argument seems correct. Greek officials have played their weak hand poorly. This seems even more true following the PSI that halved the holdings of the private sector. The official sector refused to participate, which, while understandable, complicates the situation.

It means that almost three quarters of the debt Greece owes is to official sector--ECB, IMF and EU. A unilateral moratorium, which Tsipras reportedly threatened, would hit the Troika hard. The ECB would likely need to be recapitalized. The IMF would find it more difficult to raise fresh funds. The EU would be ridiculed as well as poorer.

Yet it is also true that any effort to reduce Greece's debt burden going forward must focus on the official sector. Of course, a fallout from a Greek exit and a moratorium on its debt servicing would hurt European banks and sovereigns; some due to direct exposure, others indirectly.

One recent poll had nearly two-thirds of Germans opposing keeping Greece in the monetary union. Officials there do have not done a sufficient job explaining the costs Germany would incur if Greece left. Germany frankly does not have a choice of washing its hands of Greece and not putting in good money after bad.

The unvarnished truth is that Greece is going to cost Germany (and others) whether it is in EMU or not. The unvarnished truth is that the decision not to allow Greece a proper default (which would have included the official sector) means it is still not on a sustainable fiscal path. The unvarnished truth is that even if the old elite in Greece is able to put together a new government, its memorandum of understanding needs to be re-crafted.

Memorial Day Update

noreply@blogger.com (Marc Chandler) — Mon, 28 May 2012 04:10:49 PDT

The US dollar is broadly lower in relatively subdued activity. The major development over the weekend that has encouraged some reduction of risk averseness is several polls in Greece that showed the New Democracy pulling ahead of Syriza. Global equity markets are mostly higher, with the MSCI Asia Pacific Index gaining about 0.75% and the most European bourses are up the same or more.

Spain’s IBEX is the exception to the generalization. Modest losses are being recorded, with the financials the largest drag, following news before the weekend that Bankia needs not 4.5 bln euros, 9 bln euro, or even 15 bln euros that had been hinted at, but rather 19 bln euros.

Fresh developments on the ground are light today and largely limited to BOJ minutes from the April meeting which saw a small tweaks in the asset purchase plans, but more concern from board members that the central bank ought not be seen monetizing the government’s debt. Japan also reported April service prices, which were flat, but still posted the first year-over-year increase 3.5 years.

Italy raised about 3.5 bln euros by selling debt. It was forced to pay higher yields, reflected the heavier tone in the secondary market. Separately, it reported erosion in business confidence, which follows the poor consumer confidence report last week.

In addition to the Greek polls, there were a few polls of note. First, in the parliamentary elections next month in France, the center-left parties appear to be doing well. There has been some suggestion that the UMP may join forces with Le Pen, but the rank-and-file apparently are less keen. Second, a poll in the Netherlands warns that the 5 parties that supported austerity are beginning to be punished by waning support. The election is not until mid-September, but opposition to further austerity appears to be growing in this country that has insisted an austerity elsewhere.

Third, a poll in Germany saw a large one week shift against Merkel’s CDU. The gap between the CDU and SPD now stands at about 2 percentage points. Domestic political concerns are often an unspoken influence on Merkel’s European stance. Fourth, the latest reports suggest that Ireland approve of the fiscal pact at this week’s referendum.

The New Zealand and Australian dollars are benefiting the most from the easing of risk aversion. Both are up nearly 1.2% near midday in London. They had been beat up the most in recent sessions and the recovery looks corrective in nature. The euro and sterling over above last Friday’s highs, but follow though buying was limited. The euro ran out of steam near $1.2625 and sterling near $1.5720. The yen remained firm, despite the corrective pressures and losses on most of the crosses, the greenback slipped to about JPY79.35.

The highlights of the week ahead include PMI readings, the Irish referendum, and expected 50 bp cut in the Selic rate by the central bank of Brazil and US employment figures. The US employment figures may take on extra significance ahead of the June FOMC meeting where there is still some speculation of another round of asset purchases. Recall that April job growth was the weakest in six months. The early (prior or ADP estimate) is for 160k private sector jobs after 130k in April. A significantly worse report could fan expectations, especially after the University of Michigan consumer confidence report showed a decline in 1 and 5 year inflation expectations. On balance, we continue to expect some compromises to be worked out that keeps Greece within monetary union and we do not expect the FOMC to announce QE3.

Speculative Positioning and Technical FX Outlook

noreply@blogger.com (Marc Chandler) — Sat, 26 May 2012 08:24:56 PDT

The intensification of the European debt crisis continues to overwhelm all other considerations in the global capital markets. The corrective bounce we anticipated on May 17 largely fell shy of the technical objectives as the European officials appeared to continue to drift toward a Greek exit. In addition, the flash PMI readings from the euro zone and the German IFO warned that the regional economy cannot count on German locomotive here in the second quarter.

Regardless of the particular policy response by officials, stronger growth in the core (fueled by domestic demand) and a weaker euro would provide a more conducive environment for addressing the crisis. Although the wishes of officials do not drive currency prices, weakness of the euro should be understood as both the symptom of the crisis and also an attempt to cure, like a fever in person.

We remain concerned that market positioning and sentiment are stretched. Equities, emerging markets and most commodities have fallen sharply. Core bonds markets have rallied. The dollar and the yen have been the best performers in the foreign exchange market.

The latest Commitment of Traders report covers the week through May 22 and covered the short-lived bounce in the foreign currencies. Speculative players generally added to short foreign currency futures (euro and Swiss franc) or cut long positions (sterling and Canadian dollar). Of note the net speculative positions in the Australian dollar and the Mexican peso switched from long to short.

Before turning to the analysis of the positioning in the currency futures, a reminder is in order. The foreign exchange market is overwhelmingly an over-the-counter market. The most recent survey by the Bank for International Settlements puts the average daily turnover at around $4 trillion. The futures market is a small component.

We analyze the Commitment of Traders report (here is a link to last week's analysis) because we find it offers insight into a segment of the market whose activities provide directional views, unlike say corporate hedgers or some money managers who see the foreign exchange market as a transactional vehicle (necessary to buy foreign assets).

Speculators in the futures market may be a microcosm of trend followers and momentum players in the larger foreign exchange market. This means that although there is a record short euro position, there is no “natural” limit. The current gross short position has a notional value of about $30 bln. The over-the-counter market’s average daily volume of the euro-dollar currency pair is around $1 trillion.

Euro: The net short speculative position increased to 195.4k contracts, which is an increase of 21.5k contracts. Approximately 3.8k longs capitulated, while the shorts gained 17.7k contracts (to 230k contracts). Long commercial positions rose to another record of 308.3k contracts. Commercials are thought to largely be hedgers. That they have a growing long position in the futures market suggests commercials may be increasingly short euros in their underlying businesses.

The fundamental news stream gives the euro shorts no cause for concern. The new lows recorded in the euro were not confirmed by the relative strength index or the slow stochastics. This divergence should discourage new shorts from entering, but bounces look to be limited. The $1.2600 area offers initial resistance. The recent high near $1.2830 seems too distant to be relevant in near-term. The $1.25 level was breached only sufficiently to trigger some option structures and stops, but assuming it goes, the next immediate target would be near $1.2380.

Yen: The net short yen position was nearly cut in half from 34.3k contracts to 18.0k. This was mostly a function of shorts being redduced by 13.3k contracts. Some bottom pickers emerged and the longs grew by 3k.

The dollar looks to be caught in the JPY79.00 to JPY80.50 trading range. It has not closed above its 20-day moving average against the yen since late March. It was near JPY79.80 on May 25 and is falling a few pips a day. The yen is the only G10 currency to have gained against the dollar here in May, though it was by an inconsequential 0.18%.

A note of caution is in order as the dollar’s 5-day moving average is poised to cross above the 20-day average. Although this simply cross over “system” is not immune from being whipsawed, it has caught both the dollar’s rally from mid-Feb to late-March and its sell-off. The downside momentum appears to be faltering and the downtrend line drawn off the March high above JPY84 comes in near JPY80 and will likely be respected by trend followers.

Sterling: Last week we suggested that the late sterling longs were vulnerable. Unlike the euro, Swiss franc, and yen, a net long sterling position had been built in recent weeks. They were culled in the reporting period that ended on May 22. The net long position was more than halved to 11.3k from 25.0k contracts. This was primarily longs leaving; they fell by 16.6k contracts. Shorts were trimmed by 2.9k contracts.

Sterling’s 3.5% loss this month through May 25 makes it’s the second best performing currency against the dollar (behind the yen). The $1.5640 area represents a 61.8% retracement of the rally off the mid-Jan lows. This has been taken out on an intraday basis, but sterling has not closed below it. The $1.5600 offers backup support. The new lows in sterling, unlike, what we saw with the euro, were confirmed by the relative strength index. The $1.5725-50 area may offer initial resistance.

Swiss franc: The Swiss National Bank’s determination to put a cap on the franc’s appreciation is being tested in the spot market as safe haven is sought. The SNB does not appear to be fighting speculators as much as savers fleeing the euro zone. In the IMM futures, the net speculative short position continued to grow. Now at 34.9k contracts, it is the largest in several years. This was produced by a 4.2k cut in long franc contracts and a rise of 6.9k short contracts. The gross short position stands at a little less than 40k contracts and has essentially doubled this month.

Given the SNB’s refusal to allow the Swiss franc to find a price that clears the market, one’s franc view solely determined by one’s euro view. Yet perhaps in some ways the franc’s chart is clearer. A convincing dollar close above CHF0.9600 would encourage players to target CHF1.000. If the dollar move to parity with the Swiss franc and there is no real movement in the franc against the euro, that would put the euro near $1.20.

Canadian dollar: The net long Canadian dollar position fell to 38.6k contracts from 51k in the previous reporting period. Not only does the Canadian dollar suffer in a risk off environment, but we have warned that the market is likely getting ahead of itself in pricing in a rate hike this year. The speculative players cut longs by 8.7k contracts, but at 55.6k, the gross long position remain the largest in the futures market. Top pickers in the Canadian dollar continue to creep in as shorts rose by 3.7k contracts

Neither market positioning nor technical indicators suggest the greenback’s advance against the Loonie is over. Initial support for the dollar is pegged near CAD1.0200. The near-term upside extends toward CAD1.0420.

