US Q1 GDP: Recovery Intact, Deflation Risk Remains

The first look at Q1 US GDP was largely in line with expectations. The 3.2% annualized pace was slower than the 5.6% of Q4 09, but every one recognized that that pace was not sustainable. Although growth seemed more solid, price pressures eased, further underscoring the lack of price pressures. Despite then the slightly above trend growth for the second consecutive quarter, the Fed remains securely on the sidelines.

Consumption rose 3.6% after a 1.6% advance in Q4. It contributed about 2.5 percentage points to the GDP figure. Inventories added about 1.6%. Business spending on equipment increased 13%, but its spending on structures fell 14%. And for first time in three quarters, house construction fell.

Greece and Japan in Focus

Currency in Crisis

There are two main forces at work today in the global capital markets. The first is the signal from various sources that the aid package for Greece is at hand, following new substantial savings by the Greek government. It now looks like something could materialize over the weekend.

The second force is month-end consideration as positions and hedges are adjusted. The combination of these two forces may discourage resisting the moves in the foreign exchange market today. We do think this is what will take place even if not today.

Greece Optimism and Month-End Dominate

Currency in Crisis

The US dollar is surrendering its recent gains against most major and emerging market currencies today amid reports that new substantial Greek savings (24 bln euros) will be sufficient to spur a larger (100-120 bln euro) aid package that could be ready in days. The yen has also suffered in this less anxious environment. Polls suggesting the Tory’s Cameron put in his best showing in last night’s debate may be helping sterling. Month-end considerations are also thought to be helping sterling.

While some the imminent funding for Greece may be at hand, it is far from clear that the euro zone debt crisis is over. The euro has risen through the $1.3325 objective. The next target is near $1.3400. Sterling has neared $1.5400, but the real cap is closer to $1.55. The dollar is trying to establish a beachhead above JPY94.00. Resistance is seen near JPY94.80. While the short-term technical indicators suggest the foreign currencies are over-extended, and the US is likely to report a robust Q1 GDP, the month-end and the uncertainties about the actual details of the Greek funds, may discourage aggressive picking of a dollar bottom today.

Did the Swiss National Bank Show its Hand?

There is a suspicion in the foreign exchange market that the Swiss National Bank intervened forcefully yesterday, even if quietly, and may have been in today as well. The SNB rarely confirms intervention. Confirmation is often only available when the quarterly reserve figures are released.

Much to the surprise of the market, which thought Swiss franc's appreciation against the euro was a function of the SNB pulling back, learned that Q1 reserves rose sharply and its euro holdings rose by about 30 bln.

Newstream Turns Market Cautious

Many if not most foreign exchange participants understand that the short euro position is a crowded trade and that this leaves the market vulnerable to a short-covering bounce on a favorable news development. However, fundamentals and sentiment suggest there will be selling into euro bounces. In the European morning euro has been lifted through yesterday’s highs, we suspect this will give North American operators a better selling opportunity. Sterling too appears to be running out of steam after Europe bid it through the $1.5250 area. Stops on new short positions should be placed above $1.53.

There is much speculation around a larger Greek package, with rumors of as much as 120 bln euros. This would ostensibly be conditioned on additional savings measures by Greece. Market talk suggests Greece may be considering a 2% hike in the VAT and another round of wage cuts among government workers. A Reuters poll found 30% of those surveyed expect Greece to restructure its debt in the next five years. News that Fitch reaffirmed its AAA rating for Spain after S&P’s downgrade yesterday also is seen as a break in the negative news stream. Our proprietary assessment warns that Fitch’s affirmation notwithstanding, Spain does not deserve triple A status.

Euro Bounces; Like a Dead Cat?

The US dollar is somewhat softer today as the market takes a pause to consider recent developments. News that Fitch reaffirmed its AAA rating for Spain, despite S&P’s move yesterday, and heightened speculation that European officials are working on a larger multi-year fund for Greece, and a relatively smooth Italian bond auction, are helping to calm the foreign exchange market for the moment. Sentiment toward the euro remains poor, but many seem increasingly reluctant to add to short positions, fearful of a short-term bounce on some news development that would offer a better selling opportunity.

FX Price Action

The euro traded down to about $1.3143, which has not been seen in nearly a year. Although it found a bid there as news wires announce a number of official press conferences in Europe as officials try to calm market anxiety that the EU/IMF negotiations with Greece may include a debt restructuring. Recall that when S&P slashed Greek’s ratings yesterday, it ascribed a level 4 to its recovery rate, which means that bond holders may see a return of only 30-50% of their investment. The euro did trade higher initially in Asia, reaching a high of almost $1.3220. We expect the euro to continue to be sold into bounces. Above $1.3220, look for offers in the $1.3250-70 area to cap the upside. On the downside, there has been talk of good demand for short-dated euro puts struck near $1.30.

Europe Dominates

The US dollar is generally firmer as the European debt crisis escalates and dominates the global capital markets. As was the case in the post-Lehman environment, the demand for dollars is just as much a function of securing funding as it is a safe haven.

Ironically, sterling has been sold-off harder than the euro today. Investors continue to try to get their heads around the risk of a hung parliament, the length of time it may take to form a government, and whether the country can avoid a Greece-like debt crisis, which Vince Cable, a likely candidate for Chancellor of the Exchequer should the Lib-Dems be part of the next government. Unlike yesterday, the yen is trading a bit heavier against the dollar and most of the common crosses, except against sterling. It appears that its recent strength was more a reflection of unwinding cross positions than safe-haven demand.

Two Additional Points About Greece

First, note that Moody's rating for Greece is A3, which is the same as A-. As long as one rating agency has Greece BBB- or above, the ECB will still allow its use as collateral. Of course the S&P aggressive move is significant and cannot be for European banks, who hold Greek bond, including Greek banks themselves, but Greece is thus far not cut off from the ECB.

Second, S&P assigned a recovery rating of 4 to Greek debt issues. This means that S&P expects on average that debt holders may get only 30-50% of their investment back in the event of a debt restructuring or payment default.

