Today's Markets

The combination of a negative surprise from ADP, a disappointing Chicago PMI and talk of MSCI rejig has encouraged the market to extend the short-covering rally in the euro, sterling and Swiss francs. With the fiscal year end repatriation completed, the yen has been under pressure and remains so today. Full liquidity will not return to the foreign exchange market until next Tuesday and this may also encouraged some position adjusting.

Dollar's Share of Reserves Rises, More to Come

The most authoritative source of information about the currency allocation of fx reserves, the IMF's COFER data, was just released for Q4 09. As we have suggested, based on the dollar's appreciation, the greenback's share of reserves increased. In Q4 the dollar's share of allocated reserves rose to 62.1% from 61.5%.

The euro's share slipped to 27.4% from 27.8%. The yen's share slipped to 3.0% from 3.2% and sterling's share was steady at 4.3%. The catch-all category of other currencies rose to 3.1% from 3.0%. This includes Canadian dollars and Australian dollars as well as a host of other currencies that are used on the margins like the Norwegian krone.

Brazil and Mexico Update

Brazil will report is Feb nominal and primary budget balances today. While this report typically does not more the Brazilian market, the risk is that it does today and in disappointment. Late yesterday, it was reported that the central government balance deteriorated to BRL1.09 bln deficit compared with expectations for a BRL1.23 bln surplus. In its updated economic forecasts, the government is forecasting CPI this year at 4.9% and 4.5% next year. The central bank updated its forecasts toward and have inflation at 5.2% this year and 4.9% next year. The midpoint of the central bank target is 4.5%.

Sterling's March: In like a Lion out Like a Lamb

Official had hoped that last week’s EU/IMF deal on Greece would have put the issue to rest for a little bit, but it hasn’t. Month-end considerations appear to be offsetting the impact on the euro. Mediocre to weak demand for Greek bonds this week has resulted in widening premium Greece is being forced to pay. While the Greek government indicates that next month’s funding needs have been taken care of, it still needs to raise another roughly 11.6 bln euros by then end of May and another roughly 21 bln euros by the end of the year. In the first three months of the year it has raised about 18 bln euros. Greece budget appears to assume about a 5% interest rate and it is not seeing that. In order to bring down its borrowing costs, Greece appears to be looking at shortening maturities and is devising a regular bill issuance schedule. This poses its own roll-over risks. In addition, Greece is considering a dollar-issue in the next couple of months. Meanwhile, Moody’s warned that Italy, will have to generate a large primary budget surplus (budget balance excluding debt servicing), but Italian bonds appeared to shrug it off. In this vein, we note that Portugal, which was downgraded last week, has seen its spread (over Germany) narrow by about 11 bp over the past week.

Germany: It is Not Our Fault

The Greek fiscal problems have morphed into a larger structural issue for Europe. Germany itself has come under criticism by some euro-zone members including France, over its export reliance, its sluggish domestic economy and its stingy wage policy. Germany is responding to these criticisms.

First, it note that it has provided 90 bln euros of fiscal stimulus over the past two years. The European Commission has fixed budget deficit targets and has called on Germany to reduce its deficit. In fact, the EU has faulted Berlin for its lack of interest in additional austerity measures.

China Update

The results of the Pew Survey, recently cited in the Financial Times, captures the essence of the tension between the US and China. The survey found that a majority of American believe the Chinese economy is larger than the US economy. Not only is that patently untrue, but it is not even a close call. The US economy is more than three times as big in nominal terms and is still likely close to twice as large at some measures of fair value.

With high US unemployment, high stakes in the November election and genuine frustration over a range of economic and political issues, the US Congress is once again taking up the China issue.

Consolidative Tone Emerges

There are some observers who are suggesting that the negative swap rates in the US (from fixed to floating) is undermining the dollar just as it undermined sterling. This seems mistaken. The strongest major currency against the dollar over the past five sessions has been sterling. But even more to the point, the dollar’s recent pullback, like its strength through Q1, appears to be more a function of developments outside the US than in it. Specifically, the European debt situation and Greece in particular weighed on the euro. As Europe closed ranks, at least papered over differences, the euro found better support. We expect another leg of support for the dollar to grow and that leg is about positive developments in the US. In particular, interest rate differentials are moving in the US direction. This is changing the incentive structure. The whole US coupon curve is now above Germany’s—for the first time since mid-2007. Although Europe will be largely closed on Friday and the US equity market will be closed, the US will be reporting the March jobs figures. It is expected to mark an important turn with the consensus looking for around 200k increase. The data may be skewed to the upside by weather, other seasonal factors, and census workers. The underlying trend looks to be 50-100k. Suspicions that the European debt problem is not really resolved and the near-term strength of the US economy may limit the dollar’s downside.

