The Other UK Spectacle: Elections and Referendum

The Royal Wedding (and Kate Middleton) are capturing the world's attention, but there is another event around the corner that may be more notable for investors. On May 5th the UK will hold its first referendum since the mid-1970s. It is on the general voting style and it will likely keep the current "1st past the post" system. On the same day there will also be election in almost 280 local authorities and election in the devolved administrative areas--Wales, Scotland and Northern Ireland.

The is no direct implications from the the elections or referendum, but there could be indirect consequences that are notable for medium term investors. It could weaken the political environment and undermine the policy climate. This is all the more important because of the serious straits the country is in. Its debt/GDP ratio is worse than Spain and Portugal. The economy has essentially stagnated over the past six months.

Dollar Losses Extended

The US dollar fell to record lows against the Swiss franc and has fallen to new multi-year lows against the yuan.  Pressure remains against most of the major currencies.  The trend continues to be your friend, until it is not.  Today is the ninth consecutive day that the euro is gaining against the dolllar. 

The Swiss franc turned better bid following comments from the central bank and KOF data showing continuing strengthening of the economy depsite the appreciation of the Swiss franc.   The SNB reported CHF1.9 bln profits in Q1 and this could largely be acocunted for from what appears to be sales of some of the toxic assets it had bought from UBS a few years ago. 

Fox News: Will the Dollar Continue to Decline?

IS EMU Debt Crisis Morphing into a Euro Positive Force?

We argue that a key driver lifting the euro has been the divergent monetary policies of the Federal Reserve and the ECB. When investors perceive the European debt crisis becoming acute, it has eclipsed the main driver and weighed on the euro episodically in recent months. However, the increased speculation (and therefore risk) that Greece restructures its debt may be transforming the debt crisis into a more immediately euro positive direction.

There have been a couple of developments that spur this line of thinking. First, although Greek bonds are stabilizing today, the sharp sell-off over the past few weeks, is as much cause as effect of the restructuring speculation. European official comments do not rule it out as they once did or are not ruling it out with the same vehemence.

Dollar Heavy, Sell Shallow Bounces Prevails

The US dollar is lower.  If that sounds like a broken record is should.  The euro is higher today for the eighth consecutive session, the longest streak in several years.  The dollar's weakness ought not be seen as a flight from the US as US asset prices--bonds and stocks--continue to do well. 

Nor do I think carry really captures what is going.  For the past three weeks, the four strongest major currencies are the Swiss franc, New Zealand dollar, the Japanese yen and the Australian dollar, in that order. 

Thinking about Haircuts

What a cruel month April has been to the peripheral debt markets. Greek 10-year yields have risen 349 bp, more than the cumulative increase over the previous 11 months. Portugal's 10-year yield has risen 180 bp this month and 190 bp over the previous 11 months. Of the three, Ireland has performed best with the 10-year yield rising 42 bp this month after rising 460 bp in the prior 11 months.

FX Developments

The US dollar is more mixed today, ahead of the FOMC statement and Bernanke press conference.  The euro pushed above $1.47 in Asia, partly on the back of cross rate gains against the yen following S&P cut of the sovereign outlook for Japan and the outlook for half dozen public institutions.  JGBs were not impacted, but the yen did soften.  

In fact, yen weakness is a key theme.  It has been the strongest of the major currencies since April 8, which does not seem justified on the basis of the recent drivers like the general risk appetite.  Support fo the dollar is seen in the JPY81.80-JPY82.00 area now. 

FOMC Preview

Whatever thunder the FOMC meeting usually has is being stolen this week by the first of Bernanke's quarterly press conferences tomorrow. In fairness, the FOMC's statement is unlikely to change substantively from the mid-March statement. The press conference has potential to be more disruptive, but even here it is best to keep in mind the distinction between transparency and visibility.