Kiwi is More than a Fruit; Approaching a Low Risk Buy

The Reserve Bank of New Zealand meets tomorrow. There is little chance of a hike in the 2.5% official cash rate. The market continues to expect the RBNZ to begin raising rates in Q3. There is unlikely to be a shift in these expectations.

This should not stand in the way of a continued gradual appreciation of the New Zealand dollar. Earlier this month, the Kiwi tested the $0.7000 level and from there launched a rally that carried it above $0.7250 for the first time since mid-Jan. Last year's high was set in October near $0.7635. A run back to there assumes that the Oct-Feb decline in the Kiwi was a correction (4th wave for Elliott Wave types).

Every One Gets A Haircut?

The main talking point for many today is the ongoing tension between Greece and Germany, with the consequence being felt in the debt market and the inability of the euro to sustain even modest upticks. However, perhaps rather than the apparent differences, what is really going on is being driven by their similarities. Specifically the latest opinion polls seem very clear and in agreement. The majority of Germans do not want to bailout Greece and a majority of Greeks do not want foreign assistance. What does this mean?

It means the unthinkable has become thinkable: restructuring. The continued widening of spreads against Germany reflects this. Suppose, for example, the goal is to bring Greece’s debt/GDP ratio to 60%, as the Stability and Growth Pact mandates. In lieu of currency devaluation, many investors appear to be taking more seriously, debt deflation. All stake holders may have to take a hair cut and how the costs are distributed is what the European politics may determine.

Greenback Recovers

The US dollar has recovered from the decline seen in North America yesterday against the major European currencies. The take away from the price action is not however one of consolidation, but rather that good dollar buying emerged on the pullback.

The EMU situation is continuing to deteriorate. Good support was encountered yesterday just below $1.3300, but there is really little to hang one’s hat on until $1.3200. In the UK, while the risk of a hung parliament has long been discounted, but many of those momentum players and contrarians playing sterling from the long side have met a formidable obstacle at $1.55 and 0.8600 against the euro. Watch $1.5340, roughly the 20-day moving average, below which sterling has not finished the North American session below since 29 March. The yen is benefiting in this environment, but the dollar’s push back form the JPY94.35 high yesterday has still be fairly shallow thus far. However a break of JPY93.60 would suggest a near-term high is in place. Dollar-bloc currencies and most emerging market currencies are also softer today.

Yen Outlook and BOJ Meeting This Week

The BOJ meets at the end of the week. For good reason, no one is expecting a change in rates. The risks lie with its economic and inflation assessment. It could revise both higher. Export growth has been fairly robust in recent months and this is helping boost industrial output and capex plans.

Japan continues to be the only major industrialized country experiencing outright deflation. This was driven home earlier today as Japan reported 1.1% (year-over-year) decline in corp service prices. This was slightly better than the consensus and a minor improvement from the revised 1.2% decline in Feb (from -1.3%).

Federal Reserve: Profits and FOMC meeting

In a not very well advertised announcement last week, the Federal Reserve turned over about $47.4 bln to the US Treasury. This was a record payment. Over the past decade, the Fed typically gives the Treasury about $25 bln of its profits. The Fed reportedly made some $53.4 bln last year, mostly from its MBS investments.

However, about 10% of the profits came from its consumer credit, commercial paper purchases and the vehicles created to absorb Bear Stearns and AIG's distressed assets. Separately, we note that GM has agreed to payback Treasury the remaining $4.7 bln under TARP. One the net consequences of this and the somewhat stronger than expected economy (increased revenues) is that the amount of Treasuries the government needs to sell is somewhat less than anticipated.

Europe in Denial, UK Benefits

Throughout the unfolding of the Greek crisis, European officials have repeatedly failed to get ahead of the curve of market expectations and events and this is the case once again. The impression that officials had given was that funds would be there once Greece formally requested assistance, but now it seems that Greece’s formal request simply opened the door to a new round of negotiations. Germany is not speaking with one voice, but the Finance Minister appears to be seeking detailed plans for 2011/2012.

There was concern expressed by some German officials as well as by Canada’s Flaherty that the funds earmarked for Greece are insufficient for the task. Although denied by officials, there seems to be an arguably growing number of market participants that suspect that some kind of debt restructuring for Greece will be necessary. Estimates suggest that Greece’s debt servicing costs could be as much as €50 bln for the next five years. The cumulative cost (€50 bln x 5) is roughly a year’s worth of output (GDP). ECB officials seem to be in denial about the contagion risks, and this is preventing preemptive action. Meanwhile, the weekend polls warn that support for the Greek government is thinning and the resistance to more cuts in wages and pensions may stiffen, just as Europe and the IMF will seek additional concessions.

Dollar Bid, No Closure in Europe

The US dollar enjoys a firm tone against most of the major foreign currencies today. There are two main features in the foreign exchange market today. The first is investors still lack closure on the European crisis even after Greece formally acknowledged that it needs to draw on the European/IMF backstop facility. This has undermined the euro, which after failing to build on the pre-weekend gains has been sold in Europe, dropping 2 cents to $1.34 before finding support.

A Quick Word on Latest Developments in Greece

Apparently, German Finance Minister Schaeuble tried to attach the authorization for the Greek backstop facility. However, this path reportedly was blocked and his fall back plan is for a parliamentary meeting on Monday. This would seem to lend support to ideas that the IMF's part of the facility may be exercised first. Still Greece theoretically does not need the funds until closer to mid May.

Canada CPI

Canadian CPI figures for March were tamer than the market expected and this should help take ease what we thought had been an over-reaction to recent official statements.

Headline inflation slipped 0.2% on the month. The market had looked for a fall report. The year-over-year rate eased to 1.4% from 1.6%. More importantly from a policy point of view, the core rate fell 0.2% and eased to 1.7% year-over-year from 2.1%.