Canadian Dollar Bid Ahead of Jenkins

The Canadian dollar is well bid in the weak US dollar environment. Higher oil price and firmer commodity prices in general are thought to be lending support as well. The Bank of Canada's Jenkins speaks today near noon EST.

Gov Carney's hawkish comments last week seemed to signal the liklihood of a rate hike in June or July. Core inflation, he said, was rising more than officials had expected. Last time the Canadian dollar was near parity, there was some consternation, but not this time. Officials and market participants seem more relaxed. Carney indicated the BOC views the exchange rate "through the prism" of inflation.

German CPI Higher Than Expected, but Bunds Still Draw Bid

German March inflation surprised to the upside. The 0.5% rise in March translates into a 1.1% year-over-year rate (EU harmonized measure 1.3%) This is the highest since Nov 2008. It appears, in part, to reflect higher energy and commodity prices, which in turn could be reflecting in part the euro's pullback in recent months. The increase in food and clothing prices cold also be reflecting the impact of the poor weather.

Dollar Under Pressure at Start of the Week

The foreign exchange market has responded to the EU/IMF deal by reducing short euro positions. The latest IMM data showed that as of as of last Tuesday, March 23rd, the next speculative position was record short euros. The short-covering rally began before the weekend, with the euro recording a fresh low for the move just below $1.3270. The rally to $1.3425 on Friday has been surpassed by a full cent today. Additional position squaring seems likely over the next couple of days. The next target is near $1.3550-70. Dips to $1.3400-20 will likely be bought.

Despite polls still showing the likelihood of a hung parliament, sterling is also benefiting from the unwinding of long dollar positions. Sterling briefly poked through the $1.50 level where it hit a wall of sellers. Provided initial support in the $1.4950 area holds, sterling can make another run toward $1.5025 and maybe even $1.51 over the next day or two.

GDP Highlights

There has been little reaction to the final revisions of Q4 09 US GDP, though the North American market seems somewhat more dollar friendly than Europe was. The take away from Q4 GDP is a small downward revision in growth to 5.6% from 5.9% and a small upward revision to inflation. The core PCE measure rose 1.8% compared with 1.6% of the prior estimate.

Despite better inventory management and adoption of "just-in-time-inventories", the inventory cycle is still a key driver of business cycle--on the way down and the way up. Inventories are still be liquidated albeit at a slower rate.

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New Year: Return of the Old Yen

A new fiscal year is about to begin for Japan. The yen is likely to depreciate in the year ahead. The driving force may not be a further reduction in risk aversion, though the appetite for risk may remain robust. It is unlikely to be a result of intervention, though given the deflationary conditions and the internecine tension between the Ministry of Finance and the BOJ few will want to rule it out altogether. Nor will the anticipated yen weakness be necessarily the result of a new economic contraction in Japan, but that remains a distinct possibility, especially nominal GDP.

Foreign Currencies Mostly Higher on Short-Covering

The US dollar is broadly lower, though mostly within yesterday’s trading ranges, as the market adjusts positions in light of the European agreement on support for Greece. This is the main market development. However, it does not appear sufficient to really reverse the negative sentiment toward the euro. Resistance in the $1.3425-50 area needs to be overcome to spur another wave of position adjustment. A similar resistance area for sterling is seen near $1.4900-25. be disappointed. The most likely scenario is further consolidation in a choppy North American session.

Meanwhile the dollar has been confined to fairly narrow trading ranges against the Japanese yen. Dollar support is seen near JPY92.00. The approaching month-end, quarter-end and fiscal year-end may discourage participation. Yet, further out—a week from now—the market is looking for a strong US employment report, with such expectations further fanned by news yesterday that weekly jobless claims fell to their lowest level since December 2008.

What Does Greece Want and What's It Going to Get

Currency in Crisis

Greek Prime Minister Papandreou has been arguing that Greece is not asking for material aid, but rather some kind of convincing support that would lower the yield that it must pay. He has supported the European Socialist call for an EMU fund that lends to Greece (and ostensibly others if/when needed as well).

Papandreou may not get exactly what he wants, but he appears to be playing well with a weak hand. Greek 10-year yields have fallen 32 bp this month (bunds are unchanged) retracing about 1/3 of the increase in Jan and most of Feb.

Shifting Currency/Equity Market Relationships

The risk-on/risk-off driver seemed to characterize in many ways during the financial crisis and its immediate aftermath. One of our thematic points is that this relationship is breaking down. In this context we re-examined the correlations between the euro/dollar and dollar/yen exchange rage and the S&P 500.

Recall that in terms of methodology, we run the correlations on the percentage change of daily movement. Over the course of 2008, the euro/dollar and the S&P 500 were correlated 20.3%. Last year it rose to almost 50%. Year-o-date it is just below 44%.

