The Squeaky Wheel Gets the Grease

Currency in Crisis

Pessimism pervades discussions of Europe today. Optimists are not to be found. Many warn that the entire economic and monetary union project is likely to falter over the large deficit and debt burden of the Mediterranean members.

We have written much about the sticky wicket Europe finds itself in today: moral hazard and lack of political will on one hand and the risk of a larger sovereign and banking crisis on the other hand. There is no good choice to be made and that is why it is a tragedy.

What I am Going to Worry About This Weekend

Perhaps it is because of the snow storm here on the East Coast of the US today; perhaps it is because of the weather may have played in a role in depressing some recent economic data, including consumer confidence, weekly initial jobless claims and some chain store sales, but it strikes me that the market has yet to take aboard the impact this on next week's US jobs report. The Bloomberg consensus is for a 40k loss of jobs. It is not that I have a very scientific way of forecasting this notoriously volatile report, or pretend to have some superior approach or even any special insight. I simply think the risk is on the downside and in a significant way. Over the last three months, non-farm payrolls have declined by 106k. My down and dirty, back of the envelope guesstimate is that the job loss this month is larger than the cumulative total of those three months.

Greek Woes

Currency in Crisis

One of the key drags on the euro remains the Greek situation. Greek 2-year yields are up roughly 75 bp on the day (US 2-year yield is near 82 bp and Germany's 2 year yield is near 93 bp). A key driver today appears to be a Market News International story revealing that a draft of a joint report by the EC, ECB and IMF find that the Greek budget plan falls almost 5 bln euros shy of what is needed to reduce the deficit by 4 percentage points this year.

Of the 5 bln euros, 1 bln is due to higher debt servicing costs. The draft thinks that Greece is too optimistic in thinking that cracking down on tax evasion can raise 1.2 bln euros. The report also says that Greece may be exaggerating the funds it will get from the EU budget.

G20 Deputies Meeting This Weekend in Korea

The G20 meet this weekend and it has drawn little attention thus far. South Korea heads up the G20 this year and this meeting of deputy finance ministers and deputy central bankers will be held in Incheon, South Korea Feb 27-28. This is the first G20 meeting of the year. The IMF and World Bank will also be represented. The foreign exchange market itself does not appear to be very salient to policy makers at the moment, outside of the obvious desire on the part of the US and Europe especially for Chinese yuan appreciation.

The real focus is elsewhere. Three issues are reportedly on the top of the agenda. Exit strategies, framework for sustainable and balanced growth, and restructuring the governance of the IMF and World Bank.

Swedish Risks

Many investments houses have been extremely bullish on the Swedish krona. Swedish shares have generally outperformed most European bourses thus far this year, with the exception of Switzerland. Swedish bonds have also fared fine, with 10-year yields falling 7 bp this year and at 3.21% is between the two pillars of the euro zone--Germany (3.16%) and France (3.43%). There is a small bond auction tomorrow in Sweden and some thought this was attracting foreign interest.

Market positioning more than fundamentals is our chief concern at the moment. The euro has lost nearly 5% against Swedish krona this month as flows poured in. However, with the market over-extended and heavily positioned, a small piece of news could trigger a reversal. In fact such a reveal may be in the works and the euro may close above its 5 day moving average against the krona since Feb 8, which illustrates the pace of downmove.

Yen, Deflation, and Labor

Three month LIBOR fixings, if they are still meaningful, are poised to cross in the yen and dollar, with latter set to rise above the former. Recall that on August 24th US 3 month LIBOR was fixed below 3-month yen rates. Today the spread stands at less than 1 bp.

Even though other parts of the dollar LIBOR fixing term structure was above LIBOR yen fixings, some observers recognizing this as a benchmark focused on the yen positive implications of it not being the low rate country. Since Aug 24, the yen has been the second strongest currency against the dollar, appreciating almost 4%, trailing the Australian dollar's 7.5% gain, but outperformed the other dollar-bloc currencies--C$ 3.1% and NZD +2.2%.