Still Want to Fade Euro Bounce

Events in Athens are dominating the focus in the foreign exchange market. After yesterday’s blowout following the Eurostat report finding that last year’s deficit was even larger Greece (and Ireland) than previously reported and the Moody’s downgrade of Greek debt, initiating the emergency backstop facility appears to have become inevitable. Reports indicate there has indeed been a formal request by Greece to do so.

Initially in Asia, the euro fell to almost $1.3200 and speculation that Greece would use the funding mechanism saw a powerful recovery in the euro. The issue now is whether it is too late and what was once seen as a liquidity crisis has morphed into a solvency problem.

Greece, Greece, Greece

Currency in Crisis

The US dollar has surrendered earlier gains that pushed the euro lows not seen in nearly a year, just above $1.3200, before reports spurred speculation that Greece will seek to activate the backstop facility. The euro traded to almost $1.3350 as some shorts moved to the sidelines.

There was talk of sovereign interest as well as short-covering by high frequency traders. Disappointing Q1 GDP data from the UK, where the 0.2% expansion was half of the consensus forecast weighed independently on sterling. This disappointment does UK PM Brown no favors, especially after polls indicate he lost last night’s debate, though marginally. The other mover among the majors, the Australian dollar is heavy following comments from RBA Governor Stevens. By identifying current interest rates as near average, Stevens sparked second thoughts about a rate hike next month. The Australian dollar fell to $0.9180 before finding support. The yen appears largely sidelined today.

Europe, Japan, UK Developments

Eurostat says that Greece’s deficit last year is at least 13.6% and not the 12.9% the government estimated on April 9th. It notes that the deficit may be 0.3-0.5% higher if the off-market swaps, classification of some public entities and social security funds are taken into account.

Eurostat also noted that the Irish deficit was 14.3%, giving it the dubious honor of the largest deficit in the euro zone. Meanwhile, civil servants in Greece have taken to the streets again, in their fourth strike of the year.

Woes in ROW Lift Dollar

The US dollar is mostly firmer today. The euro is heavier following news that Greece and Ireland’s budget deficits were even larger than expected by the EU’s calculations and this is seen as much more important that the flash PMI readings, which showed continued improvement. New that Fitch warned that Japan’s creditworthiness was a risk from its rising debt initially weighed on the yen, the unwinding of cross positions lent the yen a modicum of support against the dollar. An increase in mortgage approvals and a smaller monthly budget deficit helped offset the disappointing retail sales report to give sterling a little boost, but also appeared to be dragged lower by the euro.

Let's Get Serious About the Loonie

The Bank of Canada's statement yesterday, where it dropped it conditional promise about keeping rates steady and raised this year's growth outlook triggered new Canadian dollar buying. We too have been bullish the Canadian dollar. However, what concerns us is that the market seems to be getting ahead of itself. Forward rates are rising further today after yesterday's advance.

Many now see June 1 hike as a done deal and there is talk in the local press of a 50 bp hike. We had argued that for medium term investors, the difference between a June and July hike was largely irrelevant.

European Bond Woes and German Reluctance Drives Euro Down

The euro has been pushed to an 8 day low in early North American turnover as the peripheral bonds, led by Greece and Portugal continue to sell off. Their fiscal positions are more or less known. What remains the source of anxiety is the policy response. In particular German officials seem to be in no hurry move. It is not clear whether the lack of urgency applies to 2012 and beyond or the to current backstop, which some have suggested will need parliamentary approval.

Euro-zone, UK, Switzerland and Japan Talking Points

The price action in the foreign exchange market has been particularly choppy. The last three weeks the euro has finished near $1.3500. Within that time, it traded between roughly $1.3285 and $1.3690. As I write this, it is trading almost smack in the middle of the range. While the market appears to have priced in the Greek developments, the situation remains fluid. Most reports seem to agree that Greece’s tax increases, spending cuts and other reforms, assuming that they are on track and the next formal report is due in mid-May, are sufficient to draw on the backstop facility already announced.

At the same time, reports warn of continued reluctance in Germany, with the parliamentary floor leader for the government coalition quoted opposing “rushed approval”. What seems to be the main focus the EU/ECB/IMF talks are the conditions Greece needs to meet to get funding beyond the first year. Moreover, with contagion clearly beginning to hit Portugal, the need for preemptive and bold action, larger than just the Greece situation appears beyond the reach and/vision of European officials. This general backdrop is a weight on the euro.

Today's Capital Market Drivers

The US dollar is mostly firmer today, but the drivers are elsewhere. Greek talks with the EU/ECB/IMF are to beginning, but they look to continue for a couple of weeks. It seems increasingly likely that Greece may have to initiate the backstop facility while these discussions are underway. Sterling has fully recovered the erosion seen in North America yesterday, helped by the better than expected jobs report A most hawkish read of the Reserve Bank of Australia and the Bank of Canada amid a recovery in commodity prices have bolstered the Aussie and Loonie. The dollar is holding its own against the yen, but this is more a function of cross-rate developments. Emerging market currencies were firm earlier and are softening in the face of the new decline in the euro.

Fissure in the BRICs

We recognize that BRIC was a clever marketing device, but besides being large developing economies, they don't really have that much in common outside of ambivalence toward unipolar world in which the US dominates.

The recent BRIC summit did not generate new initiatives and the subject of the yuan was not apparently on the agenda. However, Brazil's central bank chief Meirelles has broken the silence and said that it was "critical" for China to revalue the yuan and that it was important for the world economy. He noted that the issue will be on the G20 agenda. There is some suspicion that it may have been on the BRIC agenda, but summit ended early as Chinese President Hu returned home, where another devastating earthquake struck.

BOC Hawkishness Sends Loonie Back toward Parity

The Bank of Canada left rates on hold, but changed the wording of its statement to suggest the risk of a rate hike is greater and sooner than previously anticipated. This has sent the Canadian dollar broadly higher. Key support for the US dollar is seen near CAD0.9950.

The BOC said that economic conditions no longer warrant extraordinary policy. It dropped its phrase about keeping rates unchanged through mid-year, conditional on economic conditions. The Bank recognizes that inflation will be slightly higher the 2% target and this year's growth to 3.7% from 2.9%. This growth forecasts seems more optimistic than the market.