South Africa Surprises with a 50 bp Cut

South Africa's central bank surprised the market with a 50 bp rate cut that brings the key repo rate to 6.5%. A Bloomberg survey found only 2 of 24 surveyed expected a cut. While we had recognized the risk of a cut, news yesterday that Feb inflation was in line with expectations (5.7% year-over-year vs 6.2% in Jan) and still at the upper end of the central bank's 3% to 6% target band seemed to favor a stand pat stance.

Dollar Consolidates

The US dollar is consolidating yesterday’s outsized gains. Profit-taking appears largely minimal, though sterling did receive a boost by the much stronger than expected February retail sales report (2.1% vs consensus of 0.7%). However, the market quickly appreciated the weather distortions and the January series was revised sharply lower (from -1.8% to -3.0%), the momentum stalled. The European summit kicks off among much rancor still and amid talk of a 10-20 bln euro package led by the IMF for Greece, though repeatedly since the crisis first broke there have been expectations of material aid only to be disappointed. The most likely scenario is further consolidation in a choppy North American session.

One of the key points that I have been making is that while the Greek/European issue has been a major force underpinning the dollar, it is not the only factor in the foreign exchange market.

UK Budget Down and Dirty

UK gilts and the British pound have suffered in the wake of the Darling's budget presentation. The UK faces a difficult situation and sterling weakness is the path of least resistance.

Even though Darling forecast a lower borrowing need, the Debt Management Office suggested somewhat greater supply than expected (GBP187.3 bln vs this year's GBP225.1 bln). Progress on reducing the deficit seem slow compared to plans of the other weaker credits in Europe. This year's 11.8% deficit will be reduced to 11.1% next year and in 2014/15 be at 4%. Moreover, with the end of QE, the BOE won't be absorbing any of it.

Norges Bank Stands Pat, Pushes Out Hike, NOK Lower

In what was thought to be a close call the Norwegian central bank left rates unchanged at 1.75%. In its guidance it makes it seem like it was not that close of a call after all, noting that some industries are still contracting and revised up its forecast for unemployment for next year (3.75% vs 3.5%).It also noted that underlying inflation was slowing in line with expectations, but may be somewhat lower than expected, as capacity utilization is lower. At the same it said the NOK was a bit stronger than expected.

This all gives a softish tint to the stand pat stance. It says that rates will rise by later than previously anticipated.

EM Highlights

My earlier post focused on European developments, which are driving the markets today. At the same time, there are several noteworthy emerging market developments.

1. Taiwan central bank meets tomorrow. The key 10-day loan rate is likely to remain at 1.25%, but there is a risk that it hikes reserve requirements in the coming weeks. The country reported strong industrial production and export data earlier today.

Dollar Rides High

The US dollar is riding high today, with broad based gains against the major currencies and enjoying a firmer tone against most emerging market currencies. Even stronger than expected European PMI reports and a better German IFO survey failed to lend the euro much support. The single currency has been pushed to new 10-month lows and took out the longer-term stops and option structures believed to have been struck near $1.3400. This area now poses the first hurdle on corrective bounces. There does not appear to be strong support ahead of the $1.30 area, but for the moment, the $1.3300-20 area may be sufficient to slow the move. The dollar is breaking higher against the yen and is at its best level since late Feb, despite Japan larger than expected trade surplus. The JPY91.60-80 offers the next resistance to the dollar’s march. Sterling is heavy ahead of the budget, but this was most a function of dollar strength as the pound was firmer on the crosses. Support is seen ahead of Monday’s low around $1.4932.

Rand Shrugs off C/A Improvement

Earlier today South Africa reported a smaller than expected Q4 current account deficit. At 2.8% of GDP, it is the smallest in about 4 1/2 years.

South Africa's current account deficit peaked in 2008 just above 7% of GDP. For all of last year it was 4%. A combination of increased trade volumes and higher prices account for the narrower shortfall.

Export volumes (excluding gold) rose 6.6%, but in value terms exports rose 10.7%. Import volumes increased by 8%. This seems largely consistent with what other large commodity producers have experienced.

The US 2-year Yield Soon to Rise Above Germany

In our explanatory models of the dollar's movement, we tend to place greater weight on interest rate differentials, shapes of curves, etc than external imbalances per se.

During this crisis US rates fell well below Germany, the proxy for the euro zone. Just like we argue the dollar's bottom is a process and it often happens as a cascade effect, so to with the interest rate turn.

The US pays about 78 bp more than German on 30-year bonds. The US pays about 61 bp more on 10-year paper. The US pays about 30 bp more than Germany on 5-year bonds.

What FedEx Earnings Say About the Global Recovery

At the end of last week Federal Express reported Q3 earnings. Rarely are corporate earnings reviewed closely by currency strategists, but this report seems to shed light on the global economic recovery.

