House Prices, Delinquencies and the Dollar

The much watched Case/Shiller house price index pace of decline is slowing. In Jan, home prices in the 20-large urban centers were 19.01% below year ago levels and today we learned that in April prics were off 18.12% year-over-year. This is the slowest pace of decline since last Oct. Eight of the 20 cities reported an increase in prices in the month of April, the best showing since June 08. Even though the data is not seasonally adjusted, house prices rose 0.6% in San Francisco, the first increase in nearly two years and, as will be appreciated, is one of the areas that experienced a dramatic bubble.

Some Sterling Thoughts

Sterling rose to eight months highs earlier today, before the disappointingly large current account deficit. Sterling held important support near $1.6550 and is trying to recover. Only a break of this support would darken the near-term outlook. A move above $1.6650 would signal the end of the downside correction that saw cable shed nearly two cents.

The Dollar is Alive and Well - Washington Post Letter to the Editor

Staff writer Anthony Faiola has joined countless other journalists and pundits in proclaiming the demise of the dollar "Fading of the Dollar's Dominance,". His argument covered well-worn ground; it reported on what officials are saying but provided little information about what they're doing.

Gilts, Sterling, and European Bonds

UK gilts and sterling itself responded positively to earlier news that the BOE's reverse auction to buy GBP3.5 bln was well received. There were offers for GBP4.3 bln. The BOE will conduct another reverse auction on 1 July and buy GBP3 bln worth of bonds.

Debt Revival a Major Surprise of H1

One of the surprising developments in the H1 2009 has been explosion of debt issuance, outside of the sovereign sector. The $345 billion of high grade issuance in Europe, for example, surpasses full year records. Globally, the financial sector issued about $730 billion of debt while the non-financial sector issued about $886 billion, according to industry reports. Moreover, the recent trend has been toward lower coupons and heavy interest. Financial issuance was helped by the fact that a number of countries guaranteed bank bonds. In Q1 0209, nearly 805 of the bank bonds issued were guaranteed, but in Q2 it fell to 50% and looks to slip further in Q3. The financial issuance was also bloated by banks switching to less expensive debt. Bond issuance was also boosted by the impairment of banks.

China News

There are several developments to note in China.

First, with deflationary forces still gripping the economy (year-over-year CPI has been negative by more than 1% since Feb), weakness in exports, Chinese officials are unlikely to allow the yuan to appreciate very much during the second half of the calendar year. The pricing of the non-deliverable forward implies expectation for less than 1% appreciation against the dollar over the next 12-months, the smallest expected gain in a couple of months. Next month will be the one year anniversary of the Chinese decision that in essence appears largely tantamount to re-pegging the yuan to the greenback. It has been confined to a little more than a 1% range since. Recall that under the fixed exchange rate regime of Bretton Woods, currencies were allowed to move in 1% bands. Last July the pricing of the 1-yr yuan NDF implied a 6% appreciation.

Bloomberg: Dollar Ready To Rebound Again

Tankan Highlight for Japan in the Week Ahead

One of the most watched reports from Japan, the Tankan Survey, will be reported on July 1st in Tokyo. The results for large manufacturers is often the headline and it has fallen uninterrupted since the middle of 2007. Unsurprisingly it collapsed since the middle of last year. However the next reading should show the first improvement in 3 years. The consensus is for sentiment among large mfg to improve to around -45 from -58. Improvement is also expected for large non-manufacturers. If there was an improvement in small businesses, it is likely to be more modest. There is unlikely to be any significant improvement in capex plans.

CNBC: Dollar In Danger?

The Visible Hand: Central Banks at Work

In recent days the actions of the European Central Bank and Swiss National Bank have had significant implications. There are also new signals from the US Federal Reserve. These events deserve closer scrutiny.

SNB

Let’s begin with the Swiss National Bank. Recall that back in March the SNB acknowledged it faced a serious threat of deflation. It indicated it would engage in quantitative easing, but its bond market was too small, owing to fiscal conservativism, so it would sell Swiss francs and purchase foreign bonds.

More Thoughts on the SNB

The SNB is believed to have intervened Wed and Thurs in a more aggressive manner than they have since announcing their quantitative easing back in March. It does not appear to have intervened today, leaving many stale long euro/short Swiss franc positions. Many of these positions are in the hands of momentum traders. Without any fresh follow though, momentum traders have begun taking profits today, pushing the cross back toward CHF1.5250-60.

