Irish GDP Turns Positive, Sort Of

Ireland, the first euro zone country to fall into a recession in 2008 (it would have been sooner except my younger and wiser webmaster was studying abroad there in '07 and kept the economy afloat with her excessive Guinness consumption), reported today that Q1 GDP expanded by 2.7% from Q4 09.

The headline is impressive, even if Q4 09 was revised to show a 2.7% contraction rather than -2.3% as initially reported. The year-over year rate improved to -0.7% from a revised -5.8% in Q4 09. The economy has contracted for the past two year by more than 14% on a cumulative basis.

Market Overview

There has been much anxiety surrounding tomorrow’s expiry of the 442 bln euro 12-month funding operation. Spanish banks in particular were believed to be facing difficulty. Euribor rates had been creeping up. Banks were holding a large amount of funds overnight with the ECB, though earning less than they would in the interbank market.

The ECB offered unlimited 3-month funds today. Estimates were that generally between 200-300 bln euros would be taken down. In fact about 132 bln euros were taken. This is much lower than expected amount was seen as a sign that market fears were exaggerated. Banks had prepared for this well known even and as the ECB’s Noyer hinted earlier this week that the expiry would not be disruptive. The markets have responded favorable. The euro fully recovered yesterday’s losses to test the $1.2300 area. A break of this could see $1.2350, but the short-term market may not have the conviction to move it through there.

Dollar Softer, Soft Demand ECB's Refi

Currency in Crisis

The US dollar is generally softer, consolidating yesterday’s moves. In fact, the three best performers yesterday and for the month of June, namely the Swiss franc, British pound and Japanese yen, are the laggards today. Month-end and quarter-end adjustments are commingling with normal market forces after outsized moves the previous day.

The key event of the day has been the 3-month ECB tender ahead of the expiry of the 12-month 442 bln euro funds tomorrow. The relatively low demand for the 3-month funds helped lift the euro to the session highs and encouraged some risk taking in other currencies and markets.

What to Expect from the COFER data

The IMF provides the most authoritative data on the currency composition of reserves. (Think of it as the Ron Swanson of currency composition data) It is reported at the end of the quarter for the proceeding quarter. Tomorrow it is expected to report reserve holdings as of the end of Q1 10.

The COFER data is not perfect. Not every one reports their currency allocation. Notably, China does not and Taiwan, is not a member of the IMF (only countries are) so it too does not appear to report its currency allocation. Roughly speaking China and Taiwan account for almost 80% of what the IMF calls unallocated reserves.

World Growth Concerns, ECB Refi, Euro-Yen Woes

The market has been well aware that last year’s massive 442 bln euro 12-month repo operation by the ECB, which accounts for a little more than half of ECB’s outstanding 870 bln euro of liquidity, was set to expire this week, however the situation is getting a bit more acute. There has been underlying concern that banks in the periphery of Europe are particularly vulnerable because they have come to depend on ECB funding. Banks from the periphery of Europe appear to have taken about 45% of the 12-month funds. The ECB will offer unlimited 3-month funds and a special 6-day operation as well.

Dollar Broadly Higher

The US dollar is broadly higher, alongside the Japanese yen, amid heightened anxiety over the possible stalling of the global economic recovery and the fragility of the banking system. The euro has borne the brunt of the adjustment. Not only has the euro fallen below its 20-day moving average against the euro fro the first time in a couple of weeks, but the it has fallen to its lowest level against the yen since late 2001 and has slumped to levels not seen since late 08 against sterling, while continuing to make new record lows against the Swiss franc. Sterling has been knocked back after meeting a wall of offers above $1.51, but remains fairly resilient, maintaining a foothold above $1.50.

G20 Post-Mortem

The G20 meeting did not provide much in the way of fresh trading incentives. However, there were a couple of developments that were noteworthy.

The most important of these is the balance struck between growth and fiscal austerity. Ahead of the meeting much was made of the different directions that the US and Europe appeared to be headed. The US emphasized the need to ensure that the recovery becomes entrenched before taking away the punch bowl. European officials emphasized restoring investor confidence by regaining control over fiscal policy to ensure stronger growth.

Streak of Soft Data Continues; Light at the End of the Tunnel?

One of the recent developments has been increased fear that the global economic recovery is losing momentum and that renewed contraction is likely.

In the US, the string of economic data that began with disappointing May jobs data was followed by the retail sales report and poor housing data. The composition of the revisions to Q1 GDP also warned of the fragility of the recovery. Today’s US personal consumption expenditures for May will likely provide another piece in this story. The consensus expects a minor 0.1% rise, though the risk is on the downside. In Q4 09, personal consumption expenditures averaged 0.5% increase a month. In Q1 10, the average monthly rise was a little more than 0.4%. Here in Q2, even if the consensus is right the monthly average is less than 0.1%.

Capital Markets Overview on Monday

The US dollar is narrowly mixed to start the new week. It is hanged against most of the major currencies as the market waits for fresh trading incentives.

The euro was turned back on the initial test of the $1.24 area, Initial support is near $1.2320, but only a break of $1.22 would signal a break of the recent range. The dollar has been confined to a little more than a 10 tick range on either side of JPY89.35. Sterling is little changed and has held above the $1.50 level. The Swiss franc is showing independent strength as it is bid to new record highs against the euro and is at its highest level against the dollar since the start of May. Emerging market currencies are generally firmer.

Financial Reform Bill Encourages Risk-Taking

As the details of the agreement struck by the key House and Senate conference on financial reform has been embraced favorably by the US equity market, that is being led by the financials, and the foreign currencies.

In the past three months the major foreign currencies, like the euro, sterling, yen, and the Canadian and Australian dollars are more than 50% correlated with XLF, which is the Financial Select Sector exchange traded fund.

China, the Yuan and Euro

The euro has declined about 0.75% this week. This seems fairly resilient, given that news stream that included the downgrade of a large French and Dutch bank, record premiums by Greece and Portugal and disappointing euro zone industrial order data.

Some have sought to link this resilience to China, which is at the heart of so many conspiracy theories these days. The argument is that China may have bought euros in size this week to influence (or do you say manipulate?) to prevent the basket to which it is linking the yuan (taking last weekend's announcement at face value) from changing very much. In effect, revival of the basket approach may have coincided with an the PBOC buying euros again.

US GDP Revised Lower, but Corporate Profits Higher

The final revision to Q1 US GDP was disappointing in the headline and composition. It is mitigated on the margins, for investors, by the substantial upward revision in corporate profits.

Growth was revised to 2.7% from 3.0% previously and 3.2% advance reading. Consumption was cut to 3.0% from 3.5%. Equipment and software spending was revised to 11.4% from 12.7%. Net exports were a 0.82% drag rather than 0.66%.