United Kingdom

There appear to be only two factors that are weighing on sterling: politics and economics. The weekend polls show the risks of a hung parliament continue and the market sees this as sterling negative. Despite last week’s poor retail sales data and speculation that Q4 GDP may be revised lower when it is reported at the end of the week, gilts continue to be sold off, with the 10-year yield rising 26 bp in the past two weeks to stand at the highest level since Nov 2008. More supply this week will aggravate a market already disappointed with the unexpectedly large GBP4.3 bln deficit in January. GBP3 bln of a 10-year issue will be sold on Feb 24th and the UK seeks to place a 50 year bond via syndication. Sterling itself is near 9 month lows against the dollar and the end of last week and is consolidating those losses currently. Support is seen in the $1.5300-50 area.

Chinese Markets Open Once More

Chinese markets have re-opened from the week long New Year's celebration. Chinese officials have reiterated their message that their desired goal of monetary policy is "appropriately loose" and the 7-day repo rate, eased 2 basis points to 1.48%. This suggests there is plenty of inter-bank liquidity. Participants will be watching to see if the PBOC drains tomorrow or allows the 1-year bill rate to rise (CNY17 bln in 1-year bills will be auctioned on Tuesday). The yuan strengthened 0.1% against the dollar today, the largest gain in about a year. Fluctuations have been wide during the New Year's holiday. For its part, the 12 month NDF was little changed implying about a 2.6% appreciation over the year. Several well known analysts have claimed recently that they felt China was on the verge of allowing the yuan to appreciate. We have been more skeptical, seeing little near-term advantage and, on the contrary, think such a move would be seen as a concession to the G7/G20 or the US, all of which we don't see China inclined for. We recognize the risks increase nearer mid-year.

Japan

The LDP beat the government's candidate for governor of Nagasaki over the weekend. Public support for the DPJ government appears to have fallen below 50. Prime Minister Hatoyama blames the recent scandals for the poor showing and this is likely to increase pressure on DPJ-kingpin Ozawa to resign. It is among his aides that the recent scandal has broken. Attention begins to turn to the yen’s likely behavior into the end of the fiscal year. Last year, the yen strengthened in the first half of March but by mid-April had given it all back plus some. Mitigating these forces may be the stronger appetite foreign investors have shown in recent weeks for Japanese equities. The market is talking about $35 bln (JPY 3.2 tln) of Toshin funds this week with the peak issuance expected Wed.

Bernanke Update

Federal Reserve Chairman Bernanke is widely expected to reassure Congress (and the markets) this week that last week's discount rate hike does not signal a tightening of monetary policy. Nor does it signal an imminent Fed funds rate hike. This has been a consistent message from Fed officials. The Fed funds futures and the overnight index swaps are little changed since the discount rate hike. Indeed, the first monthly decline in core CPI report in nearly 30 years, reported before the weekend underscores the absence of the kind of inflation that concerns the Fed. The Fed has often cited inflation expectations as a critical factor in setting policy and here it is interesting to note that the 5-year/5-year forward has fallen from 2.87% at the start of the month to 2.48% the low point at the end of last week. That said, the recent string of economic data illustrates that growth differentials have moved in the US favor.

Greece Today

Currency in Crisis

Interest rate spreads are steady at the start of the week. The details on the currency swaps that Greece was to provide at the end of last week appear to have been partial, according to reports, as strikes in the finance ministry prevented accessing all the data. The EU has now given Greece until February 19 to provide the rest of the information. Note a general strike is planned for Feb 24.

Meanwhile, new speculation has emerged about a 20-25 bln euro package, but this still seems premature. Surely the first implementation report due March 16 is needed first. If Greece is at or ahead of plan, and there is some reason to expect many of the one-off measures to be having an impact, no package in mid-March will be needed. On the other hand, if Greece is failing to implement its program, it may be even more difficult to cobble political support for it. Op-ed arguments that Greece is just the tip, and a small tip at that, of the proverbial iceberg, is hardly news and has had little impact.