Yuan, G7/G20, Pigs and Chicken

Multilateral meetings of the G7 and G20 and IMF/World Bank begin at the end of the week. There is little doubt that either formally or informally, explicitly or implicitly, there will be calls on China to adopt allow the yuan to appreciate. If one thinks, as some do, that China won't move without international pressure, one might expect an imminent move. International pressure is likely to be ratchet up in the coming days.

Leaving aside these international meetings, note that the EU trade commissioner is scheduled to visit China next week. Even before that the Senate Banking Committee is slated for hearings on Thursday in which China's exchange rate will be discussed. Yesterday the Chair of the House Ways and Means Committee said the US would take action if the G20 and multilateral efforts fail to redress China's under-valued currency.

Greek Drama, UK Developments, German Data

Currency in Crisis

The Greek drama continues to be a key focus in the foreign exchange market. It is expected to rival financial regulation as key topics at G7 meeting and G20 meetings at the end of the week. Officials, Greek and others, continue to play down the risks of default. Even if Greece can muddle through this year, there is growing realization that that will also not mean closure. BBK President Weber, who is a leading candidate to replace Trichet as ECB President, admitted what every one knew to be the case. Greece would likely need more funds than the initial EU/IMF package.

Reports cited Weber as suggesting as much as 80 bln euros may be needed. One of the important issues apparently unresolved are the conditions of drawing on the funds. Meanwhile, many continue to suspect that at some juncture Greece will restructure its debt. However, more immediately, the successfully auction of Greek bills at a yield less than rumored has helped steady the Greek debt market. With the EU/IMF/ECB officials meeting with Bank of Greece officials, the risk is that some additional clarity is achieved that extends the fragile calm. This would also suggest scope for additional near-term euro gains.

Turn-Around Tuesday Unfolding in FX

The US dollar has surrendered yesterday’s gains most of the major foreign currencies, after the upside momentum stalled in North America yesterday. The recovery US equities yesterday helped arrest the heightened anxiety seen before the weekend and early Monday. Constructive data from Japan in the form of a smaller than expected decline in the tertiary index (-0.2% vs expectations -1.0%) , a higher than expected UK CPI (3.4% year-over-year vs 3.1% expected) and a stronger German ZEW survey (53 vs 45.1 expected), helped lift the complex of European currencies. Last Friday’s highs are seen as important swing levels now. They are found around $1.3585 and $1.5507 for the euro and sterling respectively. Although the yen is moving in the opposite fashion as positions scrambled out of yesterday are re-established. Last Friday’s dollar high here is important as well. It comes in near JPY93.20, which corresponds to a retracement objective and the 20-day moving average. Hawkish minutes from the recent RBA meeting have propelled the Australian dollar higher. It is more than a 1.5 cents above yesterday’s lows. Last Friday’s high near $0.9355 is the next objective.

Canadian Dollar Setback

Falling commodity prices amid general position adjustment in the foreign exchange market is weighing on the Canadian dollar today. The Loonie is trading at its lowest level since late March. The near-term risk seems to extend toward CAD1.03, but the underlying favorable fundamentals remain intact.

On top of the softer commodity story and unwinding of positions in the currency market, the volcanic ash that has shut airports in Europe is beginning to impact the east coast of Canada. Specifically, the main airport in Newfoundland has already begun cancelling some flights.

India Poised to Tighten Again Tomorrow

India's central bank meets tomorrow and the risk is asymmetrically biased toward continued tightening of monetary conditions. Generally speaking, following the intra-meeting move last month, most expect India's central bank to hike key short-term rates by 25 bp. However, the risk is that officials take stronger action. This could take the form of a 50 bp hike and/or another increase in required reserve ratios.

Currently, the reverse repo is set at 3.5% and the reverse repo rate at 5.%. The reserve ratio stands at 5.75%.

Greece, China, UK Drivers

Currency in Crisis

Greek interest rates are rising from levels that officials have indicated were prohibitive. The country needs to finance about 12 bln euros next month. The weekend talks have been delayed to the middle of this week due to the disruption of air flights. The pressing issue that needs is preparing for joint (EU/IMF) program of conditionality for initiating the backstop facility. As of the end of last week, Greece planned on offering a 13-week T-bill tomorrow, but the yield appears sharply higher today.

Dollar and Yen Bid on World's Woes

The US dollar is well bid against most of the major and emerging market currencies. Three issues dominate foreign exchange trading today: the now global investigation into one of the leading US banks, which appears to be part of a growing investigation that includes other banks as well; continued pressure on Greece, and to a lesser extent Portugal; and the latest polls threatening a hung parliament in next month’s UK elections. The same forces that are bolstering the dollar are also underpinning the yen, especially on cross-rate basis. With short-term technical indicators stretched, as the news is discounted, that it may be difficult to sustain the momentum in the North American session today.

EU: Closing the Barn Door after the Horses Fled

One vocal camp says European Monetary Union will disintegrate in the face of this crisis. We have consistently argued that while possible, such a scenario is unlikely because of the political will and commitment.

We argue that on the other side of the crisis, it is more likely that there will be greater integration (loss of sovereignty) and greater institutional capability.

U.S. Exports: Where and What

Presidents of the United States often announce lofty goals in their annual State of the Union addresses. President Obama is no exception, among the recent goals he cited was a commitment to double U.S. exports in the next five years. To this end he appointed what the Administration calls an “export promotion cabinet”, composed of the Secretaries of Commerce, State, Agriculture, and the Trade Representative.

The government is going to more actively pursue export growth. Obama says this will be the first time the U.S. has adopted a “single, comprehensive strategy to promote U.S. exports.” To be sure, he does not want higher exports just for themselves, but doubling exports, he figures, would create some two million jobs, he wants to promote exports as a way to bolster America’s competitive position in the world economy.