Australian dollar: The longs capitulated and drove the net speculative position to the short side for the first time in three years (March 2009) and at almost 17k contract, it is the largest net short position since September 2008. Longs were cut by 42% to 30k contracts and shorts rose by a mere 565 contracts (to almost 47k).

The risk-off environment, sell-off in commodities, concerns about the pace of slowdown in China, and expectations of additional aggressive easing by the Reserve Bank of Australia makes for a poor fundamental backdrop for the Aussie. Yet at the end of last week, as the euro fell to new lows and equities struggled to sustain uptick, the Australian dollar did not make new lows after briefly dipping below $0.9700 on May 23. If this stability can be sustained over the next few sessions, some technical readings may turn in its favor. The $0.9830 area will likely be the initial cap.

Mexican Peso: The net speculative position switched from long to short pesos in the reporting week that ended on May 22. It is the first net short position since mid-January. The flip to 16.1k net short contracts form a net long 14.4k contracts was a function of both longs getting out (13.4k contracts) and shorts coming in (17.1k contracts).

The peso has lost about 7.25% against the dollar thus far this month. It has suffered in this risk-off environment. There does not appear to be a significant chart point until MXN14.30 now. If the dollar does not continue to rise in the coming days though, the relative strength index will likely show some (dollar) bearish divergence. Initial support is seen near MXN13.92.

Note on Spain: Regions and Banks Compete for Attention

noreply@blogger.com (Marc Chandler) — Fri, 25 May 2012 10:02:30 PDT

NOTE: after this post, S&P announced it was cutting the ratings of 5 Spanish banks--and affirmed the ratings on nine others, keeping a negative outlook on five. A couple ( Banco Popular and Bankia) are below investment grade.

News that Spain's Catalonia region is seeking support from Madrid provided the headline trigger to the euro's slide and risk-off in North America after a quiet European morning. The euro slipped through the $1.25 level, triggering some stops and optionality only to bounce quickly back, which seems to be frequently the case after barriers are triggered.

The news is a useful reminder of one of our larger points. The flash points in Europe are extend well beyond Greece, which has captured everyone's imagination. Spain problems may be partly exacerbated by the tensions over Greece, but rest assured they are primarily home grown. It also follows that ejecting Greece will not solve Europe's troubles and arguably exacerbate them.

The immediate challenge in Spain is turn two-fold: The banks and the regions. The cost of supporting Bankia has risen from 4.5 bln euros to at least 13 bln and the risk is that the eventual cost is greater.

This seemed to be the story of the day, until Catalonia's news hit. This region has the largest amount of short-term debt, with 21 bln euros maturing within two years. It needs to refinance 13 bln this year alone. Catalonia also has the largest deficit among Spain's regional government.

Catalonia is not the only region have funding problems. It was just a week ago that the Rajoy government approved all of the region's 2012 budgets except Asturias, which was given two extra weeks to submit its budget. We argued at the Rajoy government was not seizing upon the opportunity to gain greater control of the region's finances.

The amount of funds that the regions need has steadily risen as older past due obligations are added up. EU staff are expected to be in Madrid next week to get better transparency of what is happening on the regional level, in light of the recent upward revision of last year's national deficit to 8.9% (cf Greece's deficit was 9.1% of its GDP).

While Catalonia's news today overwhelmed the Bankia developments, more negative news on Spanish banks should be expected shortly. Last month, S&P indicated its intention to resolve the negative outlooks on many Spanish banks by the end of May.

The euro bounced by around half a cent after taking out the $1.25 barrier, but it means that next time through there may be a more sustained break. Market positioning and sentiment is stretched, but the headline risk, as today's news from Catalonia indicates, remains on the downside.

Seeking Redemption in Europe

noreply@blogger.com (Marc Chandler) — Fri, 25 May 2012 06:24:03 PDT

Currency in Crisis

Last November, the Germany's economic advisor council, known as the Wisemen, recommended a redemption fund in the euro zone as an alternative to joint bond proposals and as a strategy to put the region's debt on a sustainable path. At the time, proposal seemed to die an ignoble death, but it has been resurrected this week. Reports suggest that just yesterday Merkel conceded she would re-examine the proposal.

The redemption fund proposal has a few components. Countries would segment their debt. That which is over 60% of the countries' GDP would be placed in the fund. It would be mutualized (jointly and severely guaranteed) in exchange for very aggressive commitments to retire that debt in 20-25 years and would only be open to countries not yet receiving funds from the EFSF/ESM.

The initial proposals suggested the redemption fund could be as much as 2.3 trillion euros and backed by the region's gold holdings. While some are suggesting the proposal is really a euro bond with a different moniker, it is probably better to think of it as part of a stronger firewall, especially for Italy. Italy's debt above 60% of GDP is equivalent to about 1 trillion euros, which would alone account for more than 40% of such a redemption fund.

The fact that Germany itself would be the second biggest participant, with its debt in excess of 60% accounting for about 500 bln euros. Its participation would reduce stigma that could be associated with the redemption fund.

In exchange for participation, countries would have to agree on a strict fiscal plans, likely even more stringent than current commitments. Some estimates, for example, suggest that in order for Italy to brings its debt to GDP to 60% in two decades would require it to run a primary budget surplus of more than 4% a year, assuming 4% refinancing costs of the debt covered by the redemption fund and 5% for the remaining debt and assuming nominal GDP grew 3% a year.

And even with this relatively optimistic assumptions the 4% primary budget surplus for a prolonged period of time would risk a potent political backlash.

We continue to believe that the condition for a joint bond in Europe is greater fiscal union. Countries have to become more willing to part with fiscal sovereignty. The redemption fund is one form that it could take. The German government and the opposition parties are set to meet again on this on June 13. It could be Germany's counter-proposal at the EU Summit at the end of June.

The devil as always is to be found in the details. How much fiscal sovereignty must be sacrificed? How large of a primary surplus is required and for how long? Is it politically sustainable ?

EU President Van Rompuy encouraged members to think big and that nothing should be taboo. Instead of the best minds thinking of ways to minimize the fall out from an imagined Greek ejection (since a vast majority do not want to leave), perhaps more brainpower should be devoted to creating a roadmap toward fiscal union. And if monetary union and fiscal union, then why not political union, a United States of Europe, if you will ?

Calmer Tone Ahead of the Weekend

noreply@blogger.com (Marc Chandler) — Fri, 25 May 2012 04:01:02 PDT

A nervous and fragile calm has settled over the global capital markets. The dollar has been thus far confined to yesterday's ranges against sterling and the euro, and attempts to push the dollar higher faltered against the yen and Swiss franc, leaving the greenback is narrowly mixed on the day. European equities are mostly slightly firmer, though of note the financials are outperforming the broader market. Most bond markets are firmer as well.

As German rate have collapsed--illustrated by the 2-year offering this week with a zero coupon that was oversubscribed--there has been increased talk of fund managers moving into Belgium, France and Austria markets to secure somewhat better yields. Ironically the divergence in the periphery is produced a type of convergence in the "core", The French premium over Germany in 10-year yields has come in from about 146 bp on May 17 to 101 bp earlier today. While hardly his doing, Hollande must be quite pleased with this market development.

The fundamental news stream from Europe remains poor, but the technical tone and extreme market positioning suggests a more cautious stance. The break to new lows yesterday in the euro failed to be confirmed by the relative strength index. This divergence suggests short-term participants will have a better opportunity to sell the euro. The same is true of the Swiss franc, where the dollar pushed through the CHF0.9600 level for the first time in a year briefly earlier in the session. Against the yen, the dollar faltered at the 20-day moving average (~JPY79.80). It has not closed above this average since March 30.

Last Friday, Spain's Bankia shares were up nearly 25%. Today the shares have been suspended amid reports suggesting that it is preparing to request 15 bln euros in aid. Recall the sequence of events. On May 9, the Bank of Spain announced the formal nationalization of this bank that was a combination of seven savings banks. The central bank converted 4.5 bln euros of preferred shares into common to give it a 45% stake. Earlier this week, the government warned the rescue costs could be 9 bln euros. The price tag seem to keep rising.

This is reminiscent of what happened in Ireland. Officials terribly underestimate the cost of taking over the banks. We have argued this is particularly true of countries that experience asset bubbles. Real estate prices have not stopped falling in Spain and "troubled" loan ratios continue to rise and with it, the cost of cleaning up Spain's banking system. Stay tuned.

Some of the funds leaving the euro zone appear to be headed to Switzerland and this is challenging the SNB's commitment to prevent the euro from falling through the CHF1.20 level. There has been talk of large scale intervention this week, but often the market has exaggerated the size of SNB operations, judging from the highly opaque reserve figures. There are many ways that a central bank can disguise its operations. It can intervene in the swaps market, for example, and the forward market.

Intervention is not the only tool that Swiss officials can deploy. There was reportedly a meeting in Italy yesterday, where Swiss officials suggested the possibility of retroactively taxing undeclared Italian funds in Swiss accounts. There is also some concern that France's Hollande's pledge to impose a 75% tax on income over one million euros will lead to some French funds fleeing to Switzerland too.

Moody's cut the long-term and deposit ratings of two Swedish banks (Nordea and Svenska) by one notch (to Aa3)and an agriculture bank (Landshypotek) by two notches (to Baa2), and reverted to stable outlooks for all. It confirmed the rating of SEB and Swedbank. The rating agency expressed concern about funding, asset quality and modest profitability. The market appeared to take Moody's announcement in stride and Swedish bank shares traded mostly firmer and the krona is firmer in the foreign exchange market.

Earlier Japan reported national consumer prices that were largely in line with market expectations. April CPI rose 0.4% year-over-year after a 0.5% increase in March. Excluding fresh food and energy, Japan remains stuck deflation; prices are 0.3% lower than a year ago. Tokyo CPI which is for May shows no relief. Tokyo deflation deepened to -0.5% from -0.3% in April. The measure excluding food and energy stands at -1.3% compared with -1.0% in April.

As noted here yesterday, the sell-off in energy prices and the nearly 8% appreciation of the yen on a trade-weighted basis since mid-March will only add to the deflationary pressure. The BOJ seems reluctant to expand its asset purchase program. Political pressure on it will likely mount, especially if the economy begins faltering again.