Little Impact From Dutch Government Collapse

The Dutch government collapsed over the weekend as the Labor Party withdrew from the government as it refused to agree to the NATO request to extend Dutch troops stay in Afghanistan.

The spread between Dutch and German 2-year and 10-year bonds today widened by a single basis point, suggesting no real market impact. On Tues, the Dutch government is expect to bring to market 2 bln euros of 2012 and 2016 paper and this seems unimpaired by the political developments.

CNBC: The Fed's Current Impact

Dollar Slips on Soft Core, but Look for it to Bounce Back

The dollar was initially sold on the softer than expected CPI data, but market sentiment is such that it is inclined to buy dollar dips rather than to sell into strength.

The core measure fell 0.1%, the first decline since the early 1980s. Trend measures of core CPI show a sharp deceleration. Home owners equivalent rent fell 0.1% and is an important restraint on core inflation.

Why I'm Not Worried About China

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Seeking Alpha

A Real Pig’s Eye

The end is nigh. The irresistible force encountered the immovable object. We learned this week that China reduced its Treasury holdings in December for the second consecutive month. Is it really true, as one analyst was quoted on the front page of the Financial Times claiming that China was “saturated” with US paper? Is this yet another nail in the coffin of America’s hegemony? Don’t bet on it.

The exaggeration here is simply breath-taking. The lead of the Financial Times story is very revealing. “Foreign demand for US Treasury bonds fell by a record amount in December…” In a pig’s eye it did. Foreign investors bought a robust $70 bln of Treasury notes and bonds. That is roughly a quarter higher than the 6-month average.

Turkey Upgraded By S&P

S&P upgraded Turkey's long-term foreign currency rating to BB from BB- and a positive outlook which suggests the likelihood of additional rating increase. S&P says this can happen in the next year or two. Our proprietary model is consistent with a BB+ rating. The reduced debt burden and the stability of Turkish banks were behind the S&P decision. Turkey's debt market did not seem to respond to the news, the lira did. The dollar shed its earlier gains against the lira and new sees support near TRY1.5150 and then TRY1.5070. We retain an optimistic outlook for the Turkish lira over the medium term and expect it to be one of the bright spots in the region.

Fed Hikes Discount Rate

The timing has caught the market off guard. The Federal Reserve announced it was lifting the discount rate to 75 bp from 50 bp. Fed Chairman Bernanke had hinted this was coming rather soon. However, even though the discount rate hike is a Federal Reserve Board decision, that the Fed would make such an announcement at an FOMC meeting. We had thought the meeting next month was mostly likely. The decision to go between meetings is important. The Fed wants to drive home the message that it does not see this move as changing monetary conditions. That is to say that it is not tightening policy.

Candian Dollar and Data Update

Canada reported an acceleration in inflation and strong capital inflows at the end of last year. The Canadian dollar, like the other major currencies, are recovering against the US dollar in the North American morning. The US dollar approached the CAD1.05 objective noted yesterday and has turned back to retes the CAD1.04 area. Although minor penetration is possible, we are more inclined to expect continued range trading today as the hourly momentum indicators are already over-extended.

Consumer prices were 1.9% above year ago levels last month, the highest since Nov 2008, representing a 0.3% increase on the month. More importantly from a policy making point of view, the core rate rose to 2.0% from 1.5%. The Bank of Canada has promised no rate hikes before mid-year. The stickiness of core inflation warns of a risk of a BOC hike in Q3.

Italy Update

The revelations about Greece's currency swap, fuller details are expected in the coming days, have raised questions about Italy.

First, there was some concern that Italy Central Bank Governor Draghi may have involved with the swaps with Greece when he worked for the US investment house that has been linked to the transactions. The Bank of Italy formally denied this.

Canadian Dollar Update

February has been kind to the Canadian dollar so far. It is the second strongest major currency, gaining about 2.5% against the US dollar, and lagging a little behind the top performer the Swedish krona.