Mexico

Mexico's central bank is widely expected to remain on hold at the conclusion of today's policy making meeting. The key rate has been steady at 4.5% for nine months. Most recently Finance Minister Cordero has argued that inflation is "controlled" and year-end inflation is likely to be just over 5%. It was just below 5% in March.

Cordero also suggests there is more peso appreciation to come, but at least in the near-term the market is not as convinced. There has been better two way activity in recent days as some suspect that the 7.7% appreciation of the peso since early Feb is a bit much. There is also some concern that Mexico's central bank may step up its dollar purchases this month.

Europe in Focus

The key talking point today is whether the EU/IMF backstop for Greece will be formally tapped this weekend. The summit in Madrid appears to be underway and the general news environment is poor. The Greek Prime Minister still is denying that funds are needed, claiming the facility is a safety net and incredulously suggests that the IMF involvement was not his idea. Recall that Papandreou previously suggested that if the Europe did not pony up, Greece could go to the IMF. Germany, in effect, for its own reasons, called Papandreou’s bluff. It will be used to demand more concessions from Greece.

Many European officials still seem to be in denial. Rather than prepare the public for an eventual use of those funds, Germany’s Finance Minister, for example, is saying that Greece is on the right path and there is no need for emergency funds. The ECB’s Notwotny is saying that backstop can only be activated if Greece losses market access. Does not the cost of market access matter? Simply put, investors are unlikely to get closure any time soon on this issue. Europe’s facility, even if implemented, is short-sighted in two important ways. First, the sums discussed a little more coverage for one year for Greece. Then what? Second, what is Europe doing to preempt the contagion risk?

Dollar Up, Europe Choking

The US dollar remains firm against the euro as Greek woes continue to weigh on sentiment. The euro has practically returned to levels seen prior to last weekend’s financial aid package details. That area, $1.3480-$1.3500 remains key support. The $1.3560 area offers the initial cap now. The immediate reaction to the UK televised debates had the LibDem’s Clegg as the winner and this reinforced fears of a hung parliament and appears to have pressured sterling, but it bounced back smartly in the European morning. Offers in the $1.55480-$1.5500 area may provide the ceiling. Heightened perceptions of risk may underpinning the yen. Cross rate demand is also noted. The dollar has recorded new lows for the week against the yen today, but support near JPY92.50 remains intact. Emerging market currencies are mostly lower.

Sweden Cuts GDP Forecasts, Boosts Stimulus

The Swedish government cuts its growth forecasts for this year and increased its spending to boost the economy, ahead of the Sept parliament elections. The krona is gaining against the euro, but this is more a reflection on the euro's weakness than the krona's strength.

This year's official GDP forecasts was cut to 2.5% from the 3% forecast made in late Jan. On the other hand, the growth was pushed out into next year with the 2011 forecast lifted to 3.9% from 3.6%. Although this is the government and not the central bank, the risk is that expectations of an early Q3 rate hike by the Riksbank prove premature. The government announced a SEK4.9 bln (~$685 mln) increase in spending, bring the stimulus spending to 1.2% of GDP. The government projects a budget surplus of 0.4% in 2012.

Good IP Data, but Drag from Utility Output

Industrial production headline increase of 0.1% seemed disappointing, but a quick look at the details shows a strong 0.9% rise in manufacturing output and a 2.3% increase in mining output (includes oil drilling). Utility output collapsed 6.4%, the largest decline in more than 4 years. This is wholly explained by the weather.

The increase in manufacturing partly a reflection of inventory building in some sectors and ongoing business and retail sales. Vehicle and parts output rose 2.2%, reversing 2/3 of the 3.9% drop in Feb. Consumer durable production increased 2% and business equipment output rose 1.4%. The increase in business equipment output speaks to capital investment.

Germany's Bruederle Lets Euro/Trade Cat Out of the Bag

The US presses China to appreciate the yuan to redress the bilateral imbalance. China says that the currency is not the key to the trade balance. US Congress seems to think this is a self-serving explanation.

Germany, which exports roughly the same share of GDP as China (~40%), is thought to often prefer a weaker euro. Today German Economics Minister Bruederle says this is not true. The euro exchange rate is not decisive for German exports. He argues the "excellent quality" of the goods drives demand.

Europe: Your Rope

Europe cannot get out of its own way. The schadenfreude of a year ago has faded and the most profound crisis more than a generation is gripping Europe. Poorer families may not have qualified for low interest rate loans to purchases houses as they were in the US. The European strain of the same virus, promoted lending to weaker sovereign credits. In both cases, the orthodoxy places the onus of responsibility on the borrower not the lender. Yet what seems to be a backlash against incumbents in various countries, with the UK seemingly less decided, is partly a protest against the favored treatment given to lenders.

At the same time it is more that in Europe. When Greece first ‘fessed up to its fiscal situation, Europe said we support that country’s efforts to rein in the deficit. The market did not buy it. Greece, in the American vernacular, said to Europe, “Show us the love”. And Europe had a summit and said, yes, we’ll work with the IMF and provide a backstop facility, but sorry we won’t say how much money, discuss the terms or conditions. The market did not buy it. Greece said in effect, it is not good enough to put the gun on the table, it must be loaded. Europe appeared to load it this past weekend.

Dollar Up on European Woes

The US dollar is broadly higher; boosted by renewed pressure on the European periphery. Greece is still the lightening rod, but the contagion is clearer today. Just like the premium Greece is being forced to pay over Germany is back to the widest of the week, so too has the euro returned to the lower end of this week’s range. Key support is seen in the $1.3480-$1.3500 range. A break could spur a quick return to last week’s low below $1.3300. Sterling is faring somewhat better. It recorded a 7-week high near $1.5525 before being dragged back down. Support is seen near $1.5350-80. The yen is outperforming. The euro and sterling had been trending higher against the yen are forcing momentum players to unwind, and this is also helping the yen hold its own against the otherwise firm US dollar. The dollar is also firmer against most of the emerging market currencies.