Was the intervention successful? Many observers have claimed the SNB drew a line a in the sand at CHF1.50. That may appear to have been true, but this weeks tactics suggest this is no longer true. The SNB appears to have intervened against the dollar as well in this week's operations. It also appeared to intervene at higher levels. The Swiss franc's trade-weighted-index (BOE version on Bloomberg is ceersz) has fallen this week from a three-month high to a 2 1/2 month low.

Some observers may also consider the intervention successful insofar as it demonstrated the SNB's resolve and enhanced its credibility.

Yet at the same time, as soon as the SNB appeared to step away, the Swiss franc strengthened. This is also what happened back in March. The shock value of the QE announcement then produced a dramatic franc sell-off, which ran out of steam in a matter of days and the euro high near CHF1.5450. Despite the aggressiveness of the recent operations, the SNB was unable to drive the euro back above CHF1.5400.

In addition, the odds of success of intervention tend to be enhanced if it is used to signal a policy change. But in the SNB's case, the intervention itself is the policy. The SNB unlike the Fed, BOE, ECB, and BOJ have not indicated the size of their QE operation. With oil and commodity prices rising, deflationary forces are weakening and the need for an aggressive QE may lessen too in the coming months.

More immediately,today and into early next week, support is seen in the euro near CHF1.5240 and then CHF1.5200. Even if one does not have exposure in the euro-Swiss cross, the implication of this analysis suggest the CHF1.1015-25 may offer formidable resistance to the US dollar. Support for the greenback is seen in the CHF1.0800-20 area. At this point, resistance looks stronger than support.

Not all Current Account Deficits are Equal

Many observers are concluding that the recent run on the South African rand, the Turkish lira, the Hungarian forint and the New Zealand dollar is a function of their current account deficits. There is some befuddlement then that the US dollar, with a current account deficit above 6% of GDP, has held in so well. The answer to the conundrum is two-fold. First, what is hobbling the many of the emerging markets goes well their external deficits and second, the US current account deficit is in a league of its own.

East European Currency Trade Idea and Implications

The Polish zloty should outperform the Czech koruna. Poland's reported stronger than expected retail sales for May today. The 2.1% decline on the monthly time series is 2/3 of the decline the consensus expected, which was largely a correction to the heady 5% rise in April. The year-over-year rate actually increased to 1.1% from 1.0% (the consensus had expected a 0.5% decline). Poland's central bank delivered the expected 25 bp rate cut yesterday. In an earlier note this week, we commented that Poland's relatively less dependent on EU growth than most other countries in the region, may help underpin the zloty. The Swiss National Bank's aggressive intervention to knock the Swiss franc down is seen as easing the currency mis-match strains that were seen in Poland and Hungary.

SNB

The Swiss National Bank has turned more aggressive in its intervention and it appears they have followed up yesterday's bouts with another one today, though with somewhat diminished effect. In addition to bidding the market higher and coming in more than once, the other way the SNB has turned more aggressive is that it also appears to have intervened against the US dollar as well. The SNB's comments had suggested the focus was strictly on the euro-franc cross.

After the Fed...

The market continues to digest the meaning of the Fed's inaction yesterday. There was no increase in Treasury or other long-term asset purchases. There was no indication that an exit strategy was coming more into view. There was not heightened commitment, beyond what it has said in the past, to keep rates low. There seemed to be no protest of the recent firming of the effective Fed funds rate to the top of its policy range. For the first time in a while, the Fed had the luxury of entering a wait-and-see mode. To the extent the statement changed, it was very subtle. In a small but significant way the Fed signaled that the risk of deflation had eased and recognized further stabilization/moderation of activity that still stops shy of recovery.

Fed Does Nothing

The dollar has rallied following news that the Federal Reserve did nothing. They did not change their assessment of the economy, the committment to keep rates low for a prolonged period of time, or the amount of Treasuries or other long-term assets to be purchased. Nor did the Fed say anything about an exit strategy.The pace of economic contraction is slowing, the Fed says, essentially the same assessment as in April, the last FOMC meeting. Spending is also showing furhter signs of stabilizing but remain hampered by rising unemployment. It recognizes that commodity prices have risen, but that the slack in the economy will prevent inflation from taking root.