The relative healthy Canadian banking system and relatively stable debt to GDP ratios, which became more salient in the face of pressure in Europe, coupled with commodity plays were among the main drivers of C$ appreciation. We also note that in a strong US dollar environment, the C$ often tends to out perform the many of the other majors. Often it seems as if Canada, a small country by G7 standards, often leads by example. We have noted how the Bank of Canada has diversified its reserves so that although the US is by far and away the largest buyer of Canadian exports, only around half of Canada's reserves are denominated in dollar assets.

Rand Bounces Back

The South African rand is benefitting from two forces. The first is the generalized recovery in risk appetites, illustrated by rising equity and commodity prices. The second force is special to South Africa. After a slow start the rand rallied in the European morning, even as the euro slipped to session lows. The proximate cause of the rand's out performance was comments by Finance Minister Gordhan. He retained the tight budget introduced last Oct that seeks to reduce the deficit by a 1.1 percentage points to 6.2% of GDP in the year through March 2011. Gordhan also is emphasizing efforts to keep inflation in check, even though the nearly 1 in 4 are unemployed (24.3% in Q4 09).

Broad Dollar Sell Off

Relatively constructive US economic data in the form of a better than expected Feb Empire Manufacturing Survey and a stronger than expected capital inflows (Dec TIC report) has seen the dollar humbled under broad based profit taking. Although there did not seem to be a trigger for the price action, there are a couple things to note. First, as mentioned earlier, Greek debt was under pressure today. The market has taken it in stride. In fact, with the EU fin min meeting out of the way, it seems the topic may be an simmer from hot as positions now seem to have been staked out ahead of the mid-March review or pending the next effort by Greece to issue debt.

Greek Update

Currency in Crisis

Greek debt instruments were sold off on Tuesday amid some disappointment that the EU finance ministers failed to provide more detail or color on official support for Greece. The most likely reason for the lack of detail is that that is the extent of the agreement: Wait and see. 

Officials seem committed to verifying that Greece is implementing its fiscal program. The next key date is March 16th when Greece is to submit a progress report. In the mean time, Greece's Finance Minister Papaconstantinou claims that Greece is ahead of schedule in meeting its targets. He cites figures published Feb 12 that showed Greece had a budget surplus of 574 mln euros in January compared with a 1.55 bln euro deficit in Jan 2009. The improvement was largely traced to a one time tax on corporate profits.

Japanese GDP Preview

Japan will report the Oct-Dec GDP figures on Monday. The pace of growth looks to be closer to the US than to the euro zone, which essentially stagnated (+0.1%). A news wire consensus is for Japanese growth to be around 3.6% (0.9% q/q) at annualized pace. And the risk seems to be on the upside after those spectacular jump in machine orders (+20.1% in Dec vs expectations of 8%).

External demand is the key driver of the Japanese economy. Asian demand, especially China has been vital to what recovery there has been in Japan. For the whole year of 2009, China surpassed the US as Japan's biggest trading partner. Net exports likely accounted for over half of Japan's growth in Q4.

Long Term Dollar Outlook

The great Lebanese poet Khali Gibran once wrote that sometimes the mountain is clearer from the plain than the summit. This insight maybe applied to the foreign exchange market. Currencies in the modern era, not backed by gold or silver as was traditionally the case, have no intrinsic value. They are accepted because the governments have commanded it so; hence they are what economists call fiat money.

The day-to-day volatility is so greater that it is difficult for even professionals to consistently forecast currency movement with any meaningful degree of accuracy. In addition the bulk of the turn-over in the $3.2 trillion a day market (BIS triennial survey 2007) is accounted for by short-term trading. Arguably, often the true signal of the market is lost in the noise and can only be seen by pulling back and looking at the bigger picture.

A Way Out?

We have argued that the EU faces a horrible dilemma. One horn is the moral hazard inherent in support for a profligate agent, while not necessarily putting a firewall around the other weaker credits in Europe. The other horn is to do nothing, risking the rout turns into a capital strike.