Great Graphic: Greece and Euro Zone Macros

noreply@blogger.com (Marc Chandler) — Thu, 24 May 2012 10:23:57 PDT

Here is a Great Graphic from Thomson Reuters depicting the Greek economy in comparison with the overall euro zone. The fact that Greece so under-performed Europe since on set of the crisis is well known and appreciated. However, it is noteworthy that Greece was generally under-performing even prior to the crisis. The crisis has exacerbated the divergence.

In addition, it seems that the difference between Greece and the euro zone is a question of degree not kind. Admittedly, a sufficiently quantitative difference can have a qualitative difference.

The differences between Greece and the euro area tend to get most of the attention. Investors may also find it helpful to consider what the two have in common. The common element of Greece and many other countries in the euro area is the lack of international competitiveness. The debt seems to be "simply" be an expression of that fact.

It seems somewhat politically naive to think that Greece can be removed like a tumor and the rest of the body politic will be saved. It is not the case that the Greek problem metastasized and that is what ails the rest. Portugal, Ireland, Spain, Italy and France have their own home grown imbalances. Unfortunately, if Greece was not serving as the lightening rod, some else would.

Yen Drivers and CPI

noreply@blogger.com (Marc Chandler) — Thu, 24 May 2012 09:18:43 PDT

Japan reports April CPI on Friday. The national headline rate is expected to be 0.4-0.5% after the 0.5% reading in March. This was the highest since November 2008. The BOJ's target is 1%. No one really expects the target will be achieved in this year or next. The fall in commodity prices and the rise of the yen (nearly 8% on a trade weighted basis since mid-March) warns that deflationary pressures may be rekindled.

Tokyo reports May inflation figures and the headline rate was last positive (0.1%) on a year-year-basis in July 2011 and before that November 2010 (0.2%). Price in Tokyo are expected to have fallen by 0.3%, the same pace as in April.

BOJ Governor Shirakawa seems to be in no hurry to take more aggressive steps to ensure that the inflation target is reached. The BOJ passed on the opportunity earlier this week. It did not even lengthen the maturity of the bonds it is willing to buy after banks failed to sell it the amount of 1-2 year notes it was committed to buying.

He noted the upward revisions to the economic assessment and suggested that the battle against deflation will be fought with its current asset buying program. Nevertheless, should the positive national inflation figures begin trending down, and the economy weakens, an extension of the current asset purchases program cannot be ruled out.

The yen itself appears to be driven by the general investment climate. The downgrade of the sovereign rating did not have much more than momentary impact on the yen. The knock-on effects of the European debt crisis seems to be the single large factor driving the yen.

Like Shirakawa, we often find the yen correlated with 2-year interest rate differentials with the US. As the interest rate differential narrows the yen tends to strengthen and vice versa. That correlation (60 day) stands at about 0.78 presently). The small interest rate differential (19 bp) means that that the smallest incremental move is deceivingly large in percentage terms, we ran the correlations on the level. In absolute terms the interest rate differential is just below 20 bp, which is near a 2-month high.

To look at the yen's relationship to the risk environment, we reviewed the yen's correlation with the US S&P 500, the proxy for risk assets. The yen is inversely correlated with the S&P 500 (60 day percentage change) at -0.43. This is the greatest inverse correlation since September 2010.

Since methodologically we conducted the correlation with interest rate differentials on levels and the correlation with the stock market on percentage change basis, the two are not directly comparable. However, to satisfy inquiring minds, we found that yen's correlation with the 2-year spread on the percentage change basis is about the same as with the S&P 500 (~0.44).

The dollar found support near JPY79. The dollar has spent little time over the last few weeks above JPY80. The dollar has not finished the NY session above its 20-day moving average since the end of March. It comes in now around JPY79.80.

Dollar Stabilizes, Europe News Stream Poor

noreply@blogger.com (Marc Chandler) — Thu, 24 May 2012 05:12:05 PDT

The US dollar is little changed is little changed against most of the major foreign currencies, European equities have higher, gold and oil prices are firmer. It is as if investors are taking a breath after recent aggressive activity. The dollar initially extended its gains before the momentum faded in the European morning.

It was not the news stream, which was poor to say the least. The flash European PMI and German IFO warns that even the German economy may be fizzling. UK Q1 GDP was revised down. Yet by the news hit the euro selling appears to exhaust itself in near $1.2520. The $1.2600 area remains the proximate ceiling and needs to be overtaken to stabilize the technical tone.

Here is a quick summary of the data:

· Euro area mfg PMI 45.0 in May vs 46.0 in April

· Euro area non-mfg PMI46.5 vs 47.9

· German mfg PMI 45 vs 46.3

· German non-mfg PMI 52.5 vs 52.6

· French mfg PMI 44.4 vs 46.9

· French non-mfg 45.2 vs 45.2

· German May IFO 106.9 vs 109.9

· UK Q1 GDP -0.3% vs -0.1% initial estimate

The euro zone PMI that the service sector seems to be stabilizing at lower levels, but the manufacturing continues to fall. The German IFO appears to be finally converging with the PMI. The engine in Europe may be beginning to sputter and this ironically may not only be saying something about Europe, but China as well, which is replacing France as Germany’s largest trading partner.

The UK GDP is worth looking at more closely. Consumption was weak, but there were two pockets of strength to note within the otherwise poor report. First, business investment is strong, rising 3.6% quarter-over-quarter. The market had expected a decline. It is up 14.2% year-over-year. This is remarkable and may be related to the Olympics. In any case, it does not seem sustainable.

The second pocket of strength is even less expected. Government spending under the austerity regime rose 0.6%. The market was expected a flat reading. It is the largest rise in Q1 08. This is the mirror image of what we have noted about the US. Even without a formal coherent fiscal strategy, the government sector has been a drag on US GDP.

Lost in the Grexit focus, yesterday the euro zone reported its current account and portfolio capital flow figures for March. The 10 bln euro inflow in February was reversed into a 35 bln net euro outflow. Deconstructing the net flows reveals that foreign investors bought 2 bln of euro zone debt and 22 bln euros of equities. European investors exported 60 bln euros, mostly in buying foreign bonds and money markets. Meanwhile, concerns that deposits in euro zone banks, especially including Spain and Italy are fleeing has spurred some talk of EU-wide deposit insurance, though it seemed that joint bonds received more discussion at yesterday's informal EU summit.

This is providing a challenge for the Swiss National Bank. It cost of maintaining the euro=Swiss floor at CHF1.20 is apparently becoming more expensive. Market talk suggest significant euro purchases have been made in recent days by the SNB. Recall though the SNB diversifies its reserves away from the euro.

In March, the most recent breakdown of reserves shows 51% are kept in euros, with the dollar receiving 28%, sterling 5%, the yen 9% and the Canadian dollar 4%. Although the SNB is known for its financial prudence, 3% of its reserves were in "other" currencies, which for the SNB includes not just the Australian dollar and Danish krone, but also the Singapore dollar and Korean won.

EU Summit Dinner Ends: No Dessert

noreply@blogger.com (Marc Chandler) — Wed, 23 May 2012 17:39:39 PDT

The euro came off in a knee-jerk fashion following the conclusion of the EU Summit dinner. The press statements indicate that nothing concrete came of it, but it did raise the stakes for the end of June formal summit. Since midday in the US on Wednesday, the euro has been in a clear $1.2550-$1.2600 range. The euro went from the top end of the range to the bottom after the European officials spoke and then quickly rebounded again. A move above $1.2600 gives $1.2650, but the $1.2700 area is the important hurdle which needs to be surmounted to begin stabilizing the technical tone.

There does seem to be a consensus emerging for a larger more active European Investment Bank and project bonds. Details have to be worked out. There also is a consensus for making it easier for countries to access cohesion funds. The ECB clearly came under stronger pressure to do more to support European bonds, but it was quickly added that the central bank's independence was respected. This is the eleventh consecutive week that that ECB does not appear to have bought sovereign bonds (but who's counting?).

Eurogroup head Juncker massacred the English language by noting that the discussion over joint euro bonds was "not unheated." And it was clear from Italy's Monti that a majority of members want them. However, as we have cautioned this is not something that will be decided by simply a majority vote.

The real dividing line in Europe is between creditors and debtors. Simply, if crudely put, the debtors cannot simply force the creditors to extend them more credit. Current treaties would have to be re-written. The creditors' position is clear: a common bond is the end point of fiscal integration, and most assuredly not the starting point.

There also appeared to be an agreement that structural funds will be made available to Greece. This is important even if the amount and conditions are not known. It is a tacit admission that there was not sufficient efforts made to help Greece grow (support aggregate demand) while it instituted austerity. This is the fifth consecutive year that the Greek economy is contracting.

This should help the more moderate forces in Greece presently. In addition, some support from a couple political parties that did not secure sufficient votes to enter parliament in the election earlier this month for the New Democracy (ND) may also help turn the tide. The first round and the subsequent world reaction may have been a catharsis for understandably malcontent Greeks. Some may be done punishing the ND (though maybe not PASOK) and the intensity of the issue may encourage greater turnout, which should also favor a moderate outcome.

Yet the election is still several weeks away. It is difficult to see the market maintaining this kind of momentum until then. When I first suggested that there was a risk of a dollar pullback (May 17), I suggested potential for the euro initially to $1.2785-$1.2850. The euro topped on May 21 just below $1.2820. Initially I thought pullback in Europe and Asia on May 22 was a "correction within the correction. I identified a break of the $1.2700 area as negating the constructive technical outlook. That said, I remain concerned that positioning is stretched and the key event is still some time away and officials seem intent on trying to walk the jumper off the edge. This tells me the waters may be more treacherous than it may appear by simply looking at the price action.

EU Summit Dinner Menu: Indigestion

noreply@blogger.com (Marc Chandler) — Wed, 23 May 2012 16:42:35 PDT

The EU informal summit will be held over a dinner and despite the attention it is receiving, it still seems unreasonable to expect anything concrete. Negotiating positions will be staked out, but most of the issues will require greater negotiations. June or even July seems a more likely time frame for yet another "comprehensive solution."

A so-called Latin-bloc of France, Italy and Spain cannot force Germany to accept joint bonds. Germany has the treaty on its side. The current treaties bar joint bonds. The agreement that establishes the ESM also seems to rule of direct lending to banks.