Data Gives Bernanke No Reason to Change Tune

We were skeptical of yesterday's speculation that Bernanke would tout a less dovish line in his testimony before the Joint Economic Committee of Congress. And today's CPI figures underscore the reason why it may still be appropriate to look for rates to reamin low for "an extended period of time.".

Headline CPI rose 0.1% and the core was flat. The core CPI is flat for the entire first quarter. This is the weakest quarterly performance in more than a quarter of a century.

Strong Brazilian Retail Sales, Strong Real

Brazil reported much better than expected Feb retail sales and this is encouraging expectations of a 75 bp rate hike later this month and allowing the real to extend its winning streak for the fifth consecutive session. The real has now recovered all the ground lost in the first several weeks of the year. Today is the first day the greenback is trading below BRL1.75 since the first half of Jan.

Retail sales jumped 1.6% in Feb, which was nearly 3 times greater than expectations and comes on the heels of a 3.0% rise in Jan. On a year-over-year basis, Brazilian retail sales have risen 12.3%. The sales were led by clothes, household goods and foodstuffs. The yield on the interest rate futures rose 5 bp.

More Mid-Week Color

Real new developments among the major industrialized countries remain thin on the ground. And this is largely conducive of the consolidative tone that has emerged since the initial reaction to the news over the past weekend that European officials were putting some details of the backstop mechanism that had apparently been agreed upon at the March 26th summit. There still has not been closure on the issue.

Given the maturity schedule, the April-May period has been the obvious hurdle. Fitch, which cut Greece’s credit rating two notches prior to last weekend, warns today that Greece may tap the facility within the next two weeks. Greek 10-year bond yields are back above 7% today. Some European officials had defended the strategic ambiguity, but that seems to put the proverbial lipstick on the pig. The so-called strategic ambiguity was not the result of conscious planning, but the reflection of the profound disagreements among the euro zone members. Not only has the Greece issue not been resolved, but the issue of contagion remains as well. The EU’s report today on Portugal highlighting that the economic assumptions may be optimistic and more measures to address the deficit may be required has seen a further widening of the spreads. Spanish and Italian spreads are wider too.

It is EM Today

The US dollar is mixed but largely within ranges that have prevailed in recent sessions. The afterglow of yesterday’s Greek T-bill auction has faded and Greek bonds are lower, but the euro is holding above yesterday’s highs in the European morning, but does not appear to have the momentum to challenge the $1.3700 cap. Sterling is challenging yesterday’s highs, but it too does appear to have the momentum to challenge the week’s high just below $1.55. Cross rate pressure is weighing on the yen, allowing the greenback to extend its recovery off yesterday’s low near JPY92.60. A new high for the week was recorded in the European morning near JPY92.63, but there are thought to be plenty of offers in the JPY93.80-JPY94.40 band to effectively cap the upside.

Fed Talk Helps Dollar Recover

Speculation that the Fed may on the verge of changing the wording of its guidance as early as tomorrow's testimony by Fed Chairman Bernanke before the Joint Economic Committee of Congress may be giving the dollar an extra boost in the North American morning.

It has been recognized that some regional Fed presidents are a bit more hawkish, if such designations are meaningful when the Fed funds target is 0-25 bp and no one is really calling for a hike now or in the immediate future. It seemed that more recently some Fed officials have explained the at the words "extended period" is more conditional than those who have been suggesting it means 4-6 months.

Trade Day for UK, US and Canada

The UK reported a smaller than expected trade deficit and, although likely distorted by weather-related effects, it helped sterling recover from early weakness and now is up more than a cent off the session lows made in Asia. We see initial resistance near the high set in Europe yesterday near $1.5465, though yesterday's Asian high was set nearer $1.5485.

Canada also reported a larger than expected trade surplus. The C$1.4 bln surplus is the largest since Oct 08 and was roughly twice what the consensus expected. Exports were up 2.8% and this could help ease fears that a strong currency would undermine exports.

Market Lacks Short-term Conviction

The US dollar is consolidating yesterday’s decline and has largely been confined to narrow trading ranges. With the Greek bill auction behind it, the market may lack a clear focus, but sentiment towards the euro remains poor, even though there had been some short-covering in the futures market in the most recent reporting week that ended April 6. Key euro support is seen in the $1.3480-$1.3500 area. Resistance is seen in near $1.3640-60. A smaller than expected trade deficit lent sterling support, but it too looks capped ahead of yesterday’s European high near $1.5465. In Japan, a DPJ panel called for JPY120 level and 2% inflation target to help break deflation. The market was unimpressed and the yen is firmer against the dollar and against the euro.

There was much drama around the Greek T-bill auction today, which ended up going off better than expected. The amount of money that Europe and the IMF are willing to commit to the backstop facility is enough to substantially lower the risk of default by Greece this year. The cautious assessment is that the conditions that Greece has to meet to tap the facility are unclear.

CNBC: Greek Bailout: What it Means for Spain & Portugual

Canada Update

The Canadian dollar has completely recouped the pre-weekend slippage recorded on the back of disappointing jobs data.

Today's economic data have been mixed, with a slightly weaker than expected March housing starts data, but a relatively healthy business outlook survey and comments from Fin Min Flaherty that seemed to welcome the recent rise of the Canadian dollar. Flaherty noted that the Canadian dollar's appreciation has been orders and reflecting fundamentals.

US Economy Real Sector Preview of the Week Ahead

Estimates for Q1 US GDP appear to be creeping higher.

Wholesale inventories were released before the weekend the 0.6% increase was twice the consensus and the Jan series was revised to 0.1% from -0.2%. This inventory accumulation seems wholly desirable and is a response to increased demand. Wholesale sales rose 0.8% in Feb.

Business inventories will released Wed and the consensus calls for a 0.4% increase in Feb, which would be the largest since Nov. Assuming a modest rise in March and Q1 10 would see the strongest increase in business inventories since Q3 08, which was largely a unwanted build up as demand all but evaporated. Back of the envelop calculations suggest that inventories could be a slightly positive for Q1 GDP, say around 0.5%.