What is needed is not only a solution for this particular crisis, but a new mechanism. A European bond has much to recommend it.

Bernanke

Federal Reserve Chairman Bernanke's written testimony provided yesterday is very important. There are three key take aways. First, investors should be prepared for a hike in the discount rate relatively soon (in what Fed-speak is "before long"). As part of the normalization of monetary policy the Fed wants to widen the spread between the Fed funds target and the discount rate, which now stands at 25 bp. A tricky thing about doing so is that it is a Federal Reserve Board decision, which means it need not take place at an FOMC meeting. Indeed by not raising the discount rate at an FOMC meeting the Fed would underscore Bernanke's point that a discount rate hike should not be seen as a policy change.

Implications of US Trade Data

The US deficit widened in December and by more than expected. The deterioration was largely a function of oil imports. Simply put, the US imported for oil products and at higher prices. The non-energy deficit was largely steady at $16.7 bln from $16.5 in Nov. 

One important implication of the wider real trade deficit is that the 0.5% the net exports contributed to US Q4 GDP will likely be revised down. On top of that, the wholesale inventory figure out earlier this week also points to a modest downward revision to Q4 GDP's preliminary 5.7% annual growth pace.

Czech Auction Failed

No doubt the focus is on attempts of Western Europe to address the Greek debt/deficit crisis. One knock on effect of the woes is that many suspect the bar to entry of future members has been raised.

While Greek, Portugal, Spain, Ireland and Irish bonds have extended yesterday's rally, absorbing the new Portuguese supply today, the Czech Republic has not been so fortunate. It managed to sell only about half (2.9 bln CZK, or ~$155 mln) of the 15 -year bond it brought to market today.

CNBC: Debt & Currencies

Spiegel Online Warns of More Accounting Gimmickry

German-based Spiegel Online has an article that is attracting market attention.

It claims that a large US investment house helped arrange a cross currency swap for Greece that helped to conceal another $1 bln in debt. Although this amount seems relatively small given the huge debt and deficit problems, many suspect it could be just the tip of the iceberg.

EU Bailout--Don't Believe It

As US players return to their posts, the have taken the euro higher amid speculation that the EU is about to announce some sort of deal for Greece. No fat wedding, but fat chance. Leave aside for the moment that Portugal's finance minister has already denied the speculation and Greece has been adament that it is not seeking external assistance. The fact of the matter is that a bailout before Greece implements its austerity program is nonsensiscal. It is putting the before the horse. Just last week a monitoring system was established and to give funds now would be to undermine that effort. Moreover, giving assistance to Greece at this juncture would risk deflecting the angst away from Greece (perhaps) and toward Portugal and Spain.

Bullard ahead of Bernanke

Much attention will be given the Federal Reserve Chairman Bernanke's mid-week testimony before the House Finance Committee. He is expected to provide more details about the Fed's exit strategy.

Atlanta Fed President Bullard is quoted on a news wire that might be anticipating Bernanke's testimony. First in terms of the economy itself, Bullard expected H1 2010 growth to be above 3%. This is a bit above the street. The Bloomberg concensus is for about 2.75% growth in H1 and 2.85% in H2.

Notes on IMM Positioning

The weekly Commitment of Traders from the IMM currency futures were reported just before the weekend. There are several noteworthy developments.

First, as of last Tuesday, the net short speculative position was a record at 43.7k contracts. The subsequent price action and open interest warns that the net short were extended in recent days.

Amor Fati: Moving toward Our Maximum Regret

The risks are asymmetrical. Many of the world’s national economies, in various stages of recovery, are still highly dependent on government support. While it is possible that the combination of aggressive fiscal and monetary policy responses have put the economies on a strong growth path, there remains a much greater risk that as the stimulus is removed the economies stagnate or worse. 

Aborted recoveries are rare. They are the exception that proves the rule. Despite the gallons of ink spilled on prognostications of a “double dip” or a “W” shaped bottom, there have only been two in the U.S.—the Great Depression and the early-1980s Reagan-Volcker recession. They seem to be products of a policy error, like removing a splint too early from a broken bone.

