ECB Rate Outlook Dominates

It appears the foreign exchange market is being driven by one overriding consideration and that is that the ECB is going to raise rates as early as next month. The debt crisis on the periphery has been ignored. Fitch cut the outlook for Spain before the weekend, noting that the financial sector may need another 38 bln euros and the euro bulls where unfazed.

Earlier today Moody's slashed Greece's rating by three notches to B1 and retained a negative outlook, citing difficulty collecting revenues and implementation risk. The rating agency said that the risks of default or distressed exchange had increased since it last cut Greece's rating near the middle of last year. Moody's noted that 20% of the B1 rated sovereigns and companies default within five years. The euro wobbled, pulled back to near $1.3960 and then soared to new highs since November.

Reports indicate Germany has rejected Irish requests for lower rates on the aid package from the EU. Ireland's request is not finding sympathy among several other members either. The new Irish cabinet is expected to announce as early as tomorrow. With very little room to maneuver, the new Irish government may introduce laws that allow a restructuring of senior bank liabilities that are unsecured and not guaranteed. The actual impact on Irish debt budget is thought to be relatively modest, but of some symbolic value.

Meanwhile on Wednesday, Portugal is going to try to raise 0.75-1.0 bln euros in a new bond issuance,t he first since the mid-Feb syndicated offering. It appears that foreign investors were net sellers of Portuguese bonds last year, while domestic banks and insurers absorbed the government's supply. Some estimates suggest the ECB absorbed the foreign selling. Unlike Ireland and Spain, Portugal did not really experience a boom and its problem stems from the chronic grind of lost competitiveness. The EFSF head Regling was quoted over the weekend suggesting that he did not expect Portugal or Spain to ask for aid. The market is less sanguine.

Japan's foreign minister Maehara resigned over the weekend over a funding scandal and this has negative implication for Japan's fiscal position. Recall that the next fiscal year's budget passed the lower house, which means it will become law, but the funding of it is being held up by a revolt within the DPJ and by the opposition in the upper house. Maehara had been tipped as a possible successor to Prime Minister Kan, but his resignation appears to weaken Kan's hand. Kan's support continues to fall and there is increased speculation he may resign if the DPJ does not do well in local elections in April.

Meanwhile, in the week through March 1, speculators in the IMM futures market swung position around again by buying tons of yen. Recall that up until the middle of February, the net speculative position was long yen. As of Feb 8, the next speculative position was long 36,7k contracts. This swung to a short 18.5k by Feb 15. The next short position was extended to 27.7k as of Feb 22, but as of March 1, the position swung back to net long by 41.3k contracts. This is the largest net long position since last Nov. Last week we noted the divergence between speculators, who where short yen (at the IMM) and real money, which had been buying Japanese stock, bonds and bills in size this year. The latest data shows speculators and real money are on the same side: long. Support for the dollar is in the JPY81.50-60 area looks likely to be tested and a break signal a return ot the JPY81.00 area.