Financial Repression

With crisis comes new vocabulary. Out of the Great Depression came the use of the word "recession" to denote the end of a business cycle rather than crises, panics, and depressions, which had previously been used.

The recent crisis has given rise to many new words, including "haircut", "re-profiling" and the "Vienna Agreement". To the lexicon, we must add "financial repression". Like the other words, the concept of "financial repression" existed long before this crisis, but its use has risen and is becoming more central to the debate.

The Significance of the Euro: A Primer

Europe’s monetary union is simply one of the most important experiments of our time. Can the countries whose wars against each other shaped to a large extent the past millennium, if not longer, form a sustainable monetary union without political union?

This experiment is being tested currently under conditions of dramatic imbalances among the participants of the union and three members have been effectively locked out of the capital markets, except for very short-term borrowing. Much has been said and written about these issues, but there are a few basic points that have tended to be overlooked.

Dollar Mostly Heavy, Euro Optimism, Positive Technicals

The US dollar is mostly lower, led by the euro.  The news stream has turned more positive regarding Greece. 

First reports suggest that part of the conditions for new aid will likely include a loss of sovereignty.  Previously, Greece's statistical collection agency had to have a Eurostat representative.  Now it seems that European representative may be included into Greece tax collection and privatization efforts. 

Dollar Upside Move Over?

The US dollar has generally trended higher in recent weeks, but provided that it does not recover today, I suspect its upside correction may very well be over.  In euro is trading at new highs for the week today and the Australian dollar and British pound are at new two week highs.   Frankly, there is some contradictory evidence and it needs to be recognized.  This would include softer than expected German state CPI figures and softer than expected euro zone money supply.   In turn this could lead to some doubts about ECB tightening in July, as is may base case.

Juncker is Talking Junk...Again, Sending Euro Lower

The leader of the euro zone finance ministers Juncker is again triggering heightened anxiety and cutting short the euro's push above $1.4200 for new highs this week.  Juncker is quoted saying that Greece will not make its deficit target this year and more importantly may not get the next tranche of aid from the EU/IMF.  The euro has dropped more than half a cent in response.  

When recognizing that Greece overshot last year's deficit target, it was widely understood that this year's initial target would be surpassed as well, so that is not really news.  Juncker's claim about the next tranche of aid gets to the heart of the matter.  Greece may run out of cash by mid-July and would not be able to service its debt if it does not get that aid.  Yesterday the government approved an accelerated privatization program and more austerity measures--the fifth such austerity program since the crisis began. 

Dollar Setback

The US dollar is mostly lower today.  The typically short run relationships don't see to be working well at the moment, which in turn keep conviction levels low.  The euro is at the highs for the week and sterling is actually at its best level since May12.  Equities are mostly higher, while commodities are mostly lower.  US-German 2-year spread is flirting with its most dollar friendly level in several weeks.

Many pundits are talking about China's interest in EFSF bonds.  This seems to me to be a post-hoc explanation. Of course China and other reserve managers will buy the AAA euro instrument.  There is simply a shortage of triple A paper.  This allows the diversification of euro reserves as well as diversification of new reserve inflows.  Observers are looking for a reason for the euro's rally and honed in on this. 

Turn Around Tuesday Challenged?

Turn Around Tuesday unfolded in Asia and early Europe as equity markets gain (after the 1% loss in the US on Monday) and the euro and dollar bloc currencies rallied.  However, news that Greek opposition leader Samaras opposed additional austerity measures, but would suipport state asset sales, is proving challenging. This stalled the euro's momentum and prompted some retracement of its gains.  Support is seen ahead of $1.4050.   On the upside a move above $1.4160-75 is needed begin healing the technical damage. 

The European data stream has been limited to the stronger than IFO survey in Germany and the softer than expected March industrial orders for the euro zone as a whole.    The recent string of data suggest that after a strong start the euro zone growth momentum faded as Q1 drew to a close and started Q2 softly.

CNBC: Should You Invest in Europe?