What Happens in Romania Stays in Romania

(With regards to the title it was either that or a Béla Károlyi pun) The Romanian leu is under pressure following the Constitutional Court finding that some of the government's austerity measures were unconstitutional. The leu is setting new six week lows against the euro today. The local stock market is also adversely impacted--with a 4.2% slide.

The austerity measures were part of the measures taken to secure IMF funding. Although the markets have taken it hard, it is likely a short-run glitch rather than a game changer.

Poor Europe No Place to Hide

Poor Europe. (Cue Charlie Brown sad music) China starts the week with an outflanking maneuver, putting the G20 once again off-balance. That leaves little to distract from Europe’s debt crisis. Yes, the G20 will talk about financial reform, but the UK, Germany and France do not yet appear to convince a majority of its bank tax proposals.

While the media has played up the split between the US and the European fiscal approaches, this is arguably just as much about rhetoric as it is substance. To be sure, the peripheral countries are tightening, but together it is a modest part of the euro zone’s GDP. The other austerity measures, including from Germany, are largely about future intentions than immediate cuts in spending. Given the recent Greek experience, it makes sense that European officials emphasize their commitment to put the economies on sounder fiscal footing. After violating their own rules, its makes sense that euro zone members try to rebuild confidence.

Dollar Firms, Risk Aversion Strong

The US dollar is little is generally firmer in a risk averse environment ahead of the weekend. The notable exception is the Swiss franc, which is benefiting from tensions in the euro zone and the recent downgrade of deflation risks by the SNB. The euro ahs fallen to new record lows against the franc and has returned to yesterday’s lows against the dollar. The short-term market has caught long sterling. Yesterday’s poke above $1.50 saw buying dry up and profit-taking. Initial support may be seen near $1.4850, but the near-term potential could extend back toward $1.4700. The dollar is sidelined against the yen, trading in less than a 20 tick range around JPY89.60.

CNBC: Midday Market Headlines

Canadian Dollar Near Swing Level

The recent buzz was how foreign central banks, like Russia, were exploring the greater use of the Canadian dollar as a reserve asset. The combination of yesterday's weaker than expected Canadian retail sales data, coupled with the dismal US housing data and the subdued Fed statement has seen the Canadian dollar losing streak extend into the fourth session today.

The news stream undermines the Canadian dollar directly by making people question the likelihood of a rate hike next month, which the majority of primary dealers in Canada expected. The news stream is also negative for the Canadian dollar to the extent that weakness in the US economy exerts a drag on the Canadian economy.

Attracitveness of Colombian Bonds

Often when global investors think about high yielding Latam debt, Brazil is the first country to come to mind. And for good reason. Brazil's local currency debt offers among the highest yields in the world. On a 2-year local currency bond, Brazil pays a little more than 12%.

Colombia has the same credit rating as Brazil at BBB- by S&P. Its 2-year yield is 5%. However, the Colombian peso is the strongest Latam currency this year, gaining 7.4% against the dollar. By comparison the Brazilian real is off 2.6% year-to-date. That suggest that on a total return basis two returns are roughly comparable.

Disappointment Reigns

In some ways, today is about disappointment. To be sure, it is not that the disappointing news is surprising, but it is disappointing nonetheless.

Yesterday the FOMC statement seemed to downgrade growth a notch and characterized underlying inflation as “trended lower” following exceptionally poor housing data. This follows the disappointing jobs data at the beginning of the month, followed by poor retail sale figures. Fed Chairman Bernanke recently acknowledged that he could not rule out a double dip to the economy, and although the FOMC statement’s very first sentence recognized “…that the economic recovery is proceeding…” there seems to be growing concern about growth in H2 10 and into 2011. Despite the federal stimulus in Q1, the cuts by the state and local governments made the overall government contribution a drag on GDP. Federal stimulus is expected to wane, while the drag from the states and local governments are likely to continue.

Capital Market Overview

The US dollar is little is generally firmer. However, the main driver is not really the greenback but heightened risk aversion and fears of a renewed economic downturn given the austerity in Europe and weakness in the US. Yesterday’s dramatic drop in new home sales and the Fed’s downgrade of its economic assessment weighs on risk appetites.

Despite a relatively healthy GDP in New Zealand (0.6% Q1) and new prime minister in Australia who is open to negotiations on the resource tax, the antipodean currencies are among the hardest hit. Weaker commodity prices and risk aversion are the main culprits.

Fed Stands Pat for an Extended Period

The decision to leave rates on hold was an easy one for the Fed to make. The Fed still anticipates this will be the case for an extended period. The statement seemed to recognize some of the less favorable data since it met last. For example it dropped the phrase that said housing starts had edged up. It recognized that financial conditions were also less supportive, though it attributed this primarily to developments abroad. Not unexpectedly, the Fed's Hoenig continued to dissent from the guidance about the extended period.

Horrific US New Home Sales--Reduce Risk

The 32.7% decline in new homes sales to a new cyclical low has actually sparked a bout of dollar and yen buying on risk aversion. The revisions to the March and April time series also point to a much weaker picture than we had.

The dollar had already turned better bid before the news as the equity market failed to hold initial gains, but the news has seen the dollar's rise accelerate.

Shifting Correlations Euro and Yen

As Q2 winds down, it is interesting to look at shifting correlations for the euro and yen. The figures cited below are based correlation studies conducted on percentage changes rather than the levels themselves.

Euro: Over the past 2 months, the euro's correlation with US-German 2-year yield differentials has turned positive (0.3) compared with a negative reading year-to-date(-0.06). The correlation with the 10-year differential has more than doubled to 0.47 from 0.21 in the year-to-date period.

Rudd to Resign (Reports say), Good for Australian Dollar

Australian PM Rudd is coming under stronger domestic pressure as the opposition to the resource tax gains momentum. There have been press reports of a leadership challenge and a local report claims that a key bloc in the Rudd's Labor Party is supporting Rudd's deputy Julia Gillard. Rudd has now called a press conference and SKY TV is now reporting he is prepared to step down. A national election does not have to be called until next April.

More on Sterling, the Euro and Korea/Taiwan

The UK budget has been widely embraced. The OECD called it “courageous”. Fitch said it strengthens the UK’s triple-A status. The IMF said it was the most rapid reduction next to Greece.

The budget credibility, the lower gilt issuance and reduced risk of a downgrade is helped sterling recover yesterday from below $1.47 to almost $1.4860. Sterling’s advance continues today, where it is the strongest of the major currencies. The minutes from the MPC meeting earlier this month were more hawkish than the market expected. The noted hawk Sentence voted in favor of an immediate 25 bp hike. It is the first split decision since Feb 2009 and it is the first vote for a hike since before Lehman’s demise. The range of views seems to have widened as inflation has remained more resilient (CPI at a 17 month high in April).

Global Market Overiview, Sterling's the Star

The US dollar is little changed against most of the major foreign currencies, but sterling continues to respond favorably to yesterday’s budget. News that for the first time since Aug 08 a BOE member (Sentence) called for a rate hike helped push sterling extend its gains, bring the week’s high near $1.4940 into view.