It is All Greek To Me

Currency in Crisis

The US dollar is broadly mixed today. Details of the funding facility for Greece spurs strong gains in the euro, lifting European currencies in general. However, the greenback is holding its own against the yen and the dollar-bloc currencies. The euro reached a high of almost $1.3700 in Asia, but has drifted off in the European session. Initial support is seen in the $1.3580-$1.3600 area. Sterling reached almost $1.55. Weekend polls continue to suggest likelihood of a hung parliament in next month’s election. Initial support is pegged near $1.54, but the tone seems more fragile than the euro. The dollar fins support against the yen just below JPY93.00. The market looks as if it wants to re-test last week’s high near JPY94.50.

The main market force today is the escalation of Europe’s support for Greece. First, it was simply verbal support for Greek efforts to rein in the deficit this year. This did not prove sufficient; so second, at the end of March Europe indicated that should it become necessary, it along with the IMF would provide some material assistance. The market was still skeptical; after all the German insistence that Greece pay market rates provided not real backstop or cap on Greek rates. This uncertainty appears to have been a factor behind Fitch’s two-step downgrade of Greece credit rating to BBB- at the end of last week. After a dramatic increase in Greek interest rates, Europe provided more details of its backstop facility for Greece. Essentially, the package consists of 30 bln euro from Europe and another 15 bln from the IMF.

3-D: Deflation, Disinflation, and the Dollar

There are many things that investors should worry about with the US economy. The federal deficit and debt, coupled with the weak finances of many state and local governments, the increasing tax burden on a shrinking number of households, regulatory uncertainty, and weakness in bank credit may be on many lists.

One issue that investors (and policy makers) do not need to worry about in the foreseeable future is inflation. On the contrary, powerful deflationary forces continue to grip the economy. This, in turn, is allowing the Federal Reserve the degrees of freedom to avoid the temptation of taking away the proverbial punch bowl too early as was arguably done in the 1930s in the US and again by Japan in the 1990s.

Thoughts on Canada after the Disappointing Job Data

Canada's employment data were disappointing. Not only did it create few overall jobs than expected, but it lost 14.2k full-time jobs. However, it seems too hasty to conclude that the Bank of Canada will not hike rates in the June/July period as previously expected. Canada created 81k jobs in Q1, after about 21k in Q4 09, when the economy expanded by 5% (quarterly annualized pace).

Canadian short-term interests rates eased a few basis points and the Canadian dollar retreated after moving above parity. While this immediate market reaction is understandable, the larger arguments for a Canadian rate hike and a strong Canadian dollar remain intact.

Greenback Eases

The US dollar has been softening since the yesterday in the European morning. There has been follow through euro buying today after the year’s low was successfully tested yesterday.

However, despite protestations from ECB Trichet that Greece would not default, the issues are far from resolved and this will likely contain euro upticks. Buying interest already seemed to ease as the European session got under way. A recent string of constructive economic data coupled with much higher than expected PPI data have pushed sterling to its best level against the dollar and euro since late Feb. The yen has been sold across the board. It is seen as part of carry trades and greater appetite for risk assets in general today. Disappointing Canadian jobs data keeps may see the Canadian dollar finish the week below parity against the US dollar.

Greece Update

Currency in Crisis

There have been two developments in the past couple of hour or so that may be helping Greek debt instruments to stabilize and lending the euro support as well.

The first are comments from Trichet. His comments suggest that officials are trying to weather the storm--the dramatic sell-off of Greek bonds--without panicking. He also suggested the risk of default was still very low. He also defended the support framework outlined by EU leaders, saying it was "workable".

Greece is the time, is the place, is the motion.

Currency in Crisis

The US dollar is again being broadly supported by heightened concern that Greece’s debt/deficit issues are soon to reach a climax. The pressure on Greece is more clearly spilling over to the other Mediterranean countries. The yen too has generally benefited from these same development, despite an unexpected and large drop in manufacturing orders (-5.4% vs +3.7% consensus). Sterling slipped in line with the euro even though the 1% rise in Feb industrial production was twice what was expected as was the March Halifax house price index (+1.1% vs consensus 0.5%). Emerging market currencies are also generally lower. As expected the BOE left policy unchanged. The ECB is not expected to alter policy either, but the focus is on the new collateral framework and the sliding haircuts, for which Trichet promised more details.

CNBC: Dollar Bull vs. Bear

Greek Bonds Reverse, Push European Currencies Lower

Currency in Crisis

Greek bonds, which had begun the day recovering from yesterday's dramatic slide, have reversed. This is weighing on the already vulnerable European currency complex. The euro has been pushed below yesterday's lows. The next target is seen near $1.3270. Sterling tested yesterday's lows near $1.5130 and thus far it has held. A break, however, would likely see a move toward last week's lows, seen just below $1.49.

The yen, in contrast, is seeing board cross rate gains and this is helping keep Japanese unit steady against the firm greenback. Canada is remains firm, but some of the earlier upside momentum has faded and the Loonie is straddling parity.

Consolidation in FX

The US dollar is narrowly mixed as a consolidative tone emerges. Technical pressures for a more serious bout of profit-taking on long dollar positions had been cut short by heightened concern about Greece’s ability to raise capital. Although the Greek debt market is calmer today, the issue has not gone away. That may help explain why the euro has hardly benefited from the stronger than expected service PMI (54.1 vs consensus 53.7), which is now at a two-year high. On the other hand, sterling was punished for a weaker than expected CIPS service PMI (56.5 vs 58.0 consensus). The Canadian dollar continues to march higher, moving above parity convincingly for the first time since mid-08. A recovery in Feb building permits, and healthy rise in the IVEY PMI will underpin expectations that the Bank of Canada will be the first G7 central bank to raise interest rates (June/July).

Fed Funds Expectations, Inflation and the Dollar

On the heels of the healthy March jobs report and new cyclical highs for both the manufacturing and service sector ISM surveys, the market moved to fully discount a 25 bp rate hike at the Nov FOMC meeting. This was evident in the Fed funds futures strip and the OIS/Fed funds rate. The market has backed off slightly today.