Nevertheless, we continue to believe there is room for compromises. The scope for compromise that seems most realistic is 1) allowing countries extra time to reach fiscal targets, 2) expanded EIB and project bonds for infrastructure/public investment, 3) provide easier access to cohesion funds and 4) EMU-wide guarantee for savings deposits. The last point seems to be a bit of a stretch.

Contrary to media reports of the isolation of Germany, the creditors in euro zone, which include Finland, Austria, Netherlands and Germany (FANG) appear to have largely uniform positions on these issues. Indeed, instead of haranguing the FANGs to concede to the demands of the debtors, the focus should shift from today's summit to under what conditions and terms would allow the FANG countries to accede to joint bonds.

The ultimate answer is clear: fiscal union. What is most desirable then is a road map for how to get there from here. There are a number of steps that are needed besides treaty changes. Essentially countries have to surrender considerably more fiscal sovereignty. There are three key components.

First, some collectivity, like the EU, needs to approve budget plans prior to national parliamentary consent. Second, various degrees of surveillance is needed during the implementation process, with pre-agreed corrective measures. Third, a larger stick is required for those who still fall short of objectives. The creditor countries have to feel confident that their wealth and credit will not be sucked away the imprudence of their neighbors.

Some wistful observers suggest that EMU was a mistake and the crisis is a creation of EMU itself. We demur. While conceding that the contours of the crisis and policy response were shaped by monetary union, we suggest that the ultimate causes lie with the global credit cycle.

We identify two spurs to EMU. The first is the post-WWII European elite strategy of greater integration. EMU is a culmination of an evolution that goes back to the 1950s. The second is the fall of the Berlin Wall, which raised anew the more than 150 year old challenge of making room for a united Germany within Europe.

We are the first generation to experience peace on the European continent and those that would jettison EMU have not proposed an alternative strategy of insuring that peace. In the 19th century, or perhaps even in the first part of the 20th century, Greece's default would have been grounds for an actual invasion of soldiers not an army of bureaucrats.

Without currency union, the loss of competitiveness in the periphery (but also France) may have been recouped through currency devaluations, but only temporarily and the underlying lack of competitiveness would re-emerge with vengeance. Germany and the creditor countries would be less well off and the periphery would not necessarily be better off.

Some observers write about the crisis as if it were a murder mystery, "Who killed Europe?", they ask. The UK, France, Germany and the US, where the credit bubble was first to pop, are often blamed. Yet, we wonder if another force is at play that would have squeezed the periphery in any event. The periphery's role in the European economy was as a source of unskilled labor. The rise of China and emerging markets more generally have challenged unskilled labor around the world, not just in the periphery of Europe, but in the US and UK too.

The bottom line is that today's informal EU summit is not the real thing. It is out of the late June summit that a new effort will likely emerge. Hollande's negotiating hand may be strengthened by a strong showing in the parliamentary elections. Ireland is likely to pass the referendum on the fiscal pact later this month. The Greek election of course is the wild card, but even if the New Democracy is able to form a new government, and a couple small parties are joining it will help, the current memorandum of understanding, will have to be adjusted, as has been the case previously, to recognize the slower growth and lower tax revenues.

Dollar Snaps Back

noreply@blogger.com (Marc Chandler) — Wed, 23 May 2012 03:29:31 PDT

The US dollar is broadly higher in Asia and Europe. Comments by Greece's Papademos put the cat among the pigeons and the euro, and the foreign currencies more broadly, have been unable to recover. We had anticipation a correction and although we got it, we had expected it to continue a bit longer and deeper. The speed of the reversal is leaving many, including ourselves a bit off balance. That said, the short-term momentum readings are stretched and it appears to require new negative news to keep the upward momentum intact.

Few probably are as surprised as Papademos by the impact of his comments. Essentially he seemed to say that a Greek exit is possible but disastrous, and acknowledged some preparation. The alternative is years of austerity, he said. The only exception we would take with that assessment is that austerity of some magnitude will be necessary even if Greece leaves the EMU and repudiates all of its debts, including to the official sector. That is the point.

When it came to sterling, we countered arguments that ongoing M&A activity was responsible for its relative strength, noting that mergers and acquisition take a period of time to be funded and that often it is for shares not cash and even when it is for cash, sterling is often borrowed rather than bought. Yet today, news that Germany's SAP will pay $4.5 bln cash for US-based Ariba is thought to have added weight on the euro.

It is possible that with the new lows being recorded that the euro's drop to $1.2615 completes the down move. However, the pace at which it fell and the fragility of sentiment warns of the risks of such a call. It may be best now to wait for some technical confirmation that a near-term low is in fact recorded.

Sterling itself has been undermined by two developments and they both point to increased likelihood of a new round of gilt purchases as early as next month. First, the BOE minutes seemed to indicate that the decision not to extent QE last month was a close call--which gives more credence then to the new data. And that has been favorable for QE, which brings us to the second development: horrific retail sales. The 2.3% decline in the month of April is roughly three times larger of a decline than the market expected and more than offset the 2.0% rise in March.

Separately, note that Deputy PM Clegg indicated that the government is putting together a large state-backed investment program for housing and infrastructure. Although it was suggested that this has long been part of the government's plans, it does seem to be parallel with the shift in tone in EMU as well.

Sterling fell to about $1.5680, bringing this month's loss to about 3.8%. Of note, the $1.5640 area corresponds to a 61.8% retracement of the rise off the mid-Jan lows. The $1.5750 area now offers resistance and needs to be overcome to stabilize the technical tone.

The Bank of Japan may have surprising some participants by standing pat. There has been pressure on the BOJ to do more to support the economy. We also noted the technical issue of the Japanese banks not allowing the BOJ to buy as much 1-2 year notes as it was committed to under its asset purchase plan. This, we thought, increased the risk that it would extend the maturities it purchases. Not.

Separately Japan reported a JPY520 bln April trade deficit. This was about 10% larger than the consensus. However after seasonal adjustments it came in at JPY480 bln, which was considerably smaller than the JPY617 bln expected. Exports rose 7.9% year-over-year, while imports rose 8%. The year-over-year comparisons are flattered by last year's disasters. Auto exports, for example, are up about 220% year-over-year.

Moreover, Japan's export growth is function of a better US economy. Consider that Japan's exports to the US rose almost 43% year-over-year. Shipments to its largest trading partner, China, are off 7% and off 2.6% to all of Asia and off nearly 2% to Europe.

The recovery of the yen seems to be mostly a function of the general risk appetite more than specific Japanese news, which taken together also seems somewhat supportive of the yen.

ELA Does not Stand for Exaggeration, Lies and Assumptions

noreply@blogger.com (Marc Chandler) — Tue, 22 May 2012 14:48:15 PDT

ELA is the acronym for Emergency Lending Assistance. This is direct lending by the national central bank, with ECB authorization to local banks with more liberal collateral requirements. The national central bank is responsible/liable for the funds not the euro system.

Last week when the ECB announced that four Greek banks were no longer able to borrow from the ECB, this forced them to borrow from the Greek national central bank's ELA facility. This in turn created confusion and all sorts of imaginary thinking.

Some have suggested that the ELA is a precursor to the issuance of Greece's own currency. Whether Greece leaves the monetary union or not, the ELA is not the decisive element. This facility is not the beginning of a new Greek drachma or a Geuro or Gyro as some have suggested.

Nor is it secret like some in the media have suggested. Moreover, contrary to some impressions, the central bank of Greece is not the only euro area central bank that is drawing the ELA. Amounts more than 500 mln euros require ECB approval. A 2/3 majority can block or veto the use of the ELA. In addition to Greece, Ireland and Cyprus appear to be the other users currently, though it appears Belgium may have also drawn on it temporarily in dealing with Dexia.

The amounts involved seem quite modest. There is about 140 bln euros outstanding under ELA, of which two thirds is accounted for by Greece. However, part of what is happening in Greece is that the banks are in the process of being recapitalized under the second aid package. An 18 bln euro payment to them is expected by the end of the week. This will help reduce the ELA borrowings.

It would be much more significant if the ECB refused to grant Greece ELA privileges. There are three things the ECB can do to force a country to exit the euro zone: deny them the ELA, prevent the country's banks from borrowing at the ECB, and denying them access to Target 2 settlement system. There is no sign that the ECB is trying to force Greece out of monetary union.

The ELA in Europe functions as a national level lending facility that is approved by the ECB, but responsibility is borne by the national central bank. It more like a discrete discount window that has different collateral rules than a secret parallel currency or monetary system.

Europe has sufficient challenges and one need not invent more. The ELA is neither a precursor of the demise of EMU nor a tell that Greece is about to leave. The opposite is more true. The ECB has most recently increased Greece's ELA limit and the recapitalization of Greek banks will help reduce its usage.

Feint and Parry and the Three No's

noreply@blogger.com (Marc Chandler) — Fri, 25 May 2012 02:37:11 PDT

In the diplomatic dance in Europe, investors are rightfully confused what is a feint and negotiating tactic and what is parry or strategic principle. A new French president and changing tone in Europe appears to have re-opened debates that had previously seemed closed. The range of possibilities all of the sudden seems large again--joint bonds, recapitalization of banks from the ESM, more aggressive ECB support for the sovereign bond markets.

Yet there is more and less here than meets the eye. In order for Hollande to maximize his negotiating position, he must press ahead with elements he knows full well that Germany cannot accept. By pressing ahead he can win concessions in other areas.

We have argued that "three no's" characterize the investment climate in Europe. No collective euro bond. No ECB backstop for sovereigns. No euro zone break up. Although the risks of a Greek exit would appear to have increased, this formulation still seems appropriate.

Germany cannot agree on a jointly guaranteed bond now. It is the fruit of fiscal integration not a means to that end. Putting the cart before the horse would jeopardize Germany's strategic interests. Germany would in essence be offering a blank check to its neighbors. It remove the pressure on countries to institute structural reforms. If some one else is going to pay for (part) of your spending, then there is less incentive to be responsible. Joint bonds now would bring Europe no closer to is goal of a solid sustainable fiscal position, from which non-debt driven growth can proceed.