The yen remains largely sidelined, with the dollar confined to about a 15 tick range around JPY90.45. Slightly softer than expected euro zone flash PMI failed to inspire the market and the euro has mostly traded in the low half of yesterday’s roughly $1.2250-$1.2350 trading range.

Canadian and Australian Dollars as Reserve Assets

Last year Russia had indicated it was thinking about adding Australian and Canadian dollar to its reserves. More recently it said it was preparing to do just that. At the end of last week, the ECB's Noyer opined that these two currencies were going to have an increased role as a reserve assets. There is even some talk that when the composition of the SDR is reviewed toward the end of the year, as it is every five years, that the Canadian and Australian dollar may be added.

While these developments and talk are supportive for the respective currencies, the risk is that observers exaggerate these structural arguments to justify a further cyclical advance.

Fed Preview

The Federal Reserve begins a two day policy meeting today. While it is highly unlikely that there will be a substantive change in policy or the guidance which suggests that rates will likely remain low for an extended period.

That said, investors should expect some changes in the Fed's economic assessment. While the FOMC is still likely to anticipate moderate growth, it may tweak several factors lower, giving a softer cast its overall assessment. For example, previously it said that "growth in household spending has picked up", but now after two disappointing retail sales reports, the Fed may downgrade its assessment. Housing starts also appear weaker than the Fed previously noted. Financial markets are somewhat less supportive of the economy as well, with LIBOR having risen and the equity market roughly 10% lower than when it met last time. Global factors are also not as supportive, given recent European developments.

China's Flexibility, UK/Japan Fiscal Plans, and Euro Weakness

China remains very much in the center of attention today. The reference rate was set at CNY6.7980, which seemed to validate yesterday’s yuan strength in the spot market. However, as the session progressed the yuan weakened and is back at CNY6.8130 in late dealings. This leaves the yuan about 0.2% higher than where it finished last week.

Dollar Firms, Yuan Softens

The US dollar remains firm after yesterday’s recovery. New concerns about the funding needs of European banks have been sufficient to offset the stronger than expected German IFO survey. Euro support is seen in the $1.2230-40 area. Sterling remains on the defensive ahead of what promises to be an austere budget.

China fixed the yuan higher, validating yesterday’s spot advance, but the yuan slipped about 0.25% against the dollar today. Asian currencies as a whole saw some of yesterday’s sharp gains pared back, with the Korean won, the big winner yesterday, leading the way lower today with a 0.85% decline. The yen is the strongest of the majors, despite a lukewarm reception to the government’s broad fiscal and growth strategy, encouraged arguably by a waning of the risk appetite. Dollar support is seen in the JPY90.40 area.

Euro Continues to Slip

North American participants have not been as enthusiastic as Asian and European operators. The euro has slipped lower throughout the session. News that Fitch cut BNP Paribas long-term international rating to AA- from AA (stable outlook)has seen the euro record new session lows.

France has been in the news. Bot the IMF and EC have expressed doubts about the government's economic forecasts. Reports suggest the government may cut its forecasts but only after the release of Q2 GDP figures, but Econ Min Lagarde denied the reports. The government forecasts 1.4% GDP this year and 2.5% next year. Last week, the IMF said French growth will be sluggish this year (1% ?)and pick up only slightly next year.

China's Impact

China's Ministry of Commerce is on the wires saying it will monitor the yuan reform impact on Chinese export companies. While China is a big exporter it is also a significant importer as well. The increase in the yuan's value may increase the price of exports, though we are skeptical on the grounds that yuan-denominated inputs are estimated at a modest 12-25% the cost of production.

In addition, an increase in the value of the yuan will also reduce the cost of imports, which are often denominated in dollars( such as raw materials and semi-finished goods).

Spain Update

Spanish sovereign bonds have been trading better and the market is still in relief of news that Spain's top two banks have fared well in the recent stress tests. However, S&P has taken action on seven different financial institutions today, mostly shifts to negative outlooks. In addition, S&P has increased the 2009-2011 loan loss assumptions for the entire Spanish banking sector and appears to have cut its forecast for Spanish growth.

Tomorrow Spain is looking to raise 3-4 bln euros in 3- and 6-month bills. Recent auctions of bills and bonds have done fairly well, but at the cost of dramatically higher yields. Spain's parliament is also set to vote on the labor market reforms that were proposed earlier this month and have begun going into effect.

Latam Currencies Poised To Benefit

Ideas that China will allow greater flexibility in the yuan, which for many means appreciation, will have positive impact on Latam currencies. The Mexican peso and Brazilian real are leading the advance with about 0.66% gain today. Chile is next with about a 0.33% rise.

The risk is that market's euphoric reaction in Asia and Europe is not followed through. This is evident already not just in the euro, which has now briefly traded below Friday's low, but also in copper prices. The Sept contract rallied to $305, but has subsequently backed up. A break of support near $300 could be an early warning sign of increased risk of profit-taking on these Latam currencies.

China --Under-whelming

There is one main talking point today: China. On Saturday, the PBOC noted on its web site that it was reforming the yuan’s mechanism for greater flexibility, but that it was not altering the 0.5% band against the dollar and did not see the necessity of a large move. The statement also seemed to upgrade the importance of its trade-weighted basket and downgrade the importance of the dollar-peg. This note was followed on Sunday with another note, written in a Q&A format that seemed to reassure a domestic audience that the currency move was not going to be very significant. The other element that some observers have emphasized is that the PBOC tried to explain the move as in China’s self-interest.

Monday Macro View

The US dollar is generally softer. News that China has agreed to make its currency more flexible has captured the imagination of the market and this has been expressed in what are regarded as risk trades. Among the majors, the dollar-bloc has led the advance, with the Australian dollar the chief beneficiary. In Asia, the South Korean won and the Malaysian ringgit gained more than 2%, but the whole region advanced. There was some disappointment when China’s fixing of the yuan was at the same level as last Friday.

China to G20: The Yuan is Not the Problem

The US Treasury and the Congress appear to be intensifying pressure on the China to allow the yuan to appreciate. Other officials may weigh in ahead of the G20 meeting (June 25-27).

Congressional support is reportedly strong for a bill that would allow US businesses to incorporate estimates of the yuan's under-valuation in setting countervailing duties they can impose on imports that are said to be unfairly subsidized.

More on European Stress Tests

Stress tests on European banks have emerged as a key talking point. The criteria is not clear, though European officials are apparently telling anyone who is interested that the these tests are more robust than the previous tests conducted last October.

One difference between the US and European approaches is that the former indicated that it was prepared to offer funds to those banks who needed it while the later appears to have ruled it out.

State and Local Governments: What A Drag

Currency in Crisis

The European debt crisis has thus far unfolded as a sovereign debt crisis. And the sovereign here is the national government. This is particularly true in Greece. However in the coming months, it may become clearer that local and regional governments in Europe, including those of Germany, Spain and Italy, also face serious fiscal challenges.