Fedex, like others in this space, typically do well in the beginning of economic recoveries. Its quarterly profit more than doubled due to a strong pick-up in Asian export volumes. The high profit-margin "International Priority" business jumped almost 18%. The volume of daily domestic packages was up a little more than 1%. This would seem to confirm the relative strength of the Asian economies and the improved trade flows.

Tuesday's FX Color

The US dollar is firmer, but still stuck in trading ranges, even if the edges have frayed a bit. Many observers will attribute the greenback’s gains to continued tension in Europe over Greece, but Greek bond yields have fallen today. Sterling is under pressure too, giving back more than half of yesterday’s gains. Margin new lows, just below $1.50 were recorded after a slightly softer than expected CPI report (0.4% vs expectations 0.5%). The dollar remains largely confined to a JPY90-JPY91 trading range against the Japanese yen, showing little impetus to convincingly break the range. Emerging market currencies are also mostly softer, the of note the South African rand has recouped most of its earlier losses after the Q4 09 current account deficit unexpectedly shrank to its smallest in 4 ½ years.

UK Reports Inflation Tuesday

The UK reports Feb inflation numbers tomorrow. After the Feb release of Jan figures, BOE's King had to write a letter to Chancellor Darling to explain the overshoot.

King explained that the inflation was due to temporary factors and that over time it will ebb due to the abundant slack in the economy. The data, including surveys, have generally been soft. Of special note was the 0.9% decline in January manufacturing output (the concensus was for a small increase) and a widening trade deficit.

Greece Update

Currency in Crisis

The euro is bouncing back as the from its stop-loss triggered move to $1.3463. Perhaps it has been helped by a more resilient than expected US equity market. The euro's low of $1.3436 seen earlier this month appears safe at the moment, though the market does not appear finished for anything for the nearest of tenors. A move above $1.3520 would help stabilize the tone and may prevent another try lower after the European markets close for the day.

There seems to be two main forces on the euro at the moment. First, reports suggest Japanese asset managers have been featured euro sellers today and some are linking this to repatriation ahead of the fiscal year end.

When Japan Returns

Japan's markets were closed Monday to celebrate the spring equinox. There are a number of economic reports that will be featured in the last full week of the fiscal year.

First thing on Tuesday, the BOJ will publish the minutes for its Feb meeting. Given that at the March meeting, the BOJ doubled the size of its 3-month fixed rate lending facility over the objection of a couple of its board members, it will be interesting to see the extent that additional measures were discussed. To the extent they were not discussed at length, it would give a greater appearance of political pressures and might be seen as yen negative, though the politicization has been long appreciated by the market.

Monday Morning Quarterback

Tom Brady playing for University of Michigan,
who has the most all time wins and highest winning
percentage in college football history

There are several developments in the foreign exchange market that are worth reviewing at the start of the week. The US dollar’s underlying tone remains firm after recovering in the second half of last week. Ahead of the EU Summit, Europe seems divided. Germany’s Merkel is keen to dampen expectations that the summit will agree on an aid package for Greece, while EC President Barroso is pressing for some kind of mechanism to be presented. Sterling trades heavily ahead of Wed budget presentation. It has spent most of the European morning below $1.50. It has shed 4.5 cents since the high recorded in the middle of last week. For its part, the euro briefly traded below $1.35 before bouncing to almost $1.3550. The risk is on the downside. Tokyo markets were closed for the spring equinox; allowing the dollar-yen to languish in uneventful range activity.

Surprise, India Hikes; More to Come

India surprised the market by announcing a 25 bp hike in key rates today. This brings the repo rate to 5% and the reverse repo rate to 3.5% To the extent there was speculation of a rate hike, it was more about China than India. That said, India had raised reserve requirement earlier this quarter and many understood a rate hike was a question of time. We had thought early Q2 was a more likely scenario. Today's move probably is in addition to the hike we expected in Q2 not instead of it.

Thoughts on Euro, Sterling and Yen

Euro: When the range breaks it could really break.

The euro has again frustrated the bottom pickers and the perma-dollar bears. It is has again been turned back after flirting with the upper end of its month long trading range. This time it was concern that Europe appeared increasingly divided over whether there should be a regional solution or should the experienced IMF play a leadership role to the deficit/debt issues of members like Greece.

Mexico: Central Bank Meeting Overshadowed

Mexico's central bank meets today. No change in the 4.5% policy rate is likely. The economy is just emerging from the worst recession in modern times, with a 6.5% contraction last year. Price pressures are rising, but the increase from 4.46% in January to 4.83% in February appears to largely reflect increases in administered prices, like gasoline, and tax hikes. The central bank expected inflation to be between 4.25% and 4.75% in Q1.