Hollande cannot, though, simply not discuss it because Germany is opposed. That would not be politically savvy. France sees its interest to have joint bonds. Sarkozy did. Hollande does. In order for France to sacrifice its interest, it ought to get something in exchange.

On the other hand, EFSF bonds and bonds that the ESM will issue and the EU bonds and EIB bonds are joint issues. These coupled with the fiscal compact are what we have called the "scaffolding" of a fiscal union. Some observers argue that monetary union has failed and it will disintegrate. We have argued to the contrary that the resolution will be greater integration rather than less.

It took the fall of the Berlin Wall and that threat of a united Germany for countries to overcome their nationalism and surrender monetary sovereignty (though they have retained central banks, suggesting that monetary unification is not complete). It may require the worst financial crisis in a couple generations and the threat of fiscal ruin to get countries to overcome their nationalism and surrender fiscal sovereignty.

When European countries get their fiscal house in order and future excesses blocked, then a European bond can be agreed by Germany. German officials, most recently deputy fin min Kampeter, and previously Asmussen and Stark have all suggested those are the only terms that are acceptable.

France's new finance minister Moscovici seemed to acknowledge the importance of the German position, even though the OECD seemed support euro zone bonds just today. Yesterday Moscovici was quoted on the news wires saying that although France still supported euro bonds, it recognized that this could not be forced on others. Germany, of course, is not the only country that is opposed to euro bonds. So is Austria and Netherlands.

We continue to insist that there still is plenty of room for compromises. France keeping items like euro bonds, and a more aggressive and pro-growth ECB makes a compromise more likely rather than less. There does seem to be a consensus emerging for a reinvigorated EIB, easier access to cohesion funds and structural funds and project bonds. It was reported just yesterday that Spain will get faster access to about 1 bln euros from the EU cohesion funds for environmental and transport infrastructure projects.

Our key point here is that the discussion of joint bonds is a bargaining chit for France (and others) to win more concessions from Germany. The austerity will be joined by some more efforts to promote growth and public investment. Joint bonds will be the result of greater fiscal integration not the cause of it. In the larger sense, rather than the contradictions in the euro zone being resolved by dissolution, we continue to think that way forward will be greater integration and increasing encroachments on fiscal sovereignty.

Correction within the Correction

noreply@blogger.com (Marc Chandler) — Tue, 22 May 2012 04:01:15 PDT

The US dollar is broadly higher today. The key question for market participants is whether this is the beginning of the resumption of the greenback's bull move or is it a simply part of the market churn. Given market positioning and the fact that the Greek election is still a month away, we are viewing today's price action is as correction within the correction. As long as euro holds above $1.27 (equates to dollar resistance near CHF0.9450) this more benign view of the price action should be preferred.

Last Friday and yesterday, the dollar weakened in the North American session. Today has the makings for a three-peat. The intraday technical show the dollar's bounce in Asia and Europe has left it over-extended and while additional modest gains are possible, the bulk have likely been scored.

There are four developments to note, leaving aside the new OECD forecasts.

First, Fitch downgraded Japan to A+ and retained a negative outlook. It cited the high and rising public sector debt ratios and noted the leisurely pace of fiscal consolidation. Lack of more serious efforts could lead to further downgrades, it warns. While the yen softened in response, there was little impact in the debt market, where the vast majority-- around 90%--of Japanese debt is owned domestically. The dollar moved up to JPY79.85, but the it may have peaked or nearly so, ahead of the lower end of the band of resistance that begins near JPY80. Initially, support is seen in JPY79.40-50 area.

Second, UK inflation was a bit softer than expected with the CPI up 3.0% from a year ago in April compared with 3.5% in March. This is the much anticipated base effects as the monthly gains was spot in line with the 0.6% consensus forecast after the 0.3% rise in March. A range of different measures in addition to the headline, including the retail price index with and without mortgages and the core rate are at 2-3 year lows.

This will be understood as increasing the likelihood of a resumption of gilt purchases as early as next month, though on the day, UK gilts, like German bunds and US Treasuries, are trading slightly heavier today. Note that the IMF calls for more stimulus from the BOE (It has also called on the ECB to cut rates). Sterling's retracement is a bit deeper than the euro's. Initial support is seen near yesterday's low around $1.5730.

Third, Germany holds a 2-year note auction tomorrow. It set the coupon today of zero. In the cash market the generic two year note is yielding 6 bp. Five billion euros will be sought. Some recent German auctions have not been covered and the zero coupon risks limited participation. Nevertheless, the low yield reflects German safe haven status. The US pays a premium of 23 bp and Japan, yes Japan pays 3-4 bp premium to Germany.

Fourth, reports indicate that Greek banks will receive 18 bln euros for recapitalization purposes at the end of the week. This is important because it shows there is not effort to cut Greece off from the European banking system. It means the Greek banks be able to borrow from the ECB again. That in turn means that the usage of the Emergency Lending Assistance (ELA) can ease, and hopefully with that the rather silly talk that ELA was either counterfeit or the beginning of the new drachma.

Shifting Agenda and Ideological Rigidities

noreply@blogger.com (Marc Chandler) — Mon, 21 May 2012 08:27:54 PDT

Over the weekend, Germany's I.G. Metall reached an agreement with employers in Baden-Wuerttemberg for a wage increase that will likely set the tone for other regions and industries. The 4.3% pay increase covers the year from May 1. However, the previous contract expired at the end of March, so the new deal really covers 13 months, which puts the annual pay increase at just below 4%. Initially I.G. Metall demanded a 6.5% pay increase.

German officials, including Fin Min Schaeuble called for stronger pay increases. The I.G. Metall deal follows the Ver.di (the largest non-manufacturing union) deal that got state workers a 6.3% pay increase over two year.

The Ver.di deal is estimated to cost tax payers 7 bln euros, which is the same cost to employers the I.G. Metall deal if it covers all 3.6 mln workers. However, the degree that this boosts domestic demand rests on what workers will do with the pay increase. If it is used to boost savings, the direct impact may be minimal.

However, there is another channel to consider. Since 2007, nominal wage growth in Germany has average 1%, whereas the euro zone average is nearer 2.7%. Higher German wages can, if not offset with productivity gains, will boost Germany's unit labor costs. This is turn will help other countries become relatively more competitive. This rather than the BBK softening its anti-inflation resolve, as the Financial Times recently claimed, seems more promising.

More broadly, the substance and tone of the political rhetoric from Europe is changing. For the first time, there seems to be a broad recognition the seemingly one-dimensional push for austerity has reached its political limits. Moreover, a bloc appears to have emerged that can check Germany. The leaders of this bloc appear to be Hollande and Monti from the heads of state and Barroso and Rehn at the EU.

It is all fine and good for Merkel to maintain that growth and austerity opposite sides of the same coin, and of course, she is right to some extent. However, they can also be sending opposite impulses and in short-run austerity can undermine growth.

Midweek European heads of state meet. Hollande's election appears to re-opened issues that were previously thought to have been resolved. Hollande, like Sarkozy before him, apparently pushing again for a collective bond There is also new talk of allowing the ESM to recapitalize banks. It was intended that only sovereigns can borrow from the ESM with conditionality. The issue of a collective guarantee of bank deposits is also back in discussion.

However, Germany strategic interests have not changed. It cannot allow a collective bond without tighter fiscal rules, otherwise Germany is handing a blank check to its neighbors. Germany cannot allow banks to borrow directly from the ESM, because this would deny the ability to use the funds to ensure reforms are adopted.

There is room on other issues to compromise. We continue to believe that investors are not fixated on a particular fiscal target in a particular time frame. Ultimately, we believe investors are interested in a plan and a commitment to implement it. There is the political desire and legal scope to allow countries another year to reach the 3% deficit/GDP target. There is also room to compromise on the EIB, structural funds and even project bonds.

Investors must jettison ideas that renegotiation is grounds for expulsion. Greece is not the only country that seeks to renegotiate. Italy and Spain have already indicated they will not achieve this year's agreed upon targets. Indeed, Spain's news at the end of last week that its 2011 deficit came in at 8.9%, not the 8.5% it previously estimate and well above the 6% agreed upon target making this year's new target of 5.3% unlikely to be reached without additional herculean efforts. No one is talking of ejecting Spain or Italy

Ireland wants to renegotiate the terms of its bank bailout, but there is no effort to eject it from EMU. In the Netherlands, the latest polls suggest the tide is turning against additional austerity measures. Wilders' Party of Freedom participated in the previous government, yet he continues to object to what he calls "subservience to Brussels". There is no talk about forcing the Dutch out.

Whereas the institutional rigidities in the euro zone are widely recognized, the key rigidity may be in the realm of ideology: the sanctity of contract. As the Keynes scholar Lord Robert Skidelsky (and professor Marcus Miller) reminded us in last week's op-ed in the Financial Times, this willingness to sacrifice everything in the name of contractual agreement bedeviled Keynes both at Versailles and later. In 1918 Keynes wrote that "We shall never be able to move again, unless we free our limbs from these paper shackles. Even stronger still, Keynes writes in 1923: "The absolutists of contract...are the real parents of revolution."

We anticipated the corrective/consolidative phase in the foreign exchange market and expect it has not run its course yet. However, over the medium and longer term, we expect the euro's decline to resume--not only as the crisis grows, but a weaker euro will help in the resolution of the crisis as well.

FX Outlook

noreply@blogger.com (Marc Chandler) — Mon, 21 May 2012 03:28:08 PDT

The week begins off with a consolidative tone. It was the alignment of technical and fundamental factors following the election results earlier this month that allowed for the strong trend moves in the foreign exchange market. Arguably the most important consideration is that the divergence between the two has emerged. While a resolution of the European crisis is not imminent, the combination of extended positioning, the price action before the weekend, and official attempts to talk the market away from the edge of the abyss, warns the short-term momentum and trend following participants may be further squeezed, creating a new opportunity to medium term investors.

Since the middle of last week, we have warned of heightened risk of a technical correction. We see the euro having scope toward $1.2850-$1.2900. This gives sterling space toward $1.5880-$1.5930. Provided the JPY79 are holds, the dollar can recover toward JPY80.00-JPY80.50. The initial pullback against the Canadian dollar can see CAD1.01, while the Australian dollar already tested initial resistance near $0.9880.