The similarities between Europe and the US, in terms of debt and deficit issues, are much greater than the different political, social and regulatory regimes may suggest. While investors are well acquainted with the US federal deficit, they may be only vaguely aware of the increasingly difficult strait of many US states and local governments. It is the latter to which we turn our attention.

Euro, Swiss Franc, Sterling, Stress Tests

One of the most important take-aways from this week’s activity is that arguably long overdue dollar correction is becoming convincing. What had begun as choppy consolidation has morphed into an outright correction.

The euro is having its best week in nearly a year, gaining a bit more than 2% against the greenback over the past five days. There have been several factors that have encouraged the position adjusting, which had been widely recognized as extreme in the first place. As we have pointed out the news stream has generally improved for the Europe and even when the news turned less favorable, the die had been cast, and momentum traders were being forced to the sidelines. Although Spain had to pay up for it, the fact that its long dated bonds were absorbed relatively smoothly by the market helped strengthen the euro’s recovery. At the same time, the economic news stream from the US has generally disappointed, beginning with the employment data and running through the retail sales and Philly Fed survey.

Capital Markets Overview

The US dollar is generally consolidating this week’s losses in quiet and largely uneventful turnover. The shallowness of dollar bounces warns that the downside correction is not complete.

Given the structural arguments that the euro bears drew upon to fuel the single currency’s 13%+ decline between mid-April and earlier this month, the risk seems to be that participants may anticipate the end of the correction prematurely. We suspect that the onus is now on the dollar bulls, though the market is still asymmetrically positioned. The correction should be assumed to be intact until proven otherwise.

Euro-Swiss and Lessons from the BOJ

The Swiss National Bank revised higher growth and inflation forecasts. Implicitly and explicitly it indicated that deflationary pressures were abating. Those deflationary forces were the justification for the quantitative easing that included large scale sales of the Swiss franc.

The last major central bank to engage is extensive intervention was the BOJ in the late 2003 through early 2004 period. Throughout the intervention, the yen continued to strengthen. The SNB's experience has been eerily similar. The Swiss franc continued to appreciate against the euro.

More On Spain, Swtizerland, UK, and Fallacy of Composition

Once the Spanish bond auction event risk passed, the euro’s recovery was extended. While Spain was able to place its paper, it came at a price and that is higher yields. The 10-year bond sale produced a bid-cover of 1.88 (vs 2.03 last time), while the yield rose to 4.84% from 4.04%. The 30-year bond had a better bid cover (2.44 vs 1.4 last) but the yield rose to 5.91% from 4.76%.

Nevertheless, the auction illustrates that the Spanish government has not been frozen out of the capital markets and its yields, even with the recent rise, are well below Greece. While the EU finance ministers meeting, beginning today, will no doubt discuss the situation, the recent slew of reports suggesting that Spain needed financial assistance, are likely wide of the mark. Meanwhile, Spain is insisting on publishing the results of the stress test on its banks and reports suggest it is prepared to release results on an individual bank basis. There had been some objection, especially from Germany on grounds that it posed unnecessary risks, but it looks like Spain’s position will carry the day. Recall that the results of the US bank stress test, despite the criticisms at the time, corresponded to a bottoming of that sector and also led to some banks raising more capital.

Dollar Slumps, Spain Bond Sale Fine, SNB Surpises

The US dollar is broadly lower, following a successful Spanish bond auctions and indications that the Swiss National Bank is not prepared to continue the heavy intervention that was reported last month. After a slow start the euro extended its recent gains, and although over-extended on a short-term basis, still appears on track for $1.25 and possibly even $1.2750 as the correction of past couple of month downdraft continues. Sterling, which dipped below $1.4650 in late Asia, has rebounded smartly to test the $1.4800 area, on the back of stronger than expected retail sales and looks poised to challenge yesterday’s high near $1.4850, the high since 13 May. The dollar is largely sidelined against the yen. For the last eight sessions, it has finished the North American session in a JPY91.30-JPY91.65 range.

Spain in the Cross Hairs

There have been several press reports in recent days, all vehemently denied, that a multilateral effort is underway to put together a special aid package for Spain. Often times, one hears "where there is smoke, there is fire." Yet in this case, the denials look credible. The European Financial Stabilization Facility (EFSF) which is the lion's share of the 750 bln euro package is only coming into effect at the end of the month.

News wires report that Germany has acknowledged that 90% of the funding has been secured and this is the threshold needed to make the facility operative. Other details of the EFSF have been reported today. Apparently the EFSF is considering issuing foreign currency bonds that could be hedged in the swap market for example. One important implication is that this foreign currency borrowing would underscore the ECB and German point that 1) it is not the beginning of a European bond market, and 2) it is temporary in nature.

Euro, Sterling, Krona, Asian Central Banks

The euro’s resilience remains impressive. The news stream has soured in the last 48 hours or so, following the Greek downgrade by Moody’s,, the dropping of Greek bonds from a couple of industry benchmark indices, the haircut on Greek bonds the ECB is requiring, continued talk of some kind of financing package for Spain (the most recent in El Economista), and the new widening of peripheral spreads in Europe, the euro remains resilient.

The 5 and 20 day moving averages are set to cross higher today for the first time since April 21st. As long as the euro holds above the $1.2220 area and ideally the $1.2250 area, the recovery would appear to remain intact. The premium for euro puts over euro calls continues to decline and implied volatility has fallen from near 16.5% and is now back below 14%. Both these readings from the options market are consistent with the firmer tone in the spot market.

Dollar Consolidates Recent Losses

The US dollar is consolidating its recent losses and is enjoying a somewhat firmer tone today. Although the initial advance in the euro was helped by a favorable news stream, macro-developments do not appear to be driving the foreign exchange market presently. That said, the news stream out of the euro zone has soured since the start of the week, but the euro, even with today’s pullback from testing the June high, the euro remains fairly resilient. Position adjustments among momentum traders and by medium term investors as the half year end approaches may be having greater sway.

Brazil Real is Rich, Might Get Richer

Brazil is getting ready to play its first World Cup game and the real is trading firmly. For the last three days, the dollar has been flirting with its 100-day moving average, just above BRL1.80. Today's break below that looks, well, for real.

The fundamental story looks fairly solid. The economy is enjoying robust growth, which by most accounts is probably above trend. It is one of the few countries to have recouped the output lost to the global crisis. The central bank has hiked rates twice by a combined 150 bp and more hikes are expected.

Empire and Import/Export prices

The Empire State manufacturing survey was in line with expectations rising to 19.57 in June from 19.11 in May. Of note new orders were strong, but weakness was seen in jobs and unfilled orders. Input prices fell sharply (to 27.16 from 44.75) while prices received softened (4.94 from 5.26), suggesting the rising orders trend is not spilling over to prices.