Begger Thy Neighbor Currency Policies, Except the United States

Much ink has been spilled on the strong dollar policy articulated by every U.S. Treasury Secretary since Robert Rubin roughly 14 years ago. The U.S. Treasury officials continue with that line. In stands in stark contrast with the stance of many other countries.

Change in SNB Tactic?

Yesterday we cautioned that the SNB's tactics appeared to have reached a point of diminishing returns. We thought the SNB would have to change their tactics. We suggested that they might let the euro go below CHF1.50 to spring a bear trap. Wrong. Instead it appears they have stepped up the aggressiveness of their intervention. Although actual confirmation remains elusive, it appears that the SNB or through a multilateral institution, are on the bid rather than just accepting offers. They also appear to have chased the market higher. The euro has now been propelled through the 200 day moving average near CHF1.5140 and gone through CHF1.5250, triggering a double-no-touch option that was rumored to have been expiring today or tomorrow. The next target would be CHF1.5300, the high from early April. The high set since the SNB's quantitative easing announcement in March was CHF1.5447.

Summary of EPRF Flow Report

The latest EPFR flow report covers the week ending June 17th. The key highlight is large sums continue to exit the money market funds and is being put to work in equities and bond funds. EPFR reported that $55 bln left money market funds in that week, which is the largest it has recorded.

Venezuela Spurs Action

Venezuela is produces a heavy crude oil that requires extra processing/upgrading to make it useful. It has been trying to diversify its sales away from the US. Not all countries have refineries that can process Venezuela's heavy crude, but China has some capacity, for example. Heavy crude supply from Mexico has also fallen over the past year. The net effect is to reduce the differential between heavy and light crude oil. The discount for heavy has been reduced according to a report in the Globe and Mail, from an average of around 22% last year to 17% this year. Recent deals it notes have been seen a 10% discount only. The big winner, the report says is Canada's oil patch which also produces heavy crude and benefits from having its crude at a smaller discount to light.

Euro-Swiss: Risk Going to the Cookie Jar Too Much

The euro is slipping back toward the CHF1.50 level, which has buoyed the euro since the SNB announced its quantitative easing/foreign bond purchases back in March. It held most recently last Thursday, when there were rumors of direct or indirect intervention by the SNB. While in the past we favored buying euros as the lower end of the range was approached, including last week, we are more cautious now. The magnitude of the bounce and the amount of time the SNB bought suggests their current tactics may have reached a point of diminishing returns. We are concerned that officials may decide to change their tactics. One practical way would be to allow the CHF1.50 level to be violated, trigger some stops and then spring the trap and intervene. Initial violation of the CHF1.50 level could quickly see CHF1.4950, with risk extending toward CHF1.49. This is not a fundamental judgment of where euro-swiss should trade. It is not a view of technical conditions. It is a view on SNB tactics, plain and simple.

Why Chile is So Strong, While Copper Prices Slide

Copper prices are off almost 4.5% today, yet the Chilean peso has recovered from early weakness to trade at fresh 9-month highs. If it is not copper driving the Chilean peso, what is?

The most important consideration that has extended the peso's advancing streak to its fifth consecutive session is anticipation that the government will increase dollar sales starting next month. This is helped the peso be the best performing currency in recent sessions.

European Bond Supply This Week, With A Twist

While there is much talk of large supply of US Treasuries this week (~$104 bln), European countries are bringing their own supply as well. However, France, Beligium and Ireland plan to sell bonds this week but rather than auction them, as they usually do, they will sell them through the banks. Bank will underwrite around 10 bln euros worth of bonds this week to help minimize market disruptions and ensure a smoother sale. Last week the UK sold GBP7 bln of bonds in the first sales managed by banks since Sept 2005.

Head and Shoulders Bottom in USD vs SEK

The new concerns about world growth and profit-taking on what have been strong performers in H1 has seen the US dollar push through a neck line of a potential head and shoulders bottoming pattern of against the Swedish krona. However, short-term momentum readings were over-bought when the dollar rose through the SEK8.00 level. Look for the dollar to find support in the SEK7.93-SEK7.95 area and get a running try at the SEK8.00 level again.