Turning first to the statement itself, it will be released tomorrow around 12:30 EST. The statement is fairly formulaic in its present incarnation. The first paragraph is the economic assessment. While there is no doubt the recovery is continuing the statement will likely acknowledge some moderation in the pace--to recognize the likelihood of a sub-2% Q1 GDP figure. The continued rise in commodity prices. The statement may also recognize that some long-term inflation expectations have risen as a result. Note that the 5-year/5-year forward has risen almost 80 bp since the last FOMC meeting.

Dollar Soft

The US dollar remains soft.  The euro has rebounded back above $1.46 after having been pushed briefly through the $1.45 level, despite the  periphery in Europe remaining under pressure.  Sterling is the main exception to the dollar weakness story and the dovish comments from BOE's Weale before the weekend, coupled with the softer  CBI trends survey that takes the shine off last week's retail sales data are the proximate culprits. 

Japan Update

Since April 8th, the Japanese yen has been the strongest of the major currencies. Yet as is often the case, the yen's performance in the foreign exchange market does not appear to be a reflection of the Japanese economy.

On the contrary, the situation in Japan is arguably even worse than the somber economic data would suggest. The power shortages and damaged factories are taking a larger toll than was initially evident. Press reports, for example, warn that the contagion via the supply chains may have greater global impact, which in turn could impact the manufacturing activity outside of Japan. Toyota, the world's largest auto producer, has indicated that its output collapsed by nearly 2/3 in March compared with a year earlier. Honda's loss of output was similar while Nissan reports its auto output was cut by a little more than half. One press report indicated that Toyota will cuts its output from its Melbourne, Australia plant by half this month and next, citing a shortage of parts that were to be shipped from Japan.

GDP, Policy Mixes and Sterling-Yen Trade Idea

The US and UK report their first estimates of Q1 11 GDP this week. While the US economic data, like ISM readings suggest the US economy is enjoying reasonably good momentum, the GDP components are distinctly softer and suggest a disappointing sub-2% reading. Headwinds caused by higher oil prices, which appears to have been a factor cutting into consumption, and the ever-difficult-to forecast-- inventory data, appear to be the main culprits.

The US report will be released on Thursday, April 28. The UK reports its Q1 GDP estimate the day before. Recall the UK economy contracted by 0.5% in Q4 10, a good part of which could be traced to the poor weather. The economic data released in recent weeks suggests the UK economy has not contracted in Q1. In fact, despite the fiscal austerity, the UK economy appears to have expanded around the same rate as the US and possibly even a little faster.

Monday Update

The US dollar is mostly softer in relatively quiet turnover as many in Europe are still celebrating the Easter holidays.  The main weight on the dollar continues to emanate from divergent interest rate paths.   The premium Germany offers over the US on 2-year sovereign paper was 20 bp at the end of last year.  Last week it reached 116 bp.

On Vacation for Two Weeks

Good Luck :)

Fedreal Resereve Custody Holdings

The Federal Reserve has long competed with the private sector in offering custodial services to foreign central banks. The Federal Reserve reports is custodial holdings every week. In the most recent week, through Wednesday, custody holdings of Agencies and Treasuries actually fell by about $250 mln.

This is a bit a quirk and is the exception to the general trend which sees foreign central banks as regular buyers of Treasuries (and often Agency paper).

Capital Offense

A disproportionate amount of mind share has been devoted to the financial aspects of the crisis. Investors and policy makers may be being distracted by this over-emphasis and leaving them vulnerable for other aspects of the crisis. The underlying challenge is sustaining aggregate demand in the face of a shift of income shares toward profits and away from wages and salaries.

Aggregate Demand

The Great Depression and the current crisis are linked by macro-economic similarities that extend beyond the dramatic deterioration of credit conditions. Consider the preceding expansions. Both the one that preceded the Great Depression and the more recent one shared the common characteristic of having been driven by consumption. This was especially true of consumer durable goods.  And in both cases the increase in aggregate demand was fueled not by higher wages and salaries but increased credit.

Dollar Hit, Market Turns Even more Aggressive

Far from the "buy the rumor sell the fact" type of activity after the ECB I had thought likely, the market has turned even more aggressive.  Euribor futures strip is implying even more aggressive tightening than it was prior to the ECB meeting and Trichet's press conference.  The euro has been up to $1.4420.  The $1.4500-$1.4600 area is the last hurdle ahead of $1.50. 