Dollar Extends Gains, Euro Pounded

The US dollar is broadly higher.  Three events have taken place and they all point in the same direction:  1) The three-notch downgrade of Greece on Friday was following by shift in the Italian debt outlook to negative from stable, 2)  Spanish and German elections which weaken the current governments, 3) softer than expected euro zone and Chinese PMI reports,  These events are weighing on equities and commodities, underpinning core bonds, and lifting the beleaguered greenback, 

Press reports suggest that Greece is running low on cash and needs to the IMF/EU too approave its next tranche, its fifth of 12 bln euros by the middle of July.  Polls shows the Socialists have slipped to a tie with the opposition, for the first time since before the 2009 election as voters grow increasingly austerity weary.  One poll found nearly 4 in 5 oppose new measures.  The French finance minister, the favorite for IMF head, warned that Greece could default.  The markets were happy to take the bait.

Ratings, Who Next?

News that S&P had put the US on credit watch saw some hand wringing and chin wagging, but the investor class did not sell US Treasuries.  As noted previously, just before that Fitch had put China's local long term debt on credit watch for possible downgrade and it went unobserved and uncommented on by many.  Before the weekend as the euro was already under some pressure after having tested important resistance near $1.4350, Fitch cut Greece's debt rating by three notches and had a negative outlook. 

IMF Leadership and German Debt Problems

Europe will always have an excuse for a European should head up the IMF.   They will be reluctant to allow some one from the emerging countries take the top spot, but that day is coming. Frankly I don't think it really matters. DSK lost his last bid for French presidency. He was given the IMF as a consolation prize. Largarde will likely be out of a job next year after the French national election. This is a consolation prize for her. I think the IMF is an institution and that the variance of different MDs pales in comparison to their similarities.

Spain--Deficit Problems Worse Next Week than Last Week?

European officials have been successful in establishing a firewall around Spain and insulating it from the crisis in the peripheral. That firewall may be tested shortly.

Spain holds local and regional elections on Sunday ahead of the national election next year. Socialist Prime Minister Zapatero has already indicated he will not seek re-election. The difference between being quitting and being fired is a fine line as Zapatero would most likely lose if he were to run.

Swiss Franc Eclipses the Euro

The decline in the euro after firming in Asia to almost $1.4350 was the dominant feature in the European session and into early in the North American session today. However it is now being eclipsed by developments in Hungary.

Specifically, Hungary's government and banks have reportedly reached an agreement to fix the CHF-HUF exchange rate for mortgages at 180, which is about 15% below prevailing prices. Swiss franc denominated mortgages were more popular than forint ones before they were banned. Reports suggest that some 90k homes in Hungary were overdue payments on Swiss franc loans at the end of 2010. This is about 25% more than the turnover of housing in Hungary last year, according to government data.

Euro Drops, Dollar Flat

There is one feature of the foreign exchange market and that is the euro's failure at the $1.4350 resistance area, that corresponds to the 50-day moving average and the high from last Friday when the euro posted an outside down day.  After spending the quiet Asian session on firm footing, as soon as Europe came in they sold it off. 

Currencies and Oil

The relationship between oil and currencies is no more stable that the relationship between the S&P 500 and currencies. As we noted yesterday in our look at the correlation between a handful of currencies and the S&P 500, it is not that there is no relationship, but rather that the relationship is far from stable. One cannot deduce the correlation from first principles, but investors should monitor the shifting  sands.

A note on our methodology. We are looking at correlations conducted on the percentage change of the currencies and the second oil contract to avoid the effect of the roll.

Dollar Down, Mostly

The US dollar has come under pressure, but well within the recent ranges, as the break of the greenback's upside momentum this week is slowly encouraging the bears to re-emerge.   The FOMC minutes, which got so much ink play, discussed exit strategies but not the key for investors--timing. 

Weaker than expected Japanese GDP figures for the Jan-Mar and a downward revision in the prior quarter suggests the Japanese economy may have been recession-bound prior to the tragedy-for which the nuclear crisis still does not have closure and the power outage may get worse before getting better. 