World Growth Donwgrade, China Weigh on Commodities

The combination of the World Bank's forecast for a deeper contaction this year than it anticipated as recently as March, coupled with some reports that China's commodity stockpiling is set to slow has weighed on industrial metal prices and has encouraged profit-taking in the so-called commodity currencies, like Canadian and Australian dollars, South African rand and the Brazilian reai.

US Housing Data This Week- Second Month of Gains Expected

The US reports existing and new home sales this week. Despite the backing up of mortgage rates in since early Q2, the housing market continues to stabilize and officials, including Fed officials who meet this week, are likely to find comfort in the data.

Inflate This

Astronomers generally believe that the universe was very compact until a cosmic explosion, the big-bang, took place, almost 14 billion years ago. Ever since the universe has been cooling and inflating. While that inflation may be good in astronomical terms, creditors and investors traditionally abhor that which destroys the value of their capital.

Key Fed Data Later Today

We continue to closely follow the Federal Reserve's Thursday data releases, which include its balance sheet and its custody holdings for foreign central banks.

The US current account deficit, economists point out, is the difference between savings and investment. It, not the budget deficit, is the amount that needs to be financed by foreign capital. The preliminary Q1 08 current account deficit was reported yesterday at $101.49 bln. It brings the four-quarter deficit to $628.27 bln.

Euro Forward Pressure

Short-term European interest rates and euro forward rates are under modest pressure and will likely remain under pressure over the next few sessions.

Next Tuesday, the ECB will auction 1 year money and there is market talk that European banks and banks with branches in the eurozone are eager to secure the longer term funding. This demand appears to be already making itself evident and this technical consideration is pressuring short-term interest rates lower. There is talk that next week's tender will be heavily over-subscribed.

Highlights of the US Current Account

The US Q1 current account figures were reported today and may have been lost in the shuffle with the unexpected Norwegian rate cut and the US CPI figures. Here are the highlights of the report:

• The preliminary deficit for Q1 stands at $101.5 bln, which is the smallest since Q4 01, but was still a bit larger than expected. The improvement from Q4's $154.9 bln deficit can be fully accounted for by the smaller goods trade deficit.

More BRIC Noises

Many people are still talking about the BRICs even though the summit concluded wihtout much in the way of fresh initiatives. Some reports suggested that the BRICs agreed to buy each other's bonds. But this seems like a gross exaggeration. Nothing has stopped these countries from buying each other's bond except prudence. Central banks appear to focus on security and liquidity, and then yields.

Fed Slowing Treasury Purchases?

Ten year Treasury yields are flat on the week after yesterday's strong rebound and limited follow through today. Yet the sharp rise in yields, including mortgages and agency bonds, had prompted speculation that the Fed would have to step up its purchases and there was even some talk that it could not wait until the next FOMC meeting which scheduled for June 24th.

Bric or Crib?

Brazil, Russia, India and China, now collectively known as the BRICs, will hold a summit in Russia on June 16th. Besides the Goldman-Sachs invented moniker, these countries have very little in common except for the fact that they believe, to seemingly varying degrees of intensity, that they deserve greater influence in the conduct of world affairs than they currently have. And given the enormity of US power, as hard-core realists, they know any increase in their power and influence will come at the expense of America’s.

10-Year Auction

The US auction was fairly well received. The bid-cover ratio was 2.62. This compares with 2.47 last month and an average of 2.40 in the past ten auctions. Indirect bidders, which include central banks, took down 34.2%, this is a modest increase from the 31.9% in May and an average of just below 26% in the last ten auctions. Despite these traditional metrics being better than expected, US yields have continued to rise. It is ture the auction was a little sloppy and the tail was large, but given the supply, it is not surprising and would appear to be offset by the more other optics. The main reason that the bonds seem to be still selling off is that large suply continues to loom on the horizon. Tomorrow the government auctions 30-year bonds.

Refi Cooling, but Fed Succeeded in Inducing Wave

Given the dramatic increase in yields recently, including mortgage rates, it is worth looking a bit closer than usual at the weekly mortgage application figures released earlier today.

Mortgage applications have slipped for three weeks now. The 7.2% decline in the recent week continues to pattern of weakness concentrated in the refi markets. Those applications fell 11.6% during the most recent week.

Near Term Currency Targets

In choppy trading the dollar is being sold into the end of the European session and new lows for the session are being recorded. Now that cooler heads are prevailing and expectations of a Fed hike are being unwound, the dollar appears poised to return to the lows seen last week.