There was a special question on capex that may be interesting for investors. Nearly twice as many firms were looking to expand capex (46%) as cutting (25%). Last June it was 56% looking to cut capex and 20% planning to increase. Specific categories on increased capital investment include technology (software/PCs) and non-computer equipment. Spending on structures was expected to be cut.

Euro, UK and Japan Update

The resilience of the euro in the face of the yesterday’s announcement by Moody, the warning by the chairman of BBVA, the weaker than expected German ZEW survey and news that euro zone exports in April declined by 2.4% is noteworthy.

In recent days I had noted that the news stream had improved and that this had encouraged a bout of short-covering. Gains on the back of good news are one thing, but gains after disappointing news are more impressive. There is talk of sovereign interest and some bottom pickers when it became clear that the $1.2150 support area would remain intact. On the upside, the $1.23 high from yesterday appears a bit too far as the short-term technical indicators are over-stretched at the start of the North American session.

Dollar Chops Around, Euro Resilient

The US dollar is mixed in choppy trading. The euro has shrugged off a weaker than expected ZEW survey (28.7 vs 42.0 consensus after finding a bid near $1.2170. The BOJ unveiled a new JPY3 trillion loan facility to aid business and, although equity prices are firm, the yen remains somewhat better bid. Slightly softer than expected UK inflation figures have done sterling little good and its remains the laggard among the G7. The dollar-bloc itself is mixed, with profit-taking among the antipodeans, but a firmer Canadian dollar. To the extent there is an overall theme it may be the consolidation of the recent foreign currency recovery in a market that lacks conviction of the near-term direction.

Moody's Downgrades Greece--Euro Already Coming Off

Currency in Crisis

News that Moody's cut Greece's credit rating to Ba1 from A3 is encouraging the market to do what it was already doing and that is paring the euro's earlier sharp gains.

This was a four notch downgrade, which reflects the slowness of Moody's to respond to developments. Moody's suggests its base case is for Greece's debt to GDP to stabilize near 150% by 2013. It recognizes that the EU/IMF package removes the actually impact should be minimal for a number of reasons. First, it is not the first rating agency to take away the country's investment grade status. Second, Moody's outlook is stable. Third, because of the EU/IMF package from early May, Greece is not expected to have to come back to the capital markets to raise funds any time soon. Fourth, the ECB already has indicated it will accept Greek bonds as collateral no matter what rating is assigned.

Why I Like Poland

There are two considerations that commend the Polish zloty--fundamentals and technicals.

The zloty had sold off against the euro as the euro declined against the dollar. This was partly a function of unwinding risk trades, but also recall that in late Q1, the Polish central bank intervened in an attempt to slow the zloty's rise.

Euro Up but Spain Under Pressure

For the fifth day, the euro is recording higher highs and higher lows. It has advanced by roughly 3.25% since last Monday's lows. While we recognize an improved news stream, the main circumstances of the European debt crisis have not gone away. Spain's challenges are overshadowing Portugal and Greece.

Last week Spain offered bonds for the first time since the Fitch downgrade. The bonds were well received, but at the price of a roughly 50% increase in yields. Spain will be issuing 10- and 20-year bonds on Thursday.

Shifting Japanese Retail

Various reports have highlight the increasing importance of the retail community in Japan. Some official estimates suggest for example that retail investors could account for a quarter of the yen turnover in Tokyo, while some industry estimates put the number significantly higher.

Japan's Investment Trust Association notes a significant shift in Japanese retail investment preferences. Euro-denominated investment trusts saw a 14.3% decline in May to JPY3.92 trillion. Part of this likely reflects valuation swings. The euro declined a little more than 10% against the yen in May, for example and the underlying investment, especially in equities and non-German bonds also lost value. The Nikkei reported that investment trusts that mainly target European stocks and bonds have seen reported their 33rd and 20th consecutive month of outflows respectively in May.

Forces at Work: Euro, Yen, Swiss franc

This is the first substantial upside correction in the euro in the better part of two months. The euro’s move above its 20-day moving average puts momentum traders on alert. While the next target comes in near $1.2300, given the extended positioning and the pace of the losses in recent weeks, a short-covering fueled recovery can exceed technical objectives.

There was talk at the end of last week of some leverage fund interest in short-dated euro calls, with 1-month $1.25 strikes seemingly popular. The recent news stream has encouraged the short-covering. The ECB promised to provide unlimited liquidity over the next three months and this has helped ease some strains in the money markets. At the end of last week, Moody’s offered a fairly optimistic assessment of European banks’ ability to cope with losses related to their holdings of peripheral euro zone bonds. China and India’s recent string of data gave hope that the global recovery was intact despite the volatility of the capital markets. The ECB revised its forecast for euro zone growth to 1.0% (from 0.8%) and the Bundesbank revised up German growth to 1.9% this year from 1.6%. Earlier today the CBI lifted its forecast for UK GDP this year to 1.3% from 1.0%.

Dollar Extends Last Week's Losses

The US dollar is extending last week’s pullback in what appears to be largely position adjustments, partly as a function of a better news stream and a healthier appetite for risk. For the first time since mid-April, the euro has traded above its 20-day moving average and sterling has completely recouped the losses seen in response to the unexpected weakness in April manufacturing output reported before the weekend.

The greenback’s losses are widespread, with the emerging market currencies also fully participating. The main exception is the Japanese yen, which is under pressure especially on the crosses. The dollar lost nearly 2% against the Korean won as the new regulations were in line with guidance and domestic and foreign banks were given time to adjust.

Shockingly Weak Retail Sales--Risk Taken Off

The unexpectedly large drop in US May retail sales has perversely boosted the dollar in early North American trading as risk is taken back off.

The 1.2% drop is the largest fall since late Q3 09. The slight upward revision tot he April series (0.6% from 0.4%) is not enough to blunt the negative implications. Of the 13 major categories, 5 declined, led by a more than 9% decline in build-materials (which offset the 8.4% gain in April). Auto sales fell 1.7%, which seems to contradict the industry reports that showed higher sales. Gas station sales also fell 3.3%. Clothing was off 1.3% and general merchandise sales were off 1.1%.

It's About Hu not Yuan

The Russian despot Vladimir Lenin was a big fan of Frederick Taylor. Taylor's time and motion studies revolutionized the work process by boosting output, albeit often at the cost of worker dehumanization. Taylorism is not about capitalism per se, it is about efficiency, and apparently good communists can respect that.

As Taylorism was adopted by the Soviet Union, so too does it appear that Fordism may be coming to China. Fordism refers to a type of a political economy that recognizes that, despite the great disparities in power, workers need to earn high enough wages to afford to purchase the products that are being created in order to complete the circuit of production.

Euro Tone Improves, Japan Machinations, Weak UK Mfg

There have been a number of positive developments in recent days that have broken the sharp downside momentum of the euro. The unlimited liquidity that the ECB promised to provide over the next three months is helping to ease some of the tensions in the money markets.