Currencies and Equities

Many medium term investors are interested in the relationship between currencies and the equity market. There is also a sense among many observers that the market is moving in waves of risk on and risk off. To help shed light on the issue, we looked at the correlation between several currencies and the US S&P 500. From a methodological point of view we are looking at the correlations on the level of percent change.

Euro: Over the past 60 days the euro's correlation with the S&P 500 is about 0.47. This represents a significant recovery from the low of below 0.2 seen in early March. The correlation had been trending lower from early last Nov (near 0.68) to that early March low and since has been trending higher.  Over the past 30 days, the euro's correlation with the S&P 500 is about 0.58, which is consistent with the trend rise in the 60 day reading. The low correlation of the year was recorded in mid-Jan near 0.

Mixed Dollar Remains Choppy

The US dollar is mixed against the majors.  This makes talk of risk-on and risk-off a greater simplification than is often the case. The yen is stronger and the Swiss franc is flattish to softer.  Sterling and the Australian dollar are lower, but the euro and New Zealand dollar are stronger.  Commodities and equities are higher and are firmer. 

The euro traded at three-day highs near $1.4290.  I have thought gains this week could extend toward last Friday's high near $1.4340 before the new euro bears make a stand.  Initial support today is pegged near $1.4220. 

More Thoughts on Greece

Currency in Crisis

The European finance ministers approved an aid package for Portugal. Ireland is still seeking better terms. Although France's effective corporate tax rate is lower than Ireland's, Sarkozy is reportedly refusing to sanction some easier terms (lower rates extension of maturities on the aid package) unless Ireland makes a compromise on its taxes.

Greece's situation is far from clear. It is now appreciated that Greece will not be able to return to the capital markets as envisioned in last year's aid package. While something needs to be done, a consensus has not emerged, except that more effort on the part of Greece is necessary.

Europe's Political Climate Impacts the Debt Crisis Response

The policy response to the European debt crisis is critical and that response is function of European politics. There have been a number of developments in European politics that investors should be aware of.

Germany: The crisis has revealed the Germany's economic and financial power, but the elite and people seem divided about projecting commensurate political power. This tension is threatening the FDP itself. A reshuffle last week, produced a new economic minister for Germany-Philipp Roesler, the new leader-designate of the party. Westerwelle, the former head of the FDP remains as foreign minister, but is clearly in a weakened position. The FDP garnered almost 15% of the vote in the last national contest, but now is polling less than 5%. The FDP appear to be transitioning from a sober centrist party to giving voice to euro skepticism. While parliament approval of Portugal's aid package is likely, support for additional measures for Greece and approval of the ESM will be an uphill fight. These will be important votes later this year.

Dollar Mixed, Underlying Themes Reemerge

The US dollar is broadly mixed, losing ground against the euro, sterling and dollar bloc, but gaining against the the Swiss franc and even more so against the Japanese yen.  Commodity prices are firmer.  Equities were lower in Asia and began lower in Europe before recovering.  

The dollar reached its best level against the yen since April 27.  The resumption of the so-called risk-on trades have "naturally" weighed on the yen.  In addition comments from the BOJ Governor Shirakawa leaves the door open for additional action.  This additional action comes as QEII draws to a close for the US and the ECB and RBA will continue to normalize policy.    The JPY82.00 area offers the next level of resistance.  Note that in the stronger dollar environment, the yen has fared the best among the majors, only losing 0.58% against the dollar this month.  If the dollar weakness resumes, as I suspect is likely, the yen is likely to lose on the crosses and this may weigh on it against the greenback. 

Dollar Mixed on Monday

The dollar is mostly firmer, but without much momentum as the market awaits fruther developments. 

The euro recovered from the dip below $1.4050, but ran out of steam near $1.4150, which was previously support.    The European finance ministers meeting begins shortly, and approval of Portugal's package may be the only concrete action that emerges.  An adjustment to Ireland's package and an extension of Greece's will have to wait until at least next month, it seems.   A break of $1.4150 would suggest a move toward $1.4200-25, but the $1.4300-50 may be a more critical area.