China

The combination of earlier than expected tightening by China reflected in bill rate increases and reserve requirement increases (and in India as well), coupled with the growing anxiety over sovereign credits in Europe has encouraged risk reduction and this is evident in flows into emerging market equity funds. In the week ending Feb 3, EPFR Global reports that $1.6 bln flowed out of emerging market equity funds, the most in nearly six months.

Sweden's Riksbank Joins Normalization Efforts

The focus was on the BOE and ECB today, but little fresh has been revealed by them. One central bank that did do something was Sweden's Riksbank. It indicated that it will no longer be proving 12-month loan to banks. Shorter term duration loans will still be provided. This is not a very big deal, as the ECB and other central banks have already begun a gradual normalization of monetary policy. However, one implication that is noteworthy is that the move would seem to be a indication of the better health of Swedish banks who probably do not need the kind of support that they needed in the recent past.

Canada Today

The Canadian dollar has been no match for its US counterpart and has declined by about 1% against the greenback thus far this year. However, it has held up better than the other major currencies, except the Japanese yen. This seems rather typical of the Canadian dollar's performance in a strong US dollar environment. Ahead of the G7 meeting and next month's budget presentation (March 4), Canada's FM Flaherty acknowledged that the economists it surveys revised up growth forecasts to 2.6% this year (from 2.3% estimate last Sept) and expect unemployment to fall to 8.5% (from its previous estimate of 9%.) Although the Conservatives are a minority government, Flaherty appears to have broad support to keep the focus on recovery rather than fiscal consolidation. Canada's debt to GDP is the lowest among the major industrialized economies, which gives it greater policy flexibility. Today, Canada reports Dec building permits and the IVEY Purchasing Manager Index. Both reports are expected to show improvement from the previous readings. Building permits are expected to have risen 2.5% after falling 4.6% in Nov. Assuming the consensus is close to the mark, Q4 09 will be the strongest quarter for permits since Q4 05. The IVEY PMI peaked in Sept and has been trending down in recent months to fall below the 50 boom/bust level in Dec. It is expected to have reversed the decline and moved back above 50 in Jan. That said, these reports pale in significance compared with tomorrow's jobs report. With a single exception since May 09, Canada's job creation has been saw-tooth, alternating months between gaining and losing jobs. That said, the 3-month average has been positive since last Aug. The consensus is looking for around a 15k gain in jobs after a 2.6k loss in Dec. The unemployment rate appears to have peaked in Aug at 8.7%, but is expected to remain near the 8.4% that prevailed in Q4 09. The US dollar peaked near CAD1.0720, which corresponds to the upper end of the range over the past few months. A break of the CAD1.0530 area is needed to help confirm that this is indeed the near-term high.

CNBC: Sovereign Debt Threat

Greece is not the Word, But Portugal is Today

Currency in Crisis

Greece who has been the center of the financial storm in Europe got a cautious vote of confidence from the EC today. It 2 and 10 year bond yields are slightly lower on the day. The lightening rod has been passed to Portugal today and this appears to be one of the factors weighing on the euro and in general helping lift the US dollar. Portugal 10-year yields are up 21 bp today the largest rise in nearly a year and the premium over Germany is the widest in almost that long too. Its 2 year yield is up 23 bp today. The 5-year CDS appears to be at record levels.

More on the G7: Yuan Debate?

There will not be a statement after this weekend's G7 meeting, but officials will likely take to the microphones and wax on global developments and their pet issues. Host Canadian Fin Min Flaherty says that foreign exchange issues will be discussed, but this seems to be normally the case, especially given that central banks will be represented.

It was up to Japanese Fin Min Kan to provide a specifics. He said that the Chinese yuan may be debated. Really ? Debated ? If the affirmative case is something like, resolve that China allows its currency to appreciate, who is going to take the opposite side?