Russia WTO Bid, GCC: More than One Way to Skin Cat

Sometimes when encountering adversity, determined countries figure out another way to achieve the objective.

Russia has been trying to join the World Trade Organization for more than 15 years. Ascension requires achieving bilateral agreements with all members. One country--Georgia--effectively vetoed Russia's membership well before the hostilities last summer. Russia retreated,seemingly to give up on is pursuit, but today announced a new initiative. It will form a customs union with Belarus and Kazakhstan. Prime Minister Putin says the customs union will begin on 1 Jan 2010. The customs union itself then will seek WTO membership. The WTO rules allow for this, according to reports. Trade between the three is extensive. It could potentially be disruptive if one joined and the others did not.

No Fed Bill Issuance

Three months ago, at a joint press conference the Federal Reserve and Treasury indicated they would seek Congressional authority for the central bank to issue its own bills. It appears to have run into a political buzz saw and contacts report Fed and Treasury officials have backed off. Contacts had suggested as much a couple of weeks ago, but press reports now lend greater credence to what we had heard.

Bloomberg Reserve Comment Exaggerates

Bloomberg article "BRICs Add $60 Billion Reserves as Zhou Derides Dollar" claims that the BRIC central banks boosted reserves in May. Yet China has not reported its April reserve figures, let alone May's. The larger point of the report, that the BRIC are accumulating reserves to prevent their currencies from appreciating is probably only partially true. It is helpful to understand the build-up in reserves especially, Russia and India as a replacement to the draw down in reserves in the second half of last year. India lost nearly a fifth of its reserve then. Russia reserves fell by almost 40%.

China Update

China reports several key pieces of economic data this week, including inflation, trade, investment and retail sales. Ironically, just as many are talking about green shoots among major industrialized economies (note OECD leading economic indicator reported today rose to 93.2 from 92.7 in March, with all members' readings increasing), China's greenshoots may not be so evident in the upcoming data.

Irish Downgrade

More on Ireland Here

S&P cut Ireland's credit rating. It nows stands at AA and, with a negative outlook, the risk is another downgrade. The debt-to-GDP ratio is approaching 100% and compared with the low 40% area before the crisis began. S&P cut its triple A rating in March and Ireland's new AA rating is the same as Japan's. The immediate reaction was to take the euro lower, which in any event was trading heavility, and the 10-year spread between Ireland and Germany widened 3-4 bp. It had closed near 200 bp before the weekend.

Ferguson vs. Krugman: Hubris of Small Diffrences

In various op-ed pages, the prolific economic historian Niall Ferguson and Nobel-prize winning economist-cum-columnist Paul Krugman are having a heated discussion. Their egos make them exaggerate what appear to be relatively minor differences, which are largely a question of emphasis.

At stake is one of the most important prices in the world—the price that the US government pays to borrow money. Despite claims of the demise of the US in general and the dollar in particular, US Treasury yields are still the benchmark for great swathes of the world’s commerce and investment in a way that Chinese, eurozone, and Japanese rates do not come anywhere close to.

Sharp Backing Up In Fed Fund Expectations

The combination of the stronger than expected US employment report and two Fed officials in the past 24 hours (Hoenig and Lockhart) talking about not waiting too long to hike rates has seen the Fed funds futures sell-off sharply. The Dec futures contract is now implying an effective Fed funds rate of 47 bp. The Sept contract is implying a 28 bp effective average. There are hawks at the Fed and they have had been beaten into submission by the crisis. The market is probably getting ahead of itself in terms of tightening and reducing the fiscal stimulus. The only thing that has happened is that the pace of decline has slowed. What green shoots there are, are terribly fragile.

Mexican Peso Bounces Back

Along side other regional and major currencies, the Mexican peso has recovered as the North American session progressed. Although it is trading within yesterday's ranges, the near-term bias is for additional peso gains.

Since early May the US dollar has traded roughly between MXN12.82 and MXN13.40. Yesterday and today, the dollar tested the upper end of that range. In addition to the broad dollar pullback, the Mexican peso has been helped by a number of factors. Some contacts cite the rally in oil prices, where the front month July contact is near $69 a barrel, the upper end of where it has trading this year. Others cite comments by Finance Minister Carstens who suggested that after another contraction in the current quarter, the Mexican economy is likely to expand in H2.