US interest rates have eased today, with coupon yields slipping 3-5 bp, perhaps on some bargain hunting after the 10-year yield reached 4% yesterday. Perhaps Us debt is also picking up a safe haven bid, given the blow out of Greek credits today.

Taiwan: Low Inflation in Region, Buys Central Bank Time

Taiwan reported lower than expected March inflation earlier today and this solidifies Taiwan's position as a low inflation country in a region that is experiencing higher inflation and prompting central banks to tighten monetary conditions. Malaysia and India have already hiked rates. Through increases in the required reserves and administrative measures, China's monetary conditions are not as accommodative as they had been.

Taiwan's CPI stood at 1.27% above year ago levels in March. Only the city-states of Hong Kong and Singapore have lower inflation than Taiwan in the region. The March reading in Taiwan was lower than the 2.35% seen in Feb and lower than the consensus forecast of just less than 2%. Seasonal decline in clothing and leisure helped produce the nearly 1% decline on the month.

Greece Returns with Vengeance

Currency in Crisis

The US dollar is enjoying broad gains today as the Greece’s fiscal woes have returned with vengeance. Market News International reports that having been given some idea of what an IMF program could entail is now looking for support excluding. The sharp backing up in Greek yields plays on market fears over the country’s ability to secure financing ahead of large coupon payments and maturities this month and next. This is not only helping the dollar, but is also seeing the yen recover as well. The 25 bp rate increase by the Reserve Bank of Australia as helped allow the Aussie to remain resilient in the face of the stronger greenback.

The bond markets are also playing catch-up. Tepid reception to Japan’s 10-year auction weighed on JGB prices, with the 10-year yield rising 2 bp. European bond yields are mostly 3-5 bp higher. Greek bond yields have risen sharply. The 2-year yield is up 30 bp to 5.34% and the 10-year yield is 24 bp higher at 6.76. The premium over Germany is near 362 bp, up from around 300 after the EU/IMF support agreement. Ironically, this may be helping US Treasuries stabilize by providing a safe haven bid. The US sells $40 bln 3-year notes today.

USD Responds Well to Better than Expected Data

For most of last year, it seemed that better US economic data was often greeted with a weaker dollar on ideas that it encouraged the risk-on trades, which involved selling the greenback. Last week's US jobs data were generally favorable, especially given the back month revisions and the longer work week and the dollar advanced. Today the stronger than expected service ISM and pending home sales cut short another attempt to push the greenback lower.

Taken together the ISM report and employment data do point to some broadening and deepening of the economic recovery. The housing market softened at the end of last year into early this year. The increase in Feb pending home sales (8.2%) offset in full the revised 7.8% decline in Jan (initially-7.6%) and points to better existing home sales in the coming months.

Brazil Update: Meirelles Stays, BRL Firm

Brazil's central bank President Henrique Meirelles has decided to resist the temptation of politics and will stay at his post. Speculation that Meirelles would step down may have been a slight negative for the Brazilian real, which has lost almost 0.9% against the US dollar this year.

The outlook for monetary policy is largely the same, even though the IPC (weekly urban) and the FIPE inflation measures have moderated a bit. The central bank meets on April 28th. Some observers had expected a rate hike in March and although the central bank did not move, an April hike is as certain as these kinds of things get. What is at issue is whether the move is a 50 bp hike or 75 bp.

Monday Morning Quarterback

Denard 'Shoelace' Robinson
of University of Michigan who
have the Highest Winning Percentage
In College Football History

The US dollar is mixed to start the week, though market conditions remain thin due to the holiday. The constructive employment report before the weekend has kept the greenback bid against the euro and Swiss franc. Opinion polls in the UK suggest the Tory Party may be pulling ahead, with an election announcement expected as early as tomorrow. The dollar has been confined to less than half a yen range against the Japanese currency. Some export-related dollar sales helped cap it near JPY94.80, but the market does not appear done probing the upside. The Australian dollar remains firm ahead of the RBA meeting tomorrow where another rate hike seems likely in a close call.

Many markets remain closed for the long Easter holiday, but those markets that were open in Asia saw equity prices move higher. The MSCI Asia-Pacific Index rose 0.3%. The Nikkei gained 0.4% to reach its highest level since Sept 08, encouraged by the weaker yen and ideas that the BOJ may upgrade its assessment of the economy late this week.

Generally Good News for US Economy, but USD May Still Weaken

The 162k rise in March non-farm payrolls was a little below expectations but the Feb series was revised to a loss of 14k rather than a loss of 36k. The unemployment rate was steady at 9.7%. 

The private sector added 123k jobs and this was a bit better than expected. Feb's initial 18k loss was revised to +8k. The average private sector job growth then over the first two months of the year was 65.5k. Given the decline in weekly initial jobless claims, this is may be close to the underlying trend.

Holiday Pre-Jobs Data Note

Asia: Asian equities rallied on improving global growth prospects, with the MSCI Asia-Pacific Index advancing for its 6th consecutive session. The 0.3% rise puts the index at its highest level since mid-Jan. Of note, the Nikkei closed almost 0.4% higher, for a 2.7% rise on the week to new six month highs. Leading sectors including oil & gas, technology and financials, while telecom, utilities and health care were drags.

There were three main developments to note:

What to Make of the Swiss Franc

The SNB's apparent absence had emboldened the market, which has driven the euro to record lows against the Swiss franc. The SNB had been clear. It was still closely monitoring the Swiss franc even though it acknowledged that at some point its QE would end. The Swiss reported a very strong PMI earlier today and the market was returning to its recent cash register of buying Swiss francs.

There is little doubt that the SNB intervened today, even if confirmation is not forthcoming. What is at issue are two questions: size (which may reflect commitment) and whether it sticks.

Euro and Stocks--Shifting Sands

My hypothesis is that the risk-on/risk-off matrix that seemed to dominate market development during much of the crisis is breaking down. I suspect it is being replaced by a greater emphasis on country specific macro-economic developments that we place under the rubric of the closure of the output gap.