There are two other issues that may be more important to the near-term outlook for the peso. Most importantly, the new finance minister, who also heads up the government's currency commission, has indicated that it is considering boosting its dollar purchases. Currently through an auction of options, it essentially buys $600 mln a month. It is not clear when and by how much this could increase, but a decision is expected in the coming weeks and there is talk it could increase to $800 mln to $1 bln.

No Discount Rate Hike, but Another is Coming

Speculation swept NY on Thursday that the Fed could raise the discount rate. We were unconvinced and sure enough no discount rate hike was delivered. However, a discount rate hike before the end of the month cannot be ruled out.

On Feb 18th the Fed hiked the discount rate by 25 bp to 75 bp. Perhaps because it was the month anniversary some chins starting wagging, but one of the criticisms now levied against the Fed is that after allegedly leaving rates too low for too long, when it did begin raising rates it did so in a predictable fashion which did not encourage more prudent risk taking. There is not reason to have expected the Fed to celebrate the one month anniversary with another hike.

Swiss Franc Stealing the Show

In a session primarily marked by 1) talk of fissure in Europe over IMF aid for Greece,and 2) speculation of a Fed discount rate, the Swiss franc is threatening to steal the show in the otherwise quiet NY afternoon.

The Swiss franc is posting dramatic gains, ostensibly on the back of SNB comments. New board member Jean Pierre Danthine is quoted on the news wires seemingly trying to prepare the market that eventually rates will have to rise and the exchange rate will be determined by the market.

Color Me Skeptical about Discount Rate Hike Speculation

Speculation that the Federal Reserve is going to hike the discount rate today has weighed on the Treasury market and is helping to lift an already recovering US dollar in the foreign exchange market.

The speculation is likely to be for naught and this may leave the markets vulnerable to a reversal. The last discount rate hike was largely tipped by Bernanke himself and explained. With the Fed having recognized again in the latest FOMC statement the weakness in bank credit, and not wanting to spark additional tightening of monetary conditions, some preparation would seem necessary.

What's So Bad about the IMF Supporting Greece?

Currency in Crisis

The markets have sold the euro in response to news that maybe the obstacles to a European initiative to aid Greece are too greater and maybe the IMF has a substantive role after all.

Although what appears to be a crack in the German government over the issue may have set the proverbial cat among the pigeons, Germany is not alone. Press reports suggest that among euro zone members, Finland, Netherlands and Italy have become more sympathetic to Greece getting financial aid from the IMF.

Implications of the Euro Zone's Current Account Deficit

The euro zone reported one of its largest monthly current account deficits on record. The 16.7 bln euro short fall in January compares with a 9.8 bln surplus in December. There seems to be a seasonal factor that makes the January shortfall typically large. In January 2009 the current account deficit was 19.9 bln euros and in January 2008 the deficit was 17.9 bln euros.

Yet what is disturbing about the January report is the widespread deterioration. The merchandise trade balance swung into deficit (7.4 bln euros vs a surplus of 5.2 bln in Dec). The service surplus all but evaporated (100 mln euros vs 4.6 bln euros in Dec). Investment income slipped back into deficit (-0.8 bln euros vs 1.3 bln euro surplus). Transfer payments increased to an 8.7 bln euro outflow from 1.3 bln outflow in Dec.

Brazil Left Rates Steady, But April Hike More Likely

In what we thought was a close call, the central bank of Brazil left its overnight rate steady at 8.75%, a record low. The decision was made by a 5-3 majority. The dissenters wanted a 50 bp rate hike.

The closeness of the vote is a strong signal that barring a significant downside surprise over the next several weeks, Brazil's central bank will hike rates and in so doing could very well be the first BRIC country to formally hike rates. Both China and India have raised reserve requirements, but neither has hiked benchmark rates.

Role for IMF After All?

News wires are reporting what could be a shift in the German position vis a vis Greece and the IMF. Until now, Germany had seemed to agree with other European officials-- including ECB's Trichet, Eurogroup's Junker, France's Sarkozy--that the IMF can provide technical advice, but this is a problem for the euro zone to resolve.

Underlying Euro Weakness Evident on Crosses

The euro has once again been turned back from the upper end of its 4-5 week trading range against the dollar. The euro has been unable to make much head way despite a couple of favorable developments, including a relaxation of anxiety over Greece and the weaker credits in Europe, economic data that suggests a recovery is taking hold, and that the Federal Reserve appears in no special hurry to raise interest rates--maintaining its signaling device of "extended period."

Close Call on Brazil Today

Brazil's central bank meets today and surveys suggest the market is nearly evenly divided over the outlook. Strong growth and rising inflation and inflation expectations requires a rate hike and the issue is whether the central bank goes today or waits a month to lift the overnight Selic rate which currently stands at 8.75%.