European Leaders Hanging from their own Petard

European leaders are hanging from their petard.  The aid package put together barely a year ago, and belatedly at that, is proving insufficient for Greece.  The Irish package is hardly six months old and is under review.  Portugal’s package is likely to receive endorsement by the euro zone finance ministers at the summit on Monday and Tuesday.  The euro finished near its lows before the weekend.  The technical tone is weak.

One man who wishes he could be in that room of haranguing European finance ministers is Strauss-Kahn.  As the managing director of the IMF, he planned to attend.  However, shortly after he boarded his flight that was to take him from NYC to Paris, he was dramatically escorted off the plane by police and subsequently arrested for allegedly sexually attacking a hotel maid. 

Big Picture Thinking: The Euro, Greece, Europe, ECB

Currency in Crisis

There have been a number of developments in Europe over the past several days and the euro has broken down. Its nine cent decline in nine days demands attention. The 5 and 20 day moving average have generated bearish technical signals, led by sterling, followed by the euro, and confirmed by the Swiss franc. Other bearish technical developments have taken place.

The euro broke below its 50 day moving average for the first time since mid-January, came back to test it before the weekend and failed. The euro posted an outside down day on Friday the thirteenth as did the Swiss franc. Sterling staged its own reversal in the middle of last week when the market assumed the downward revision to the Bank of England's growth forecast and upward revision to inflation forecasts meant a rate hike would be forthcoming. The next key chart points are found in the $.139-$1.40 area for the euro and $1.60 for sterling.

Market Lacks Conviction

The US dollar is mostly firmer today, but the market lacks near-term conviction.   After last Friday's unscheduled mini-EU summit, it seemed like key officials recognized that something more needs to be done for and with Greece, shy of asking it to leave the monetary union and shy of a default, but today it is far less clear that the political elite in Europe are united.  Moreover, the secretive nature and limited attendance of last Friday's meeting is an additional annoyance/frustration.  

 Exactly what needs to be done and under what terms is open to debate, it appears.   The flare up of the euro zone debt crisis is helping to mitigate what has been the main driver of the dollar, namely the divergent monetary paths.   Greece 6-month bill auction showed a minor 8 bp yield increase from April.  The bid to cover was a bit lower and the foreign take down was somewhat smaller,but on the whole was not a disruptive force today. 

Importance of Boeing

Given the size of the US economy, it is not usual for a particular company to impact macro economic data. Yet Boeing's report before the weekend has negative implication for April durable and factory orders data, and to a less extent US exports.

Arguably the Boeing report was overshadowed by the US jobs report and the speculation about Greece's tenure in EMU. However, Boeing news was dramatic. Total orders in April collapsed to just two from the outsized 98 orders in March. The 3-month average in March was 51 orders. Moreover, it is the first month since January there were no foreign orders.

CNY/CNH: Chinese Financial Review

On April 18, S&P cut its credit outlook for US Treasuries from stable to negative. This was seen as a clear warning that if the US politicos cannot agree on a sustainable fiscal adjustment plan, the US triple-A rating was at risk. This shot across the bow, on the heels of President Obama’s proposed alternative to the Ryan plan, was widely discussed. With the US dollar being driven down by the continued easing of US monetary policy, the fiscal pressures were broadly seen as evidence the US was headed in the wrong direction.

Almost a week before S&P’s move, Fitch cut the outlook for China’s yuan debt to negative from stable. Media coverage was almost non-existent and there has hardly been any commentary. Frankly, most observers don’t even seem to know it took place.

Euro Recovery Tentative

The US dollar is softer, but in terms of price action there are two developments.  The first is the recovery of the euro from the sell-off before the weekend on the Greek exit rumors.  The euro recover to a high near $.14440 in early Europe before steadying.  The second feature is the strength of the dollar bloc, perhaps haleped by the recovery in commodity prices from last week's shellacking and the more hawkish RBA.   Note China releases its trade figures tomorrow and ideas that April will show a significant recovery from the lunar new year distortions in March may also be encouraging some gains in commodities and the Australian dollar today. 