Moody’s has opined that European banks can cope with the losses related to their holdings of peripheral euro zone bonds. The ECB revised up this year’s GDP forecast from 0.8% to 1.0%. The Bundesbank revised its GDP forecast for Germany to 1.9% this year from 1.6%. The consolidation of Spanish cajas continue ahead of the month-end deadline to draw on the government’s fund.

Consolidation in FX, Gains in Equities

The US dollar is mixed in choppy trading as yesterday’s sharp moves are consolidated. The shallowness of the euro’s pullback suggests continued position squaring may be taking place. Some short-term momentum players may be playing from the long side, and there is talk of short dated euro calls being bought. Sterling is underperforming following the much weaker than expected manufacturing data after recording new six day highs.

Rising equity prices, fairly robust data from Japan, China, Australia, New Zealand, India and Sweden over the last couple of sessions, coupled with the ECB revising up this year’s growth forecasts for the region and the Bundesbank revising up German growth and the ECB’s promise of unlimited liquidity over the next three months has helped ease investor anxiety and bolstered the appetite for risk.

Euro May Be Aided By Constitutional Court

News that the German Constitutional Court has reject efforts to block Germany from participating in the guarantees that are a critical part of the Stabilization Mechanism.

While many expected such a ruling, there was a risk that may have weighed on the euro sentiment. This decision coupled with the unlimited 3-month funding by the ECB for the next several months is encouraging short covering.

More Trichet

Trichet announced the ECB will provide unlimited funding at the 3-month tenor and this seems to be helping euribor rates ease. Separately, Trichet said that while the ECB is looking at various options it will not issue debt certificates to absorb the excess liquidity generated by the sovereign bond purchases.

The euro has recovered and is back near session high, but stopped shy of the high recorded in Europe just below $1.2090. The appetite for risk appears strengthening as emerging market currencies also are joining in today's advance.

Initial Take on ECB

Besides the boilerplate comments about inflation being anchored, emergency measures are temporary, the important part of the prepared remarks are the new staff forecasts--slightly higher forecasts this year, a little less next year and slightly higher inflation forecasts, largely a function of higher commodity prices.

ECB Meeting, Rate Hikes and Chinese Data

There is no reason to expect that the ECB wil change rates today. Instead the key focus is on possible new measures in terms of the short and long-term repo operations and the ECB’s bond sterilization efforts. With last year’s 442 bln euro 12-month repo expiring at the end of the month, banks are seen hoarding cash—overnight deposits at the ECB are at or near record levels.

The market will be disappointed if there are no modifications in the ECB liquidity stance. The euro’s 5-day moving average is near $1.1985 today and it has not closed the NY session above that average this month. A move above $1.2100 could see additional short-covering to lift the single currency toward the $1.2150 area. Our caution, however, is 1) the euro’s gains may be position squaring ahead of the ECB meeting and 2) short-term technical indicators are not moving above yesterday’s levels despite the euro doing so, and this is seen as a bearish divergence, and 3) many medium term participants had previously signaled a desire to wait for a euro bounce to sell into.

Look for the Dollar to Recover Today

The US dollar is softer across the board and is indeed at new lows for the week against most of the major currencies ahead of amid relatively constructive string economic data and rate hikes from New Zealand and Brazil, a healthy reception to the first Spanish bond auction since the credit downgrade at the end of May. The Bank of England left rates steady and the focus is on the ECB meeting and the subsequent press conference. Barring a surprise from Trichet, look for the US dollar to see its losses pared in the North American session today.

Euro as Reserve and Invoicing Currency

A news wire is reporting that Russia remains committed to diversifying its reserves and has not changed its view of the euro. This is consistent with what several other central banks, including China, Japan and South Korea have indicated recently.

That said, Russian data out in the middle of last month showed an increase in dollar holdings (44.5% vs 41.5% at the end of 2009) and a decrease in euro holdings (43.8% from 47.5%) However, valuation shifts likely account for the bulk of the change. In the first four months of the year the euro was the worst performing among the G10 currencies, falling about 7.2%. And two other currencies that Russia may hold in reserves, the Australian and Canadian dollars were the strongest in the first third of the year, appreciating about 3% and 3.5% respectively.

Developments in Europe, UK, Japan and Sweden

Tomorrow’s ECB meeting is drawing attention today. No one expects a change in rates. Instead the focus is on liquidity provisions. A news wire report claiming that the ECB would announce an extension of some facilities.

There is some thought that given the systemic strains, the ECB may want to take additional measures to help smooth the maturation of the 442 bln 12-month repo. Three month Euribor edged to new multi-month highs today. In any event the press report has been denied and in public remarks ECB President Trichet has not revealed anything. On balance, the market may be disappointed if it expects new lending facilities or an extension of some existing ones.

Range Trading Day

The US dollar is narrowly mixed in relatively quiet, though choppy, trading. The euro has largely been confined to a $1.1920-$1.1990 trading as the market awaits fresh trading incentives. There is some talk of Asian sovereign interest in the single currency, though market sentiment remains overwhelmingly bearish. The dollar-bloc is seeing yesterday’s gains pared, but here too a consolidative tone is evident. Sterling and the yen are also little changed in fairly narrow trading ranges. More of the same can be expected in North America today.

More Thoughts on Switzerland and Why the Euro is Not Lower

Investors are still trying to get their heads around the SNB's preliminary indication that is reserves rose to CHF232 bln in May from CHF153 bln in April. This represents more than a 50% increase in reserves in a single month.

It would be tempting to attribute this to valuation changes. As we have noted when looking at the IMF's COFER data, valuation shifts often swamp the actually flows. However, in this case it is largely a reflection of SNB intervention. During the month of May, the Swiss franc declined 6.7% against the dollar, while the euro declined by 7.4%. That 1.3% difference is a rounding error when considering a more than 50% increase in the valuation of SNB reserves.

Fitch Warning Gives Osborne Tailwind

Fitch warned earlier today that the UK government faces a "formidable" challenge in addressing it's debt and deficits. Although sterling sold in reaction, Fitch's warnings may help the new UK government. It provides additional justification for a significant cuts in spending and a tighter fiscal policy in general.

Before parliament today Chancellor of the Exchequer Osborne emphasized the structural nature of the of the UK's deficit, which means that it cannot grow out of it. Some estimates suggest that nearly half of the UK's deficit is structural in nature--ie what it would be at full employment.

Two Potential Asian Financial Adjustments

Japan and China are contemplating adjustments international investors should note.

Japanese news wires are reporting that the BOJ and Financial Services Agency and financial services companies may be considering reducing the settlement period for Japanese government bonds to 2 days from 3 days. This is thought to reduce settlement risk. It is possible that this is a preliminary step on the way to one day settlement.