Healthy German Bund Auction, Little Support for Euro

Germany managed to draw a good reception to its 10-year bund auction. Despite a lower yield compared with last month, the bid-to-cover was higher and this despite the improvement in the performance of the weaker credits, which was supposed to erode the safe haven bid for bunds.

Today's auction produced an average yield of 3.13% compared with 3.2% at last month's sale. The bid to cover was 2.0 vs 1.7x in February. If there was a weka spot it might be that the Bundesbank retained a little more than 900 mln euros of the issue vs 767 mln euros at last month's auction.

BOJ Moves Reluctantly

The Bank of Japan left the key target rate unchanged at 10 bp, but appeared to bow to government pressure and increased the size of the three-month loan facility arranged last December to JPY20 trillion from JPY10 trillion.

Tweaking this facility was widely tipped as a likely compromise formation between the BOJ who has argued that monetary policy was already extraordinarily easy and interest rates were extremely low, while the government wants more efforts to combat deflation. Nevertheless, the compromise was not satisfactory and two BOJ members (Noda and Suda) dissented.

The FOMC meets this week. While slower perhaps than desirable, the Fed officials should be generally pleased with the trajectory of developments since they met last in late January. On the real economy side, Q4 09 turned out to be quite strong at 5.9% and the Q1 10 appears to be tracking something closer to 3%. Of course, Q4 was flattered by a large shift in the inventory component which no one expects to be sustained. Consumption and hourly earnings are rising.

Inventories and the US Economy

Business inventories were on the soft side. Not only was the Jan reading flat, but the Dec series was revised to -0.3% from -0.2%. Jan wholesale and factory inventories had previously been released so the new information today was largely the 0.1% decline in retail inventories.

Inventories added mightily to Q4 09 5.9% annualzed GDP and some what to dismiss the growth because of that. However, a large part of the contraction was also due to inventories. Depsite the adoption of just-in-time inventory management and other practices, the business cycle is still heavily influenced by swings in inventories.

Currency Confusion

The foreign exchange market is being accused of confusing the euro for the Greek drachma. Whereas many might be tempted to ignore the accusation, the fact that it was issued by the highly respected Martin Feldstein who is a Harvard professor, an official in the Reagan government and a member (and former chairman) of the NBER committee that is the official arbiter of US recessions, requires taking the claim seriously.

Feldstein’s argument is straight forward. It can be recapitulated quickly. He says the euro’s decline this year is unjustified. He told a Bloomberg TV audience that “There is in my judgment, no real reason for the euro to have sold off overall. After all, Germany is not at risk. France is not at risk”. Feldstein would have us believe that the euro is really more the German uber-mark than the Greek drachma.

Retail Sales Much Stronger than Expected

The February US retail sales data was much stronger than expected, even when taking into account the downward revisions in January. A picture of a broadening of the recovery is emerging. Looking at the Jan-Fed period combined, the headline rate rose a combined 0.4% and the market had expected a 0.3% increase, but the real strength is excluding autos and gasoline. The market expected a 0.9% increase. Instead it rose 1.4%. Ten of the 13 major categories of good/services increased, led by electronics (3.7%) and appliances. The core--ex auto, gasoline and building materials, feeds into GDP estimate. It rose 0.9% and is up 4.5% at the three month annualized pace. This is off the 5.4% pace in Q4 09, but is well above the 1.4% pace of Q3.

Dollar Today

The US dollar's broad pullback is obscuring two otherwise noteworthy developments in Japan. First, both the prime minister and the finance minister made a none-too-thinly veiled threat of foreign exchange intervention.

Although one investment house was quoted on the wires late yesterday suggesting the odds of intervention stood at 47%, we suspect this verbal outburst is part of the on-going battle between the MOF and BOJ. Even though the latter may take another step this month or next to combat deflation, the MOF wants more action.

If You Like the Greenback, You Might Like Canada More

Canada reported a larger than expected trade surplus earlier today. At C$0.8 bln, it was four times larger than expected and the December figures were revised to show a C$0.1 bln surplus instead of a C$0.2 bln deficit. Canada also reported a strong rise in Q4 capacity utilization rate to 70.9% from a revised 68.7% in Q3 (previously estimated at 67.5%). Tomorrow Canada will report February employment figures tomorrow. The unemployment rate is expected to have remained steady at 8.3%. It appears that Canadian unemployment may have peaked in the middle of Q3 09 at 8.7%.

A favorable fundamental case for the US dollar can be built on ideas that the output gap will close in the US before Japan and Europe. However, Canada appears to be the only other G7 country that can match the US. Canada is expected to either match US growth this year or nearly match it.

Is the Market Confusing the Euro with the Drachma?

Harvard Professor Martin Feldstein and member of the NBER committee that is the official arbiter of US recessions was on Bloomberg TV today suggesting that the the euro's decline this year was a reflecting of unjustified panic over Greece.

