Commitment of Traders and Other Flows

Confounding expectations, the net speculative short euro position grew over the week to January 24, despite the single currency's three cent advance.   The net speculative short position at the IMM reached a new record of 171.3k contracts.  Thus far over the course of the month, the net short position has grown by 44k contracts, a little more than last month.  

Since January 24, the euro has rallied another three cents, arguably encouraged by the stabilization of the PMI readings (though forward looking new orders measures are still worrisome) and the Federal Reserve statement, pushing out expectations for the first tightening.

Lisbon Woes, Headed on the Road to Athens

European officials have insisted that Greece is unique. Many market participants do not believe them. Portugal appears to be headed down that same road. While we have warned in the past of risks that Portugal would need a second aid package, it is only since S&P joined the other major rating agencies in rating Portuguese debt below investment grade on January 13 that more market participants have come over to this view.

Portugal's 10-year yield poked through the 15% level for the first time ever. On January 12th, the eve of the downgrade the yield was about 12.4%. The shorter end of the curve has also been crushed and 2-10 yr is inverted. The 2-year was yielding 12.31% before the S&P downgrade. Now it is approaching 17%.

A Few Thoughts About Q4 US GDP

US Q4 GDP disappointed in the headline at 2.8% instead of 3%, but the real disappointment is in the details.  The key there is inventories, where the preliminary figures showed rose $56 bln at an annual pace, adding 1.9 percentage points to GDP.    This build up may weigh on Q1 12 GDP as inventories are unwound.   Equipment and software spending rose 5.2% vs 16.2% in Q3.  This slowdown is likely to continue as the end of the tax break is felt. 

Another disappointing detail was in inflation and that plunged.  The GDP deflator rose 0.4% after a 2.6% rise in Q3.  The core PCE deflator rose 1.1% down from 23.1% in Q3.  This is important, especially in light of the Fed's statement.  This is not deflation, of course, but if it persists, the risk of QE3 increases. 

Euro at Cross Roads?

A well received Italian bill auction coupled with hopes of a near-term Greek deal has seen the euro recover from the slide in North America yesterday.  The euro came within about 20 points of yesterday's high after slipping to just below $1.3080 in Asia.  Short-term technical indicators warn the euro is over-extended a convincing break of that $1.3080 to boost confidence a near-term top is in place. 

In some ways this is consistent with the recent pattern for the euro to do well in the run-up to a European heads of state summit (Monday) to sell off afterward.  Note too that the balance of European bond maturities and coupon payments falls considerably behind the new anticipated issuance in February.  The return of the Chinese market from the lunar new year celebration may also be a factor, though the directional implication is not clear. 

Deja Vu All Over Again?

There is an eerie sense we have been here before.  The dollar rallied following the announcement of QE2 in early November 2010.  The strength continued into early 2011.  Then Trichet began threatening rate hikes.  At first it seem ludicrous--that his tough talk was going to get the market's to do his heavy lifting, though as we know, the ECB did hike rates in April and then again in July.   

In addition, the US economy, which had seemed to be on the mend in Q4 10, noticeably began to weaken at the start of 2011.  At the start of 2011, the US 2-year yield was 20 bp below Germany.  The combination of a hawkish ECB and weak US data pushed the US discount to Germany to 132 bp by early May.  The dollar sold off hard.  The euro rallied from about $1.2850 in January to almost $1.50 in May. 

Reuters TV: Fed Watchers See No New Stimulus

FOMC Statement --Pushes Out to Late 2014 First Hike

The FOMC statement is slightly more dovish than expected and this has seen a knee jerk drop in the dollar and US equities bounce. These are likely to prove short lived moves. The key change was in the "exceptionally low rate" guidance. It has shifted from mid-2013 to at least late 2014. Many had expected the shift to mid-2014.

In a couple of hours the Fed will publish its anticipated Fed funds trajectory and the statement suggests the median is for the late 2014 period.

Will the ECB Take a Haircut?

It appears that over the past 24 hours or so, the ECB has come under pressure to participate in Greece's PSI. Reports that the IMF were pushing for this has quickly been denied. The ECB has also formally rejected participating. Nevertheless, Dallara, representing private sector creditors, is insisting that all creditors, private and public, share in the adjustment.

We have written about the thorny issues raised by the ECB's bond purchases, leaving aside the objections that led to the resignation of both Weber and Stark. The more the ECB buys, while refusing a haircut, the greater the haircut on the private sector is required to voluntarily take to reduce Greece's overall debt burden to what the IMF says is sustainable, which appears to be 120% in 2020.

Dollar Bid

The dollar's downside momentum has faded since the start of the week and short-term momentum traders have to adjust.  There does not seem to be a precipitating factor.  The German IFO was mostly better than expected and while the UK Q4 GDP was off 0.2% rather -0.1% may could have been a factor, but sterling is holding in better.  Key support is seen for sterling near $1.5520.    Initial euro support is seen near $1.2950 now.    The Fed meeting will be of interest of course, but it is unlikely to a major factor for the dollar. 

Asia, integrated in US tech cycle, seemed to have been boosted by Apple news, but he favorable tone did not carry over into Europe.  Ironically, the tech sector is the weakest today in Europe, off more than 3% at pixel time while the overall Stoxx 600 was off about 0.8%.    Ericsson earnings were lower than expected, hitting share prices.  This also appears to have prompted a bout of profit-taking on long Swedish krona positions. 

The Federal Reserve and the New Transparency

At the conclusion of the FOMC meeting, the usual statement will be issued, but what is capturing the attention of the market is that the Fed will also publish the expected path of the Fed funds rate and the expected timing of the first hike.  

The statement itself is important.  It has become largely formulaic.  The FOMC provides an assessment of the recent economic data.  The Fed here will be somewhat more upbeat.  The recent string of data, including employment, housing and output has generally surprised on the upside.  While acknowledging this, the Fed is likely to continue to warn of downside risks.