Market participants remain fixated about the possibility; some would say likelihood, of a Greek exit from monetary union. Some of the recent speculation has focused not on Greece pulling out but being pushed out.

Although there is no formal mechanism to eject a member, there are ways that life can be made unbearable. The ECB is the key. It can do two things. First, it can stop lending to Greek banks. Second, it can deny the central bank of Greece the ability to provide Emergency Lending Assistance (ELA). It is widely thought that most Greek banks have run out of collateral that ECB is willing to take, which limits the ability to take the first step. That leaves preventing an extension of the ELA. The ECB, to the contrary, has moved in the opposite direction. Reports indicate that early last week, the ECB agreed to increase Greece’s ELA ceiling to 100 bln euros from 90 bln. Recall that that Greek bank recapitalization is to be funded by the second aid package and an 18 bln euro payment is expected by mid-week.

The recent events in Greece and Spain have fanned concerns that depositors will flee and trigger an old fashioned bank run. The Financial Times reported that some 5 bln euros have left Greek banks since the election, which is about 3% drawdown. If this were to continue, it underscores our warning that a part of the Greek economy may remain euro-ized even if it leaves EMU. Spain’s Bankia was subject to rumors of depositor flight last week and although they were met with denials by Spanish officials, investors remain on edge. The LTROs reduced the roll-over risk that the euro area banks faced. That has little to do with an institution’s ability to withstand large scale withdrawal by depositors.

The EU informal summit this week will likely see old issues re-opened, including a common deposit insurance, allowing ESM to recapitalize banks directly, common European bonds, and the dramatically ramped up efforts by the ECB to backstop Spanish and Italian bonds (as argued by the Polish foreign minister in today’s Financial Times).

Supportive comments from the G8 meeting, news that Germany’s I.G. Metall reached an agreement with employers in Baden-Wuerttemberg for a 4.3% wage increase (which technically covers 13 months, as contract starts May 1, previous contract expired at the end of March), which is well above the German inflation rate, and the realization that the ECB is not cutting Greece off (ELA, Target 2) works in line with the technical correction we envision.

The main data this week is the flash euro zone PMI, which is expected to stabilize albeit at levels consistent with a recession regardless of the fact that Q1 GDP was flat. In the UK, soft inflation data may encourage speculation for another round of gilt purchases. Meanwhile, the a story still unfolding is French mortgage lender Caisse Centrale du Credit Immobilier de France (3CIF), which Moody’s downgraded on a standalone basis last Thursday has speculation of an imminent nationalization.

We note that Japanese banks failed to sell sufficient 1-2 year bonds to the BOJ last week and this raises the specter of the BOJ announcing a lengthening of maturities under its JGB purchase plan at the conclusion of its two-day meeting on Wednesday. While the recent string of US economic data seems consistent with a downward revision to Q1’s 2.2% initial estimate, a better showing is now expected for Q2. The Philadelphia Fed report was disappointing, but investors will watch carefully if it is repeated in this week’s reports.

Finally, we note that the European debt crisis appears to be having an impact on Treasuries of a QE operation. Ten year yields are near record lows and yields have fallen for nine consecutive weeks. The seven year note yield did fall to record lows last week. The 2-10 yr curve has flattened and is near its flattest since the end of 2008.

FX: Speculative Positioning and Technical Outlook

noreply@blogger.com (Marc Chandler) — Mon, 21 May 2012 03:34:29 PDT

The heightened risks to the European monetary union following the election results in both Greece and France earlier this month continued to drive the foreign exchange market. In the week through May 15, speculative participants in the currency futures generally either added to shorts or cut longs.

Although the fundamental drivers have not changed, the technical condition of the market has. We began warning of the risk of an upside correction for the major currencies in the middle of the week. On May 18, the euro and the Swiss franc posted what is technically a potential key reversal. Both currencies traded below the previous day’s low (and when doing so, made new lows for the move) and then rallied above the previous day’s high and managed to close above those highs.

Sterling did not record a key reversal, but after selling off sharply earlier in the session and then rallying to close at its highs, a bullish hammer pattern in Japanese candle sticks was recorded. To be sure, both the key reversals and hammer require some follow through action for confirmation. However, a key take away is that our reading of the technical condition of the market is more constructive than our fundamental assessment.

While medium term investors may be best served to continue to focus on the underlying fundamentals, technical indications suggest a better opportunity to position for those fundamentals may be seen over the near-term. Medium terms investors need not chase the market.

Euro: The net short speculative position jumped to a record of almost 174k contracts in the week that ended May 15 from 144k the prior week. This was purely a function of the establishment of new shorts, which grew by a little more than 32k contracts. At 212k, the gross short euro position is also a record. Those apparently trying to pick a bottom in the euro rose 2.4k contracts.

Anticipating the extended nature of market position, the fact that the Greek election is a month away, and that officials would likely try to pull sentiment away from the edge of the abyss, led to our expectation for a technical recovery in the euro. A move now above $1.2805 could spur a move toward $1.2850-$1.2900 initially.

Japanese yen: With increased speculation that EMU may be on the verge of dissolving and German 2-year interest rates half of what they are in Japan, it is not very surprising that the net speculative short yen position was trimmed. The net short position fell to 34.3k contracts from 41.1k the previous week. Long yen positions grew by a 1.1k contracts. The shorts were cut by 5.7k contracts.

Cross rate demand for yen against the euro, sterling, and the Canadian and Australian dollars weighed on the greenback against the yen, despite talk that Japanese officials were preparing for intervention. The dollar may see some support in front of JPY79, while a break will encourage a move to JPY78.30. Important resistance is now seen in the JPY80.00-50 area.

British pound: Sterling fell through most of the week covered by the latest Commitment of Traders, but the net speculative position hardly changed. Sterling has fallen for 10 of the 14 sessions this month thus far. Yet, in the latest reporting period, the net long position fell about 300 contracts to 25.0k. Longs were shaved by 2.2k contracts and the shorts were trimmed by 1.9k. The subsequent slide in sterling after the end of the reporting period warns that more of the gross longs were likely cut. They remained substantial on May 15 at almost 57.5k.

In the second half of last week, the combination of soft economic data, dovish comments by the Bank of England and speculation that gilt purchases (QE) may be resumed as early as next month, saw sterling slide in the spot market. If the recovery before the weekend sees follow through gains, the first real test for sterling is seen in the $1.5880-$1.5930 band.

Swiss franc: We recognize that the Swiss National Bank’s effort to prevent franc appreciation against the euro has generally been successful. The SNB succeeded in deflecting speculative attention away from the franc. Speculative participants have, at least for the moment, given up playing the franc from the long side, even though there remains a high level of anxiety. They are choosing instead to play the franc from the short side.

The net speculative short franc position jumped to 26.7k from 16.5k contracts. This is the largest net short position since September 2007. The gross shorts grew by 11.3k contracts to stand at almost 33k. This is the largest gross short franc position since Oct 07. The gross longs increased by 1.1k. The dollar is likely to encounter bids near CHF0.9385, but near-term potential extends toward CHF0.9310.

Canadian dollar: The net long speculative position was cut by about 15% to 51k contracts. This was a function of both longs getting out (-3.6k) and shorts getting established (5.5k). The net and the gross long Canadian dollar positions are the highest among the currency futures.

The Canadian dollar did not participate in the foreign currency bounce ahead of the weekend, and in fact the US dollar settled near session highs against the Canadian dollar, which is near the best level since mid-January. The underlying fundamentals remain constructive for the Canadian dollar. The strength of the recent employment report coupled with the firmer than expected CPI data on May 18 should help underpin expectations that the Bank of Canada is likely to be the first to raise rates within the G7.

Medium term participants should stay alert for a new opportunity to build Canadian dollar exposure. However, a recovery in the Canadian dollar would seem to require a stabilization of equities. While the decline in oil prices may not be doing the Loonie any favors, it is the performance of the S&P 500 that appears to be taking a bigger toll. Note that the over the past 60 days, the Canadian dollar’s correlation (percentage change) with the S&P 500 is near 0.80 while the correlation with oil is about 0.58. Over the past 30 days, the correlations are 0.84 and 0.61 respectively. Risk extends toward CAD1.03.

Australian dollar: One of the most notable aspects of the Commitment of Traders report was the despite the Australian dollar’s slide over the reporting period, the net speculative position remained long. To be sure, it was sharply reduced from 25.1k contracts to 4.7k, which is the smallest net long position since March 2009. The gross longs were culled by nearly a third to 51.1k from 72.2k contracts. The shorts were pared by a few hundred contracts to about 46.3.

The Australian dollar, like its Canadian counterpart, did not participate in the pre-weekend recovery against the dollar. It has not managed to close above its 5-day moving average since the end of April. Speculation that the Reserve Bank of Australia, which delivered a 50 bp rate cut earlier this month can follow up with another 50 bp cut in early June maybe a bit rich. It has declined nearly 5% already this month and if a corrective phase is indeed at hand, the Aussie should participate. The first hurdle comes in around $0.9880-$0.9910.

Mexican Peso: Risk aversion helped encourage a dramatic adjustment of position and the net long position was slashed by nearly 2/3 to 14.4k contracts. The longs were cut by 17.5k contracts, while the shorts grew by almost 5k. Mexico’s macro-fundamental outlook appears relatively constructive and the nearly 6% loss this month reflects the heightened anxiety throughout the capital markets, more than a Mexico-level development.

The peso, like the Canadian dollar, is higher correlated to the S&P 500 than oil and the first sign of stability in equities may see the peso recover. Initial support for the greenback is seen near MXN13.70 and then MXN13.50.

Spain: Double Barrel Disappontment

noreply@blogger.com (Marc Chandler) — Sun, 20 May 2012 11:21:55 PDT

The fact that Spanish bank shares have rallied today (3.1% at pixel time) and have easily outperformed the market (IBEX up 0.3%) following Moody's downgrade of 16 Spanish banks should be understood as a bit of a fluke. Some observers will use this price action as evidence that rating agencies are laggards. While there can be little doubt that the epithet is true, it is also true that today's correction comes despite some other bad news as well. This was in the form of the Bank of Spain's latest assessment that bad loans in the banking system rose in March to 8.37%.