While of course the concerns about Greece and the lack of sufficient institutional capacity was a important drag on the euro, there seems to be something else at work. Greek bonds have been steady to higher for the better part of the past two weeks and the euro remains stuck in relatively narrow trading range that has prevailed since at least the middle of February.

Turkey and IMF End Aid Talks

In a long engagement, Turkey and the IMF have been negotiating a stand-by package for well over a year. Today Turkey announced that there would be no marriage afterall--no deal. The impasse appeared to be over municipal expenditures. PM Erodogan's government had previously negotiated two programs with the IMF since coming to power in 2002.

ECB and Greece

Currency in Crisis

Bundesbank President Weber has been the most candid to date about what the ECB could do in case Greece is downgraded again, especially by Moody's. Recall the problem: Prior to the crisis, the ECB would take as collateral only paper rated A- or better. During the crisis they have extended it to BBB-. It is due to revert back at the end of the year. Fitch and S&P rates Greece below A-, leaving only Moody's above the normal threshold.

The ECB seems to loathe to postpone the return to normalcy again. And yet as Austrian central banker Notwotny pointed out earlier this week, it seems unfair and untenable that a single rating agency determines whether a sovereign has access to the ECB's lending facilities.

China

China reported stronger export and import figures for February than expected, with the net result of a smaller than expected trade surplus. In fact, February's trade surplus of $7.6 bln is the smallest in a year and a bit more than half of the January surplus. This is consistent, however, with an under-appreciated development that we think is important. In terms of global imbalances, the US trade deficit and the Chinese trade surplus have been roughly halved as a percentage of GDP over the last couple of years. In the US case, it seems largely cyclical and the growth differentials that we expected to close the output gap in the US before Europe and Japan will likely see the US trade deficit grow again, though from a lower base. In China's case, the possibility of a structural shift is greater, though too early to tell. China's exports rose 45.7% in February from the depressed year-ago levels. Yet this is more than twice the pace in January and may also have been distorted by the earlier lunar New Year.

Thoughts about Dollar's Share of Reserves

The IMF's COFER data is the most authoritative on the currency allocation of central bank reserves. It is updated at the end of every quarter for the preceding quarter. At the end of Dec 2009, Q3 data was released. At the end of this month, Q4 data will be published.

Recall that in Q3 09, the dollar's share of allocated reserves has slipped to 61.6% from 62.8%. The euro's share rose to 27.7% from 27.4%. Sterling and the yen's share together was little changed at 7.5%. The "other" category rose to 2.9% from 2.2%. This would include the Australian and Canadian dollars for example.

A Year in Stocks

The US stock markets bottomed on March 6, 2009. It is surprising to see what has really taken place over the past year. We looked at the performance in local currency terms to keep a cleaner read.

Among the G5 equity markets, the US S&P 500 was the clear winner advancing 68.4%. Both German's Dax and the UK's FTSE were up almost 60% (59.2% and 58.0% respectively). France and Japan trailed (55% and 49% respectively). However, if the universe were expanded slightly to the G7, Italy's FTSE MIB Index takes first place with a 77% increase. Canada's TSE rose 57.7%, in the neighborhood of Germany and the UK and better than the another "commodity" country bourse--S&P/ASX200 in Australia, which has risen almost 53%.

Pressure on Turkey

Along with other emerging market currencies, the Turkish lira is under pressure. In addition to broader risk aversion, Turkey-specific developments are also undermining the lira.

At the end of last week Turkey reported that CPI rose to 10.1% in February form 8.2% in January. This coupled with evidence that an economic recovery is gaining traction, has renewed ideas that the central bank to hike rates before too long, even if not at the next meeting on March 18th. The base rate stands at 6.5%.

Portugal Update

With the anxiety caused by the Greece situation alleviated for the time being by last week's successful auction, words of support from Germany and especially France over the weekend, and follow through gains in the Greek debt market, attention may turn elsewhere ahead of Greece's mid-March status report.

Portugal is the likely candidate and although the IMF's Strauss-Kahn says that the Greek crisis will not spread to other euro zone countries, at least Portuguese officials are not as convinced.

Favorable US Economic Data

The favorable news on the US economy extended beyond the jobs data before the weekend. We learned that consumer credit rose in January for the first time since Jan 2009. The $5 bln increase contrasts with expectations of a contraction of a similar magnitude. Some of the details, like an outsized surge in government student loans, seems unlikely to be repeated. The next reports on consumer credit may offer cleaner reads, but we do know that the US savings rates eased in Q4 09 and that consumers have been shopping again here in early 2010.