Sterling also is being lifted by rate hike expectations as easrly as next month, with today's PPI figures.  Short sterling futures strip is implying higher interest rates, but on the week the contracts imply slightly lower.  That said, it is interesting to note that sterling is the strongest of the G10 currencies this week, rising 1.56% compared with say the euro's 1.2% advance.  The antipodean curencies are just behind sterling for the weekly performance, followed by the Norwegian krone. 

Don't Fret about the Potential Closure of the US Federal Government

What would Josh Lyman do?

Without a compromise, the US Federal Government may close down over the weekend. (Personally I am hoping for a West Wing-esq resolution) This is more a story of inconvenience for some services that may be disrupted and political theater than substantive political,financial or economic risk. Even the furloughed government workers are likely to be paid retroactively.

While not exactly sure what credit default swaps on the US really reflect, but it is interesting to now that the 5-year CDS was trading at the lows since August earlier today, according to indicative pricing. Some large money managers who reportedly cut their Treasury holdings also acknowledged earlier this year that they were selling CDS on the US, not buying, apparently as a way to raise cash and have some exposure to the US market.

Trichet, Trichet, Trichet or Not

The US dollar is mixed, though the euro is clearly lower ahead of the ECB meeting and, more importantly, Trichet's press conference.  Every one and their sister expects a 25 bp hike, but the guidance going forward is important, or maybe not. Observers recall that Trichet's past suggest that a tightening cycle is not at hand has not proved advice to bank on. 

My idea of heightened risk of "buy the rumor sell the fact"  type of of activity was not solely based on the likelihood that Trichet may try to calm market anxiety about the extent and pace of hikes.  Rather it was also on market positioning--the euro has been trending higher since early Jan on ideas ECB was going to hike and not just hike, but hike ahead of the US, something it has not done in a generation.  The intreest rate market, it seems to me, is too aggressive. 

Portugal Bites the Bullet?

Portugal's caretake Prime Minister bowed to international and domestic pressure and announced he was going to make a formal request for aid within the existing framework. This would seem to suggest a package, like Greece and Ireland, that covers the anticipated financing needs for three years. However, it is not clear that he has the authority to do so. Instead there has been much speculation about a bridge loan until the early June elections.

Color on UK Surprise

The economic surprise of the day was UK industrial output, which fell 1.2% instead of rise the 0.4% the consensus expected. First let's look at the source of the disappointment and second, implications.

Weakness was seen in all three components of UK industrial output--mining, utilities and manufacturing. Mining and quarrying fell 2.8% and this seemed largely the result of seasonal maintenance. Utility output fell 2.1% and this seemed largely a function of weather.

Euro and Swiss franc Surge, Yen Weakens

The euro has shot higher, reaching 15 month highs, while the US dollar firms to 6 month highs against the yen.  The main driving for remains interest rates and interest rate expectations.  Strong German manufacturing underscores ECB rate hike inevitablity tomorrow, while the FOMC minutes and recent speeches by Fed leadership clearly indicates Treasury purchases and unconventional easing continues apace.

UK data disappointed.  The 1.3% decline in Feb industrial production raises fears of renewed economic weakness, despite the strong service PMI yesterday.  Short sterling futures are recovering from yesterday's sell-off.   Sterling itself is flattish against the dollar aorund $1.6300, but the strength of the euro means that sterling is suggering on the cross.  It is not about 0.75% off the low we identified yesterday. 

Notes from Private Briefing with BOJ

Featured On
FT Alphaville

The BOJ's rep office in NY invited a number of analysts to meet the Deputy Director of the stats office and hear a presentation about the economic impact from the recent disaster.

The key take away points from the BOJ is that disaster may not be as costly, but it will take a quite a while to fully recover. Specifically the govern initial estimate is JPY16-JPY25 trillion (~$200-$300 bln). The damages to the plants in the stricken area may cut the country's output by 0.2-0.4%. This was regarded as a preliminary figure and does not include the impact of the electricity shortage. This number is more likely to be revised down to show a larger GDP impact.