Europe Moves, Market Yawns

The market seems largely unimpressed with the European finance minister’s decision yesterday to formally initiate the special purpose vehicle that will sell bonds backed by guarantees from euro zone countries and then uses those funds to make loans to members in need.

The bonds will be sold only if/when aid is requested. The European Financial Stability Facility is initially projected to be a 3-year project. The guarantees will be for 120% of each country’s pro-rata share and this is seen as helping ensure that the bonds will be rated triple-A and would be acceptable as collateral for ECB operations. Many observers are skeptical that new debt can really be an effective remedy for countries that have too much debt.

Euro Still Can't Sustain Upticks

The US dollar eased in Asia as a modicum of an appetite for risk returned, but the greenback rebounded in the European session. The euro returned to the $1.19 area after being unable to rise above the $1.20 level.

Comments by Fitch, that the UK fiscal challenge is “formidable” ahead of Chancellor of the Exchequer Osborne’s speech before the House of Commons later today sent sterling though yesterday’s lows (~$1.4389). News that the Swiss National Bank reserves rose CHF78.8 bln in May, on intervention, seemed to embolden the market as it had managed to absorb the full amount. The euro has been pushed to new lows today below CHF1.38. Meanwhile, the dollar-bloc currencies remain firmer, as do most emerging market currencies.

German Constitutional Court To Get into Mix

The G20 tried to paper over differences, but to little avail. The shift in the statement from the need for fiscal support for the fragile recoveries to the need for fiscal consolidation did not survive through the press conferences, which saw US Treasury Secretary Geithner call on Europe and Japan to boost domestic demand and not to count on exports and the stretched US consumer. The US and European proposal of a global tax on banks was defeated, but the UK’s Osborne seemed to suggest that maybe the UK will unilaterally try to implement it.

Dollar Pares Early Gains

The US dollar has seen its initial gains scored in Asia pared, but the risk is that North American players resume the buying of the greenback. The euro initially fell to about $1.1876 in early Asia before recovering. The $1.2000-$1.2050 area may be sufficient to cap the single currency. There is some chatter that of some official interest that might have helped stabilize it, but it is difficult to verify. Other major currencies have also seen initial losses pared. In the yen’s case, the opposite: early gains have been pared. The dollar largely held JPY91 support. The euro fell to almost JPY108 before find a big, but now approaching JPY110, may also seen fresh North American sales.

Gas Now, Brake Later

The G20 finance ministers and central bankers are meeting in South Korea to prepare for the summit in Toronto in a few weeks time. There seem to be three broad areas of discussion. The first is the European debt crisis, which causing some disruptions and strains in the global capital markets and could put at risk the fragile economic recovery. The second is balancing the economic risks with the need for fiscal consolidation and coordination the re-regulation of the financial sector. The third is the old nemesis of global imbalance and here China may be encouraged to allow the yuan to appreciate.

Euro Holds for the Moment above $1.20

After being crushed, the euro is stabilizing for the moment. The combination of the reassessment of the French PM comments and the disappointing US employment data by be contributing to the more stable tone as Europe prepares to close the week. There is a Eurogroup meeting of euro zone finance ministers on Monday and more jawboning is likely.

The stress in Europe is now well beyond Greece and the periphery, including Hungary, which is on the hot seat today. Note that S&P just lowered the rating of the French state-run railroad SNCF to AA+ from AAA. Core spreads--Netherlands, France and Belgium, for example are all widening.

Jobs Data Disappoints

The US employment data was disappointing. The key measure of private sector job creation was only 41k compared with expectations for 180k and a 3 month moving average of 155.6k. The fact that the unemployment rate ticked down is not really good news as the decline in unemployment was not a function of more jobs but a reflection of people leaving the work force.

Jungary Plunges

A combination of ill-thought out comments by the new Hungarian government coupled with a surge in the Swiss franc is seeing the forint drop like a rock and is seeing CDS on Hungary explode.

Where is the SNB

The euro has collapsed through the CHF1.40 level where the SNB had thought to be defending. It quickly slumped to CHFCHF1.3865 before finding a bid. This has helped drag the euro below $1.21. Strains are growing in the European bond markets and Eastern European currencies are being hit hard. It is difficult to see exactly what was the trigger, but all capital markets have been impacted. Equity markets have slumped. Even the Canadian dollar, which posted very good employment has gotten hit. It makes the market's reaction to the US employment data due out shortly more difficult to anticipate. Still the price action, with new multi-year lows in the euro, will continue to buffer dollar sentiment and the relative safety of US Treasuries.

Jobs Data in Focus

Today’s US employment data is important. Market participants are now well aware that the Census workers will flatter the headline number of non-farm payrolls. The key will be the private sector. Recall that in recent months, the US state and local governments have been laying off people sometimes faster than the census department hired. This was also picked up in Q1 GDP where the state and local government cuts offset in full the new spending by the Federal government. This means that the government’s total contribution to today’s data may be a little less than what the Census contributed. The Bloomberg consensus is for a 180k rise in private sector jobs. This is a little above April’s 3-month average of 155.6k, which itself compares to an 84k 3-month average in March and a -90k 3-month average in Dec. 09.

Today's Markets

The US dollar trading higher just as the North American session is about to start. However, position squaring in Asia and Europe had pushed short-term technical indicators into an over-extended condition and near-midday in Europe, the dollar began recovering. The euro has been sliding across the board. One trigger may have been the collapse in the euro against the Swiss franc when the CHF1.40 level gave way. Yet there is some risk of ‘buy the rumor, sell the fact’ activity after the jobs data. New Japanese Prime Minister Kan is talking a tougher fiscal line but has not distanced himself from previous soft yen comments. The dollar has made a new marginal high against the yen for the week and reached its best level since May 18, but resistance in the JPY93.00-30 area remains intact. The Canadian jobs data were better than expected with 24.7k jobs created compared with 15.0k expected, but the key is a whopping 67.3k full time jobs.

Spanish Cajas Merging, but are They Serious Yet?

Spanish savings banks, called cajas, are finally moving. It took the central bank to take over CajaSur, which is controlled by the Catholic church in Cardoba, ten days ago to light a fire under the others. There were about 45 of these cajas and a number of mergers have been announced in recent days.

Another 4 announced a merger earlier today. The end goal is the reduce the number to around 20-25. The government has set up a fund (Funds for Orderly Bank Restructuring), known by its Spanish acronym FROB. It was funded with 99 bln euros. The government gave the cajas until the end of the June to draw from the fund to restructure.

Despite Upticks Euro Still Fragile

The euro is advancing for a second day after recording new 4-year lows on Tuesday. It is moving above a 5-point downtrend line in place for the past month. It comes in near $1.2262 today.