Careful with the Zloty

The Polish zloty has been a market darling. We have liked it as well. It is among the best emerging market currencies over the past week, gaining nearly 2.25% against the dollar and nearly 2.75% against the euro. Caution is in order now. After funds poured into Poland, one of the few countries to avoid an outright recession, the market is now vulnerable to less favorable news.

The attention is on the EC's review of Greece's proposals, but it some not very favorable things to say about Poland too and this is enough to spark a potential reversal in the zloty against the euro. The euro had earlier extended its recent losses against the zloty, amid follow through selling after the PLN4.0 level gave way on Monday. A break back above PLN4.0 could help shake out some of the last zloty longs/euro shorts making a PLN4.05 initial target reasonable.

EC Verdict on Greece Wednesday

Currency in Crisis

The European Commission will give its verdict on Greece's new fiscal initiatives tomorrow. There are two main issues. The first is the credibility of Greece's macro-economic statistics. Some reports suggest that the new commission established to ensure accuracy of Greece's statistics has covered another 40 bln euro shortfall. To be sure though the reports do not appear to be officially confirmed (yet?). The second issue is whether Greece should take more measures.

We suspect that the EC will be mostly supportive for Greece's efforts, but will chastise it and call more steps. But this seems like a largely scripted drama and by calling for additional measures, the EC positions itself well, while being supportive and encouraging. For its part, contacts suggest, Greece is prepared to announce another initiative. This choreographic dance may increase Greece and the EC's credibility.

Preliminary Thoughts about the Upcoming G7 Meeting

There have been suggestions that the G20 becomes the basis for a new governance structure of the IMF. If if this does not come to pass, it is clear the the G7 has been downgraded to a caucus within that larger group. Canada heads up this year and its influence is greater in the G7 than in the G20 so it is little wonder that it is trying to build an separate agenda for the G7. With Canada at the helm, it may postpone an real identity crisis for the G7 until next year, when it appears France will host both the G7 and G20.

Phillippines

While attention has been focused on Europe's fiscal challenges, developments in the Philippines today is a good reminder of the global nature of problem. It experienced its second failed auction here at the start of 2010. Today it rejected all the offers for PHP8.5 bln (~$183 mln) 2016 bonds that had produced an average yield of 7.465%, which was about 10 bp above the prevailing rate in the secondary market. There are a couple of considerations behind the market's demand for higher interest rates: Expectations for rate hikes to check inflation. The Jan CPI figures are due later this week and are expected to have risen 0.6% for a 4.9% year-over-year rate. Although the Philippines was able to raise money in the international capital markets ($1.5 bln dollar offering in Jan and is reportedly working on a samurai issue), the record budget deficit may be difficult to smoothly fund. Pre-election spending may help boost the economy, but it also increases the deficit. On the other hand, there has been a relaxation of China's interbank market rates and this, coupled with the unchanged one-year bill rate for the second consecutive week, has eased some anxiety, though the Chinese stock market failed to sustain its early gains. The Shanghai Composite closed below its 200-day moving average last Friday and yesterday and was turned back from a test on it earlier today, which is also where an uptrend line drawn off the summer lows comes in. The risk is that the 12% decline since last month's high is not complete and this may weigh on other markets in the region.

Dollar Carry Trade and Positioning

Three important developments to note:

1. In our discussion with clients and policy makers over the past 3-6 months we argued that one of the potential surprises that few were prepared for was a stronger dollar. The Deputy Governor of the PBOC was quoted from Davos making a similar assessment. "To me, the big risk this year is the dollar carry trades. It is a massive issue. Estimates are that the dollar carry trade is $1.5 trillion, which is much bigger than Japan's carry trade was."

Thailand Joins the Club, Encouraging Capital Outflows

Apparently learning for the fiasco in 2006, when it imposed controls to limit the Thai baht appreciation, by limiting inflows, Thailand announced today measures to liberalize outflows. The goal appears largely the same. Reduce the upside pressure on the currency. 

The steps announced today include abolishing the cap on overseas investments by Thai companies and easing the ability of businesses to manage their FX risks.