DJ FX Trader Roundtable

Canada Reserve Figures and More

The Bank of Canada reports its reserve figures every week. Today's report is interesting because it covers the joint intervention.

The Bank of Canada sold roughly $124 mln in yen. This follows the UK Treasury's admission that it sold about $150 mln of yen. The BOJ figures suggest it sold JPY692.5 bln (~$8.5 bln). What is particularly noteworthy about the Bank of Canada's operation is that its intervention cut its yen holdings nearly in half. On the face of it, this would suggest a limit to the potential intervention. However, in the past, Japan has provided the yen to foreign central banks that they in turn would sell. Thus, while we regard last month's coordinated intervention as the one way bet on the yen was broken and yen volatility has been sharply reduced, there is no real material barrier to future intervention, which we regard as unlikely.

India: Foreign Investors Returning, Data Softens

Overseas investors have stepped up their purchases of Indian equities in recent days and have reversed the earlier outflows to be net purchasers here in 2011. Between last Thursday, March 31, Friday April 1 and yesterday April 4, foreign investors bought nearly $1 bln of Indian shares according to the Securities and Exchange Board. The net INR43.5 bln purchased in those three sessions offset in full and more INR25 bln sold in the year-to-date period.

Foreign investors were net sellers of INR94 bln of Indian shares in Jan and Feb, but turned to the buy side in March. Through March 30th, foreign investors bought $1.5 bln of Indian shares.

Dollar Mostly Firmer, Sterling Higher

The US dollar is firmer against most of the major and emerging market currencies, with the notable exception being sterling, which has ben boosted a much stronger than expected services PMI (57.1 vs 52.6 in Feb).

Sterling reached $1.6250  but is over-extended on the short-term basis and a break back below $1.6200 would suggest the day's high is in place.  The data may have been skewed by a blip in government spending. .  With the UK eocnomy expanding after a contraction in Q4, many see the risks increasing of BOE ratye hikes, but not right away.  The short-sterling futures curve has steppened sharply.  The implied yield in June is 2 bp higher, but in Dec 6 bp higher. 

Five-Year/Five Year Forwards: US and Europe

The five-year/five year forward has been cited by various officials in the US and Europe as a useful metric of inflation expectations. It is interesting to review where they are in light of the ECB's likely hike this week and increased talk about inflation in the US as commodity prices, especially oil prices, continue to edge higher.

The US 5-year/5-year forward, which is a five year forward on the second five years of a 10-year TIP implies expected inflation of 2.57%. It has largely moved in a 2.30%-2.70% range for most of Q1 after being confined mostly to a 2.70%-3.00% range in Q4 10. By this measure inflation expectations have eased, not risen.

The ECB and the Fed

If there is a single factor that was the main driver of US dollar in the first quarter, it would be the divergence between the trajectory of US and European monetary policy. The Federal Reserve is still engaged in easing monetary policy through unconventional purchase of Treasuries.

On its current path, QEII is worth something on the magnitude of 20-30 bp of easing in Q2. The European Central Bank has since early January steadily increased its commitment to tightening monetary policy through hiking interest rates and raising the decibel and frequency of its anti-inflation rhetoric.

Monday Overview

Out visiting clients in the second half of last week.  Still managed to monitor developments.  There are a number of take aways.  First, the best quarterly jobs performance since 2004 in the US failed to give the dollar a sustained lift.  This is because, with NY Fed's Dudley help, the market was reminded that US monetary policy has not yet reached its most accommodative stance.  QE2 is continuing, despite some hawkish comments from the hawkish wing of the Fed,  And this will likely be underscored with the release of the recent FOMC mintues.  The ECB is to hike rates Thursday this week.     

Second, the US consumer, which contributed mightily to Q4 GDP, is pullking back a bit and the March auto sales numbers were a bit soft, suggesting a soft retail sales report next week.