The two main reasons we have been negative the euro are intact. The European crisis is not over. One indication of this is that overnight deposits at the ECB reached a record high yesterday or 320.4 bln euros (almost $400 bln). Those overnight deposits have been above 300 bln euros for the past five sessions. Three-month Euribor reached a new high for 2010 yesterday. In contrast note that 3-month Swiss franc LIBOR is slipping to a new record low of a little more than 9 bp. The second factor is positive developments in the US. Expectations for tomorrow’s jobs report are creeping higher, underscoring the growth differentials that favor the US.

Consolidative Phase

The US dollar is modestly lower against the major and emerging market currencies. The key driver is really the absence of bad news and some position adjusting in the wake of stronger commodity and equity prices.

The dollar-bloc currencies are leading the way higher, while the yen is being undermined by the likelihood that Finance Minister Kan, a vocal yen bear, is tipped to become Japan’s next Prime Minister. The greater appetite for risk is also weighing on the yen.

Some Interesting Price Action

Canadian dollar: The US dollar is recording an outside down day against the Canadian dollar--that is it has traded on both sides of yesterday's range and the US dollar looks likely to finish the NY session below yesterday's low ~CAD1.0420. The BOC hiked rates as widely expected and traders searched high and low for all sorts of reasons for its weakness. Today's gains lend credence to our idea that yesterday's disappointing price action had to do more with the general market conditions and the unwinding of risk. The US dollar is breaking below the 20-day moving average, something that has not since May 13th, which was a one day wonder. The dollar has not closed below its 20-day moving average since April 26th. The break below CAD1.04, which is the 50% retracement of the USD rally. The next objective comes in near CAD1.0280. We look for a test on parity again toward the middle of Q3.

More About Japan and the Yen

The yen is drifting lower in the North American morning. If at first in response to the resignation of Prime Minister Hatoyama the yen was sold on political uncertainty, it may be being sold because of uncertainty appears to be diminishing and the more likely successor as prime minister is a person who is vocally in favor of a weaker yen.

It will be recalled that even before becoming finance minister, Kan advocated a weaker yen in general and not in the context of a particular move in the foreign exchange market. Kan is also a strong advocate of the BOJ to take more measures to combat deflation. Here too a decline in the yen is desired.

A New EMU Member before Any Exits

There has been much talk in the markets that a country like Greece or Germany drop out of the euro zone. There were press reports that indicated that using brinkmanship tactics, French President Sarkozy threatened to leave. We have consistently argued against such ideas and in fact, sometimes have even gone one step further: that a new country will join before a country exits.

Back after 9/11, there was talk by the doom and gloom camp that globalization was going to end. Expanding the WTO to include China at the end of 2001 sent a strong message of the commitment to globalization in the face of terrorism.

Japanese Politics, Central Banks, and Sterling Outperforms

Japan’s Prime Minister Hatoyama resigned. There were such hopes for the DPJ, but the combination of party scandals and the controversy over the failure to carry out a campaign promise about moving the US Marine Corp base off of Okinawa ultimately proved overwhelming. His resignation and the resignation of the DPJ Secretary General Ozawa, who was also the key strategist and powerbroker leaves the DPJ seemingly rudderless ahead of two key events.

Dollar Sidelined, Yen in focus

The US dollar is little changed against most of the European currencies and within the dollar-bloc as a consolidative phase is emerging. The yen is center stage today following the resignation of Japan’s prime minister. The political uncertainty and calmer capital markets have seen the greenback extended its recovery against the yen to about 3% off the recent (May 20th low) near JPY89. Resistance in the JPY92.00-JPY92.30 area is being flirted with just prior to the start of the North American session.

Sterling is also a standout as its recent gains are extended. Unwinding Prudential/AIA related positions/hedges and flows out the euro zone are the key talking points. Since its recent low (May 20th) sterling has advanced about 3.8%. In consolidative/risk-on phases, we think attractive tactical opportunities exist in the dollar-bloc. We also like Sweden (though it is near the year’s highs against the euro), as the Riksbank is among the leading candidates for a rate hike in early H2.

Hard Asset Investor: Bullish on the Dollar

I did an interview with Mike Norman of Hard Asset Investor you can watch it here.

CNBC: Currency Plays

CNBC: Impact of Canada's Rate Hike

RBA Sits Tight, Q1 GDP Up Next

The Reserve Bank of Australia met earlier today and as widely expected kept the official rate steady at 4.5%. The tone of the statement was fairly neutral, as one might expect after 6 rates hikes since last October and increased uncertainty about the economic outlook of Europe and China.

Australia reports Q1 GDP figures first thing in the Australian morning on Wednesday. The consensus expects a 0.6% quarter-over-quarter expansion; slower than the 0.9% pace seen in Q4 09, but near last year's average quarterly pace (0.67%).

US Holding Up Better than Europe

The US manufacturing ISM held up better than expected and better than the euro zone. The US ISM slipped to 59.7 from 60.4. Orders were steady at the lofty 65.7 while production slipped slightly (66.6 from 66.9). Employment rose to 59.8 from 58.5 and this will likely encourage some economists to revise higher forecasts for the employment data due at the end of the week.

The euro zone PMI fell to 55.8 from 57.6.

Canada Hikes, No Promise for Next Month

The Bank of Canada hiked its overnight target 25 bp to 0.50%, as widely expected. A Reuters poll showed all primary dealers expected it and expect a hike at next month's meeting as well (July 20). However, the Bank of Canada's statement is somewhat more neutral, The BOC also took measures to restore the normal operating band to 50 bp.

The uneven economic recovery globally and what the BOC called "the possibility of renewed weakness in Europe" is one of the factors that might give the central bank pause. Given the substantial uncertainty surrounding the global outlook, the BOC cautioned "any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments."

Two Things Ail the Euro: What We Know and What We Suspect

The euro is plagued by two things: what the market knows and what the market suspects.

What the market knows has increased today with the euro zone manufacturing PMI readings for May. While readings remain above the 50 boom/bust level, the pace of activity slowed. For the euro zone as a whole the headline pace slowed to 55.8 from 57.6 in April. Separately, the region’s unemployment rate rose to a 12-year high of 10.1% in April, though Germany reported a decline to 7.7% (from 7.8% as the unemployment queues fell 45k, more than twice the consensus expectation. This plays on fears that the fiscal consolidation in Europe will slow growth. The market also learned from the EMU’s stability report that European banks may have to write down another 195 bln euros in the 2010-2011 period.

New Month -- Same Weak Euro

The US dollar has begun the new month off on strong footing against both and emerging market currencies. The yen is the sole exception.

There are three drivers today. The first is economic data from China and Europe that play on fears that the financial turmoil is taking a toll on the real economies. The second is continued concerns about European debt situation, with some speculation spread to France today. Third, political leadership is severely challenged. Japanese Prime Minister Hatayama is apparently considering stepping down and the President of Germany Koehler resigned yesterday and the deputy CDU leaders Roland Koch, and premier of the state of Hesse resigned last week. The net consequence is that the euro has been driven to a new low (since April 2006) and is now in the middle of the life-time range.