Dollar's Safe Haven or Beneficiary of Short-Covering

The narrative told by many is that as the financial crisis became more acute, capital from around the world flocked to the US Treasury market, and especially the short-end of the curve, for security. The dollar was driven higher on safe haven flows and now as the financial crisis has eased and some turning of second derivatives--pace of contraction slowing--the safe haven demand has eased and the dollar has fallen.

Bank of Canada Also Meets Today and C$ Sensitive

No doubt the greater interest lies with the ECB President Trichet's press conference, details about the covered bond purchases and new staff forecasts, but the Bank of Canada also meets today. There is no doubt that the BOC will leave the overnight rate at 25 bp. It has promised to leave it there until at middle of next year. The promise is an attempt to influence psychology--rates are not simply low but they will remain low for a long time.

TARP Money may not be so Easy to Return

After passing the stress tests, several US banks made it clear they want to return the TARP funds post haste. However, signals from Fed officials indicate not so fast. Reports cites three institutions, JP Morgan Chase, American Express and Morgan Stanley, which were directed to boost common equity (the former two) or raise more capital (the latter, after it already indicated it would sell shares to cover the shortfall identified by the stress test.

US Auto Sales, GM Bankruptcy, Manufacturing and the Dollar

May auto sales were stronger than expected at a 9.9 million annual unit pace. In the same week GM filed for bankruptcy, domestic auto sales rose to 7.4 million, the highest since December (Q1 average was 6.8 million). There are several, even if underappreciated, implications. First, the inventory overhang in this sector appears to be easing and production looks to be below the level of sales, so this may help underpin manufacturing in the months ahead. Second, the increase in auto sales likely points to a stronger than currently anticipated retail sales report, which is expected June 11th. The early consensus is for a 0.2% increase on the headline and ex-auto components. Look for economists to revise up their forecasts after tomorrow's chain store sales. Gasoline prices rose a little more than 20 cents in the month.

Near-Term Setback in Canada May Offer a New Buy Opportunity

Since early April, the Canadian dollar has been the best performing currency, gaining about 14% against the US dollar. The Canadian dollar's rise is a function of higher commodity prices, narrowing of interest premium offered by the US (Dec Canada BAs vs Dec Eurodollars), and the preliminary signs that the global economic crisis may be easing.

Which Interest Rate is Key for the Dollar?

Before the Fed's mid-March FOMC meeting it had already been engaged in purchasing mortgage-backed securities and agency bonds, yet its decision at that meeting to ramp things up and purchase Treasuries was seen by investors as a watershed. It is interesting to re-look at the relationship between the euro and yen and other asset classes with this periodization in mind.

Dollar Bears Still Focused on Treasury Meltdown

US Treasury yields are surging. The 10-year note yield is now up 27 bp on the session at 3.72%. Several factors are weighing on US yields today. The ISM report, coupled with the the better readings in Europe and China, keeps the greenshoots story intact. Various measures of the tensions in the financial markets have eased. There are annecdotal reports of portfolio shifts from fixed income to equities. There are of course also concerns about supply.

Market Reads Middle East News as Dollar Negative

The way the markets respond to news sometimes is more revealing of the market than the news itself. Consider news an economic advisor to Qatar's Emir is worried about the dollar and suggested that now is an opportunity to diversify into different countries and currencies. Dollar bears seemed to like this news, but two important points need to be made. First, Qatar's reserves by themselves are inconsequential. They are estimated around $7 bln. Second, Qater is not representative of the region. Over the weekend, the Governor of UAE's central bank was quoted by the news wires say, "The dollar is the currency of international trade, not the euro." The peg to the dollar was not going to be changed in the near-future. He told a conference in Morocco that UAE was not diversifying away from the dollar. Previously a news wire misquoted the Governor. In recent weeks, Saudi Arabia and Bahrain also reinterated their commitment to the dollar.

Debt Market Developments Don't Explain the Dollar's Slump

Many investors and observers are concerned about the implications of the aggressive monetary and fiscal policy in the US. The dollar's recent slide has come alongside a sharp rise in US interest rates. Many are connecting the dots in a causal fashion, but appear to be jumping to a hasty conclusion.