Yen Slumps

There are several factors weighing on the yen:

1. Speculation spurred by a unsourced story in an English version of a Japanese paper suggesting that the BOJ is considering additional monetary measures to combat deflation and lower yen borrowing costs. The BOJ seems to be under some pressure from the MOF to do more on this front. The BOJ's response appears to be that the government needs to reduce its deficit financing.

Germany: The Unnamed Co-Conspirator

Currency in Crisis

For the better part of the past four months, Greece has been the center of the European maelstrom. It tried concealing the full magnitude of its deficits and debt for years. The proverbial chickens came home to roost when George Papandreou led the Socialists to electoral victory and when he went into the Treasury and found the cupboards were worse than bare.

Europe’s AIG Moment

The markets and, seemingly, most Europeans have very little sympathy for Greece. The situation it finds itself in today is its own doing. Yet the risk of financial contagion is forcing Europe to do much soul searching in the same way the US policy makers did when it came to taking over AIG.

What's Up with Fed Funds ?

The Fed funds rate has been creeping up in recent days. At first, many dismissed it as a technical quirk. In early February, the effective Fed funds rate firmed to 14 bp as it did in early March. However it did not stop there and yesterday was at 16 bp. Dealers report a tight market and it also appears to be reflected in the OIS-1 month swaps.

There is much talk about what lies behind this firm Fed funds rate. Several hypotheses focus on the agencies. There is speculation Fannie Mae is preparing to implement is distress mortgage purchase plan and is parking funds in the market. There is some talk that some US GSEs have reduced lines to European banks, forcing them to pay up for funds.

Iceland Referendum--New Risks, Old Story

Officials have been trying to come up with some way to avoid the weekend referendum in Iceland but it looks likely those efforts have been in vain. Polls show that nearly three-quarters of the Iceland voters will reject the deal that parliament had approved that would pay the UK and the Netherlands 3.9 bln euros (~$5.3 bln) to reimburse the third of a million savers that lost money when Icesave bank failed.

Iceland's GDP is about $17 bln. The payment turns out to be 30% of Iceland's annual GDP. The population of Iceland is only around 320k. The payment is equivalent to roughly $16.5k per person. Originally proposed, the money would be paid over the a 14-year period and would be about $100 per month per person until 2025.

CNBC: PIIGS Impact on the Dollar

Greece Seeks to Save another 2% of GDP and Euro Yawns

Currency in Crisis

As widely expected, Greece announced another package of savings, roughly split between tax hike and spending cuts, that projects to save another 4.8 bln euros, which is roughly 2% of GDP. The measures are harsh, but it is still too soon to expect Europe to provide anything but verbal support and solidarity. Nor can there be any money forthcoming from the Greek PM visiting the German Chancellor on Friday.

The key now is implementation. As we have argued, that is why March 16th is important. It is the first status report of the implementation. In Jan,due to one-off corporate tax, Greece appeared ahead of plan. Many of the initial efforts by Greece appeared aimed at showing immediate results.

Greece Update: More Efforts before Assistance

Currency in Crisis

Greek bonds are continuing to recover from the sell-off at the end of last week that took the 10-year yield to 6.65%. Now quoted near 6.12%, it is the lowest yield since Feb 11, down 14 bp today.

The key consideration is that Greece has 1) delayed the bond offering expected this week after being postponed last week and 2) indications that Greece will announce new savings measures. These new savings measures are thought to be part of the precondition for material assistance that some suspect will emerge from Papandreou's meeting with Merkel on March 5th.

Sterling Sell-Off but No Crisis

Sterling sold off hard on Monday and had a range (according to Bloomberg data) of $1.4784-$1.5209. While such a steep sell-off is rare, they do happen more often than many headline writers and market participants seem to recall. Last year it happened several times and a review of them maybe useful.

The first time was so wicked that it took place over two days. On January 19, 2009, sterling's range was $1.4909-$1.4418 and on January 20th, the range was $1.4443 to $1.3863. Sterling fell 10.5 cents in two days. There was not a crisis. There was some follow through for three days. Sterling fell to a low of almost $1.3500 before putting in a low that has not been seen since--though we would anticipte seeing it again in this bear cycle for sterling. That violent two day sell-off is probably best understood as a capitulation trade.

Euro Drivers

The Financial Times carried a story in the weekend edition quoting a couple analysts suggesting that the 10-year bond differentials are helping drive the euro lower. In our analysis, we have generally attributed a greater role to interest rate differentials than to external imbalances. Nevertheless, at this juncture, the interest rate differential does not seem like a key driver.

Look to Sell into Sterling Bounce

While we have been decidedly sterling negative, the move is taking place much quicker than we (or any one) appears to have anticipated. Both political and economic considerations are behind sterling's slide and M&A flows are not seen as currently helpful.

Sterling is terribly oversold here and a bounce should not be surprising. This bounce we anticipate should be viewed as an opportunity to improve the average on short positions and not to go long sterling.