Significance of the EU Gathering on May 6

The unscheduled meeting between several euro zone finance ministers, Eurogroup head Juncker, EU Monetary Affairs Commissioner Rehn, ECB President Trichet and a few other senior officials was important.  It marks the official recognition that the year-old Greek aid package is not working. This does not mean that Greece is about to exit monetary union, rather it means officials are going back to the drawing board and re-evaluating their options.  It raises the significance of next week's (May 16) summit of European finance ministers.

Drawing on my analysis of other debt crisis, I have consistently argued that Greece (and Ireland, and possibly Portugal) will have to restructure their debt.  In a recent post I argued European officials would soon have to make some difficult decisions because Greece needs more funds and it would most likely not be able to effectively tap the capital markets next year as the IMF/EU assistance program had assumed. 

Update ECB Poliltics

A German paper is reporting that Chancellor Merkel is not accepting the fait accompli that is being delivered to have Bank of Italy Governor Draghi replace Trichet when his term expires in early Q4.

Since Weber submitted his resignation, Merkel has been without a German candidate for ECB head. Recall that previously she had done a lot of "horse trading" to ensure that after Trichet, it was Germany's turn. This includes in the European Commission posts and also getting a small southern county to be represented as the vice president of the ECB.

In recent weeks, support for Draghi seemed to grow. Eurogroup's Junker suggested Draghi's candidacy enjoyed unstoppable momentum and France's Sarkozy offered his backing. First mover is not always advantageous and since Sarkozy tipped his hand, we suggested that Merkel would try to eke out some concessions for her "willingness" to support "France's candidate".

Observers have raised a few issues about Draghi's candidacy, which seemed to have been overlooked because 1) there did not seem to be another strong candidate and 2) Draghi has said all the right things and is in any event a competent and well respected central banker.

These issues included the kind of balance Europe likes including a balance of southerners and northerner, Draghi's tenure at a large investment bank during the period in which that investment bank sold derivative to Greece (and others) that allowed some concealment of sovereign debt, and that Italy is a heavily indebted country. In recent days some tried to take the last point and turned it on its head: That an indebted country may be more able to rein in other debtors. This is a weak argument and this seems to be where Merkel, according to the German paper, is making her stand.

It is not clear whether this is a principled issue or whether the master tactician Merkel is simply "negotiating". That she reportedly favors Draghi for the next IMF head does not clarify the issue and pretends that no doubts have been raised to the tradition of a European at the head of the IMF.

While the immediate market impact of the possibility that Germany does not endorse Draghi is not obvious. Yet who heads up the ECB is arguably an important influence on policy, even though the ECB is a diverse group of national central bankers with a small core, which as we have pointed out previously, is the exact opposite structure of the FOMC.

Dollar Consolidates Yesterday's Gains

The US dollar is largely steady, having trouble extending yesterday's recovery but not giving much back either.  The Australian dollar is a notable exception, boosted by hawkish guidance from the central bank.  This has strengthened market conviction for additional rate hikes. 

The re-opening of Japanese markets has  coincided with a somewhat softer yen.  The greenback's broader recovery may have helped Japanese officials avoid a difficult situation.  Unilateral intervention has a poor track record and the bar to coordinated intervention seems well above prevailing conditions.

Trichet Less Dovish

Trichet's comments seem less hawkish than the market had anticipated and the euro is coming off sharply. While recognizing policy remains accommodative, he is using none of the word cues that point to a June hike. Euribor yields has fallen 8-13 bp in response to that sense. He said that price pressures are not broad based. This is forcing the market to reconsider tightening path. Risks he says remain on the upside and his Q&A that follows shortly may be more pointed. A July rate hike is still the most likely scenario. With the market also thinking that Italy Draghi is the most probably successor to Trichet, a rate hike in Q4 also seems to be a likely scenario. US rates are also falling so the decline in euribor is not fully being reflected in the spreads. Support has yet to be found as late euro longs appear to be bailing out. Although hourly momentum indicators are overstretched, euro potential is now toward $1.4660.

Choppy Price Action in FX

There are a couple of standout developments in the FX market today.