That means that another 8.2 bln euros in loans soured in Q1. In turn this means that the 30 bln euro that Spanish banks are being required to add to their loan loss reserves will not be sufficient to cover this year's deterioration if it does not slow down. And there is no reason to expect it to slow as the recession deepens and real estate and house prices do not appear to have bottomed.

Moreover, the independent audit on Spanish banks will likely reveal weaker rather than stronger institutions. The stress tests themselves will be conducted in two parts, according to reports. The first is a stress test that will take about a month to complete. The second and more important aspect is a detailed analysis of the banks' assets.

There had been some hope among investors that BBVA and Santander (which by some measures is the largest bank within the euro zone) would be able to escape the fate of the sovereign, which Moody's recently cut to A3. After all, these two banks have diversified globally and by doing so diluted the impact of Spain's domestic economy on their corporate success. Sometimes, a company can have a higher rating than the sovereign, but this was not such a case. Moody's slashed BBVA and Santander by three notches to match the sovereign rating.

The other area of disappointment comes from a lost opportunity for Madrid to get a tighter hold on the regional fiscal situation. As we have consistently argued here that the solution to the euro zone problems will come from greater integration rather than less, the same applies to Spain itself, which is the most decentralized member of monetary union.

The regions account for around half of government spending and are responsible for health care and education, but it is Madrid that collects most of the taxes. Ironically, while Moody's downgrade of the banks is the subject of much discussion, considerably less attention has been given to its decision to downgrade four of the regions at the same time.

Yesterday. Madrid approved the 2012 budget plans of all the regions except tiny Asturias, which has yet to form a government after the recent election (sounds familiar?) and has been given a 15 day extension. The regional budgets include 13 bln euro in spending cuts and 5 bln euro in revenue increases. Spending cuts will have to focus on education and health care.

This is not the end of the story. By the middle of June the regions are expected to outline their 2013-2014 fiscal plans to Madrid. In July, Madrid will unveiled a new mechanism to assist the regions that are meeting their fiscal targets in securing financing.

New "hispanobonos" may be issued, which in effect will be regional debt underwritten by Madrid. The ICO (Instituto de Credito Oficial) is government's development bank, created in the 1970s. Institutional capacity (scale) needs to be build but the function in there. It has already raised 60% of this years 20 bln euro target. By the end of June it will provide regions with 7 bln euros to cover unpaid bills and 5 bln to cover bond maturities.

Moreover, as a bank, the ICO can borrow from the ECB and secure lower cost funding that it has to buy currently in the market. In some ways then the ICO may serve a similar function as the EFSF/ESM does for the euro zone as a whole.

While this development seems promising, it may be too little too late. Catalonia and Valencia are the two most indebted regions, with their respective debt equaling a fifth or more of their GDP. They each face sizable debt repayments over the next few weeks. The latter has lost its investment grade rating from S&P and has been forced to pay 6-7% to roll-over short-term bills over the past couple of weeks.

Prime Minister Rajoy missed an opportunity. Despite the short-term price action, Madrid did not get ahead of the curve here. Some observers argue that Europe should allow Greece to leave and the crisis that follows will provide powerful incentive to others not to go that route. In China, they call such tactics, killing the chicken to scare the monkeys. Madrid failed to do that.

Rayjoy hinted at more decisive action. Three regions offered him a opportunity to take stronger action and to get ahead of the curve of expectations. Madrid could have in effect nationalized Asturias, where an interim government has not agreed on a spending program.

He could have "nationalized" Valencia to save it from itself, using its lost of investment grade status and exorbitant interest rates as the rationale. Lastly, and more risky politically, Rajoy could have found some pretense to reject Andalucia's budget, which was already rejected once. It is the most populated state and one where Rajoy's Popular Party had failed to capture in a recent election.

In another parallel to the larger monetary union, the Stability and Growth Pact has existed since EMU began. In response to the violations, members have been asked to agree to a new and tougher fiscal pact. A new one may not have been needed as much as the enforcement of the existing one.

The same is true in Spain. The problem has not been that the rules were not clear. The problem lies with implementation and application which Madrid's new agreement and mechanism does not seem to convincingly address.

This means that like the banking reform announced last week, there is a lack of closure and that assures that these issues will have to be addressed again.

Half Dozen Observations as Week Winds Down

noreply@blogger.com (Marc Chandler) — Thu, 17 May 2012 20:40:14 PDT

This has been an important week in terms of price action throughout the capital market. The down draft in the equity markets, most foreign currencies, most commodities, is both a cause and effect of rattled investors.

Often it seems that market sentiment tends to overshoot in one direction and then the other. Sentiment is clearly in one direction. It remains to be seen if it is overshooting. There are six observations that we'd like to share as you think about not only this week but next week.

First, the recent post here suggests there is increased risk that sentiment is indeed getting ahead of itself. Yet the steady drum beat of negative news from Europe, the single most important force shaping the investment climate, continued on May 17th with Moody's slashing the rating of Spanish banks and several regions. While new lows for the euro (and other currencies) were recorded, the market failed to sustain the downside momentum. If the elections in France and Greece gave one a green light to sell euros, the price action's reaction to recent poor news, is flashing an amber light. This is not to be understood as recommending one should buy euros. Rather it means that the bears may want to avoid chasing the euro lower at this juncture. Sell into bounce may seem like banal, but we are warning that the technical conditions increase the risk of such a bounce.

Second, the yen surged and this has sparked some speculation that the BOJ is poised to intervene. We suspect this is not very likely, even though the decibel of the official rhetoric has increased and the Noda government is interventionist in principle as last year's large scale unilateral intervention reflected. What appears as yen strength is likely to be understood at the highest levels as really euro weakness. Japan also just reported the strongest GDP for Q1 among the high income countries. Many European countries would be happy with for their economies to grow in a year what Japan's did in the Jan-March period. The 1.0% quarter-over-quarter pace is a 4.1% annualized pace. The US, by comparison grew 2.2% annualized, but subsequent data warns of likely downward revisions. German expanded at half the pace as Japan. Judging from the recent past, it takes the dollar to be closer to record lows against the yen for a pro-intervention consensus to crystallize. Lastly, Japan's modus operandi suggests intervention is more likely after a G7/G20 meeting than before it.

Three, if the yen bulls showed their hand, the sterling bears came out of the wood work. Despite the deterioration of the situation in the euro zone, sterling has actually fallen more than the euro over the past five sessions against the dollar. The data has not been favorable. The BOE's Fisher seemed to attempt to talk sterling down. The prospects for more QE appear to have increased. Market positioning was may be the most important consideration. As the commitment of traders in the futures market has shown, and sterling's gains in the spot market have illustrated, many had embraced sterling as the better alternative to the euro than the dollar. That view was called into question in recent days. Long sterling positions, against the dollar, euro and yen have been shaken out in dramatic fashion in recent days. The next level of support is seen near $1.5760 and if that breaks, the $1.55 area may beckon. Against the yen, sterling can move toward JPY123.50. The euro faces an important test closer to GBP0.8080.

Four, many market participants seem to believe the central banks are back in play. The BOJ meets next week and there is increased talk, especially after the yen rallied, that act to offset the deflationary impulses. Yet is unlikely to announce an expansion of its asset purchase plans. Reports suggest that it is falling behind in implementing the purchases it has already announced. This cannot be the result of accident or oversight. Market conditions do not seem a compelling explanation,which makes purposeful intent. Soft data including and the dovish inflation report has seen spurred speculation that the BOE's recent decision not to expand its gilt purchase program will be reversed as early as next month. This is possible, but we expect it, like the Federal Reserve, to remain in a wait an see mode. The market is doing a lot of the work that QE may do in terms of lowering yields. US and UK bond yields are at or near record lows. The ECB is under pressure to act. Spanish and Italian bond yields are rising, which in it terms, weakens the transmission mechanism of monetary policy. While Q1 GDP was flat instead of negative, the data thus far for Q2 suggests that is a bit of a statistical quirk and/or in any event, a function of the upside surprise of the German economy. Yet the ECB does not appear poised to cut rates, which the IMF has urged it to do. At the June meeting, though the groundwork for a cut may be laid, if its economic forecasts are cut sharply. A resumption of the sovereign bond purchase program seems more likely than a rate cut or a new LTRO, and this of course runs into German objections.

Five, some investors think that QE3 by the Fed is the "Bernanke put". They argue that it is not simply the threat of deflation or recession that will get the Fed to act, but the fall in the stock market. This seems to exaggerate the weakness of the stock market. Consider it not as short-term, momentum trader, but from the point of view of a policy maker. The S&P 500 appreciated by nearly a third between early Oct 2011 and early April 2012. It is since sold off by about 8%, which leaves it still up by a quarter in 7 months. The retreat has orderly but nearly constant. The next level of technical support is seen near the 38.2% retracement objective and 200-day moving average, which comes in 1275-1290 area. If the economy continues to point to near trend growth and in line with the Fed's base line forecasts, the job market does not deteriorate and inflation remains near the Fed's target, the case for QE3 solely based on the stock market seems a stretch.

Six, policy makers see the same things that investors are. They are going to try to push sentiment away from the edge of the abyss. It is not just the G8 and G20 summits, but the intensification of the crisis is likely to force compromises. Ultimately, investors do not care, we would argue, whether the 3% deficit to GDP target is reached in 2014, 2015 or 2016. What the markets want is a vision and a sense that the commitment to implement it is there, and this implies a sustainable path. We have drawn parallels to the NY Mets. There was a policy response to getting the least amount of home runs (hitting the ball out of the park) in the Major Leagues. It did not put the players on special diets or feed them steroids. It did not spend much more money on buying new talent. No, it simply brought in the fences--made the target easier to reach. This is not fantasy. There does seem to be a move underway to extend the fiscal objectives in Europe. This is not simply kicking the can down the road, it is buying more time to make the necessary reforms without triggering a political or economic backlash that topples the entire project, for which the European elites do not have alternative strategy.

Them Are Fightin' Words

noreply@blogger.com (Marc Chandler) — Sat, 19 May 2012 08:10:24 PDT

Currency in Crisis

The debate about Greece's future in the monetary union is mis-framed and this leads to faulty analysis by investors and policy makers. Even if European integration is incomplete, and there is no fiscal union, members of the monetary union should be thought of as if states in the United States in many important ways. Joining EMU should be just as irrevocable as joining the USA.