First, the yen has strengthened and now the dollar is trading below JPY80.  This is the lowest level since the coordinated intervention back in March.  However, the move is orderly and volatility is only slightly firmer, but well off the pre-intervnetion levels.  I understand the purpose of the intervention was to address volatility not a specific level.   Therefore intervention is unlikely.  QED

Dollar Mixed

The US dollar is mixed today.  The dollar-bloc is softer, led by the New Zealand dollar.  Th yen and Swiss franc are slightly softer as well.  The euro is firmer, as the pullback to $1.4780 in Asia was snapped up.  The persistent purchases of euro on relatively modest corrections and the rising interest rates suggest the late positioning in favoring more hawkish ECB.    Sterling is also firmer, but the slew of economic data has been poor, including service sector PMI (53.3 vs 56.4 in March) and is the weakest since last December, and soft Nationwide home price index and mortgage lending and approval figures. 

Thoughts on Portugal's Package

Portugal's caretaker Prime Minister Socrates appears to have negotiated a better deal than Greece and Ireland.  The plan actually sanctions larger deficits that Socrates are pressed for, under pressure pressure from the EU and ECB when he was a minority government.  This is simply astounding.  

Less than two months ago, Socrates proposed additional savings measures that he projected would mean a 4.6% budget deficit this year.  The new plan allows for a 5.9% deficit.  Socrates proposed a 3% deficit in 2012.  The EU/IMF now says 4.5% is good enough.  Socrates had projected a 2% budget deficit for 2013 (apparently assuming the world survives the winter solstice of 2012 and the end of the Mayan calendar). The EU/IMF says 3% is fine.

Odds the Euro Reaches $1.60

The euro is struggling to extend its advancing streak to the eleventh session. However, the main driver, of divergent monetary policy stances remains intact. In fact, news today that 3-month Euribor is at 2-year highs and 3-month Libor was fixed at its lowest level since March 2010, illustrates this force.

The word signals by Trichet on Thursday will help guide the market toward fine tuning of expectations for the next ECB hike. The market leans heavily toward July, but this could change depending on Trichet's comments. For example, mentioning "strong vigilance" would encourage the market to look for a June hike. Or if Trichet does not say "interest rates are appropriate" a June hike would seem more likely.

Euro Streak Ends ?

The euro has advanced for ten consecutive sessions coming into today.  Yesterday's failure to establish a foothold above $1.49 appears to have triggred a bout of profit-taking and the euro has retreated to yesterday's lows. 

Profit-taking is also being seen in the dollar bloc.  The Reserve Bank of Australia left rates on hold for the sixth month and its statement was slightly tweaked suggesting a little more inflation altertness, but not enough to prevent the Australian dollar from testing a 4-day low near $1.0850.  Soft wage data in New Zealand is helping ush out expectations of a rate hike.  A majority victory for the Canadian Conservatives has not protected the Loonie from the US dollar's recovery. 

CNBC: Turning Point for Commodities & Dollar?

Catalysts for Change in the FX Driver

The main driver that has led to a persistent decline in the US dollar through the last several months is the divergent thrust of monetary policy. It has left the Federal Reserve as a laggard in the global cycle and, in turn, has left the dollar with little support. Indeed after performing well following the announcement of QEII last November, the greenback’s fall from grace can be traced, with the benefit of hindsight, to the ECB’s first press conference of the year on January 13, when the hawkish signaling began.

The FOMC and Chairman Bernanke confirmed last week, as many had expected, that the current program of Treasuries will be completed as planned by the end of June. For an unspecified period after that, the Federal Reserve will continue to replace the maturing mortgage backed securities with Treasuries and thereby maintain the size of its balance sheet. Shortly after the Fed finishes QEII proper, the ECB is expected to deliver its second interest rate hike. It may very well deliver a third hike by the time the Federal Reserve begins to allow its balance sheet to shrink.

Dollar Mostly Firmer, but Euro even Firmer

The greenback is licking its recently inflecting wounds and has begun the week on somewhat firmer footing against most of the majors, except the euro and Swedish krona.  London markets are closed and so turnover appears soemwhat lighter than usual.  The general tone is consolidative in nature.  Outside of the death of Bin Laden, there were three developments to note.