If New Jersey's inflation runs above New York's, we don't say that the New Jersey dollar is over-valued against the New York dollar. We do not say that New Jersey should devalue. When a US state has financial difficulties, such as when several states defaulted in the 19th century, or when the largest state in the union issued its own IOUs more recently, there was no effort to evict them from the union.

On the contrary, the war that cost the most American lives remains to this day the Civil War. We call it the Civil War because the North won. It could have been the war for southern independence. The North's victory led to the maintenance of the union.

German finance officials are wrong to try to turn the Greek election into a referendum on membership in the monetary union. Greece made their choice, as much as Illinois did in 1818. They chose monetary union. Ironically, it was the German people that did not chose. It never held a referendum there, plebiscite or otherwise.

There have often been parallels drawn between the US post-Revolutionary War financial plan that included nationalization of the state's debts and what European officials ought to consider. "Europe needs an Alexander Hamilton", many said. Yet in order to make space for Hamilton, Europe may need a Lincoln and his commitment to Union.

If the EU officials, ECB officials and German officials embraced this commitment to union it would help stem the hemorrhaging of confidence. The international gatherings over the next several days would be timely forums to get the message out: the Union prevails. What is happening is a debate within the union about how best to secure fiscal stability and competitive economies.

Late Dollar Longs Vulnerable

noreply@blogger.com (Marc Chandler) — Thu, 17 May 2012 16:54:57 PDT

Perhaps it is the California air, where I am on a business trip, but it seems that the euro bears have run their course for the time being and a corrective phase may be unfolding. The late buyers of dollars against most of the major and emerging market currencies look vulnerable.

Just like I brought to your attention the importance of the gaps in the euro and Swiss franc created by the sharply lower opening on May 7, I warn that the price action following the news about the ECB cutting of credit to a few Greek banks was important and revealing.

When the news first broke, the euro was of course sold off, but it could not make a new low and then rebounded quickly. The same is true for the Swiss franc, or the inverse for the dollar. I see it as a further confirmation of the extent that the market is short euros and long dollars (against a range of currencies). It warns the market is stretched and vulnerable.

The price action, coupled with the high probability some are assessing a Greek exit, reveals market psychology. Participants are seem too confident in knowing the outcome of what is still a life time away in terms of short-term momentum players time horizon.

We have seen this before. The market acts is if the apocalypse is are the corner. Yet, there seems to be almost a self-correcting mechanism at work. Policy makers take some steps to demonstrate their resolve and take a step away from the edge of the abyss.

The pressure on the euro, and the risk-off general theme requires a steady stream of poor news to continue to feed the Bear. Suggestive comments from policy makers, more emphasis on the growth/investment pact. The G8 Summit and the EU Summit (heads of state) are both forums for such talk. The rhetoric that most often emerges is one of cooperation and resolve to act. Market positioning is so stretched that anticipation of this is all it may take.

Let's be clear. My understanding of the macro fundamentals have not changed. They favor the dollar. I am warning here that the technical condition may be changing. Specifically, here is the kind of move that I think is increasingly likely:

The euro initially has potential toward $1.2785-$1.2850. A move through the top end of the range could see $1.30. The key gap resistance is essentially $1.3065-$1.3080. Sterling can initially test on $1.60 and if that is easily broken there is potential toward $1.61. The Australian dollar can test $1.0000-20. The US dollar can slip back into the CAD1.0050-70 area. On the crosses, Norway has outperformed Sweden and Australia has outperformed New Zealand. Neither cross shows signs of topping, but if the correction unfolds they should also correct.

The yen seems particularly difficult. On one hand, corrective pressures should weigh on the yen against the dollar and euro (and other currencies). On the other hand, the dollar has been gaining on the yen for more than a week. I suspect this means that the yen may weaken more on the crosses than against the dollar.

Emerging market currencies can also rebound. In that space, I like the Mexican peso and the South African rand.

US Economy Update: Still No QE3

noreply@blogger.com (Marc Chandler) — Thu, 17 May 2012 06:11:14 PDT

The recent string of US economic data does not change our view that renewed asset purchases by the Federal Reserve as early as next month as some have suggested remains unlikely. The data does warn that Q1 GDP is likely to be revised lower, toward almost half of the Q4 '11 3.0% pace.

The data suggests the economy is likely back in the middle of the 2-3% range that the economy has averaged since the recovery began and is consistent with the Fed's base line forecasts.

Today's industrial production news is consistent with that. Output was revised out of March and put into April. So, for example, April industrial production came in at 1.1%, twice what the market expected, but the March series was revised from flat to -0.6%. Manufacturing rose 0.6% in April, about half of which was accounted for by the auto sector, but the March contraction was revised to -0.5% from -0.2%.

Note too that capacity utilization rose to 79.2% from 78.4% in March and is the highest since 2008. It is not inflationary, but one of the pre-conditions for QE would seem to be a new threat of deflation, and it simply is not there,

Housing starts rose in April and the March time series was revised higher. At over 700k, this is the upper end of housing starts and gives support to the idea that some kind of modest recovery is at hand. Indeed, it is consistent with earlier reports we noted pointing to a decline in vacancies in both multifamily and single family units. In addition, yesterday's report showed home builders sentiment is at recovery highs.

In addition, we have noted and repeat here, that the drop in gasoline prices will help support spending and the recent senior loan officer survey showed the strongest demand for credit from households and businesses in nearly a decade.

The market debate over QE is likely to continue. It does seem reasonable that if the head winds from Europe become more powerful, the negative impact on the US economy can increase the odds of QE. However, the euro area GDP was expected to contract in Q1 and instead it was flat. This would seem to imply the headwind is not strong enough yet. Plus the flight to Treasuries as a safe haven have helped keep yields down, arguably lower than they otherwise would be.

On balance, given the data and recent comments by the US Troika BYD (Bernanke, Yellen and Dudley), QE3 continues not to look like the best case scenario for next month's FOMC meeting.

Great Graphic: Future of the Workforce

noreply@blogger.com (magonomics) — Wed, 16 May 2012 06:20:45 PDT

My brilliant webmaster found this great graphic on the demographics of the workforce of the future. I thought it would be interesting following April's disappointing jobs report.

Fear Overwhelms Everythng, Drives Dollar Higher

noreply@blogger.com (Marc Chandler) — Wed, 16 May 2012 04:38:01 PDT

There driver of the capital markets today has a name: Fear. It has overwhelmed nearly every other consideration and is driving the dollar higher against all the major and emerging market currencies.

Even the Japanese yen is not match today. Despite narrow interest rate differentials and heightened anxiety, the dollar is trading at its best level against the yen since May 3. In fact, although the euro is at the epicenter, and made new lows for the move as it approaches the year's low set in January near $1.2625, it is gaining modestly today against both sterling and the yen.

Talk of a Greek exit continue to run high and contingency plans are being developed. They underscore complication and the likely costs involved. There won't be any winners. Greece will be plunged into an economic and political nightmare that may even make Argentina's experience look like a tea party.

We have noted the geo-strategic importance of Greece as well, and note today that a recent poll of 60 important policy makers by the Atlantic Council and Foreign Policy magazine found that Greece was picked by the most (18) as their pick to be ejected from NATO (ostensibly over treatment of Macedonia and Turkey). The direct costs of a complete unilateral moratorium on the rest of Europe is at least 400 bln euros and this does not take into account contagion and other knock-on effects.

The odds of a country leaving the euro zone continues to edge higher on the www.intrade platform. At pixel time, the odds stand at 42%, 60.8% and 65% respectively for the end of 2012, 2013 and 2014. The 2012 odds are approaching twice the level that prevailed prior to the election.

Spanish and Italian bond yields now are well above 6%. Germany and France found little difficulty in selling their bonds today. A few German auctions recently were under-subscribed, but not so today with strong safe haven bids. Economic data from the euro zone can be lost in the fear-driven market and participants barely noticed that EMU CPI edged lower in April to 2.6% from 2.7% in March.

Talk of an emergency ECB meeting appears to have fallen wide of the mark. Note that yesterday IMF's Lagarde reiterated the institution's view that the ECB can cut rates. While a rate cut next month cannot be ruled out entirely, it is important to understand that the ECB draws an important distinction, as does the Federal Reserve, between liquidity provisions as such and monetary policy. The latter is about interest rates. The former is about quantities.

The first step from the ECB to address the current flare up is not a rate cut, after all Q1 GDP reported yesterday was flat, while the ECB was likely prepared for a modest contraction. Rather the first line of defense would be a resumption of its sovereign bond purchases. While there is talk of another LTRO, that also seems quite a bit less likely than sovereign bond purchases.

While EMU's future, or lack thereof, is once against the overwhelming focus in the market, sterling's decline in recent days is noteworthy. Sterling began the week above $1.61 and today broke below $1.59.

We never really liked the M&A story cited by some banks to explain sterling strength. While we acknowledge some related demand around some announcements, there is a difference between that and real flows. We have pointed out that often in M&A transactions real flows lag the announcement by months, if not quarters and often corporate Treasuries will not buy the target currency but borrow it.

In any event, the bloom is off the rose. The asymmetrical response to data today suggest stale longs are being forced to exit. First the UK reported better than expected jobs data. Although the unemployment rate was unchanged at 4.9%, the jobless claims fell by almost 14k, whereas the market had been looking for an increase. Sterling did not gain any traction on the report. The wage component of the employment report has an extra month lag and covers the month of March and wage pressure continued to evaporate.

Secondly, the BOE issued its inflation report. It was dovish--there is no doubt- and sterling was sold on the news, triggering more stops, and recorded its sub-$1.59 print in reaction.

Less than a fortnight ago, the BOE decided to let its asset purchase scheme end without renewing it. The dovish inflation report may spur speculation that it will resume shortly. Yet one cannot help but suspect that the MPC had a good sense of what was going to be in the inflation report at the MPC meeting and it alone won't change official views.

Moreover, as we have noted before, despite what economic theory may say, in practice, those countries that have pursued some form of quantitative easing, from Japan and Switzerland the US and UK, have not, for the most part, experienced currency depreciation as a result. More importantly, sterling was the only top tier currency that speculative players had built up a net long position in the futures market. Sterling's slide appears to be stale longs being forced to the sidelines.

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