Latest COFER Data--Reserve Allocations

The IMF publishes its COFER report of official reserve holdings at the end of the quarter for the proceeding quarter. Q1 data was released today. 

In percentage terms, the US dollar's share slipped to 60.7% of the allocated reserves, down from 61.5% in Q4 10 (61.8% in Q1 10). Contrary to some market talk, the yen's share did not increase and remains at 3.8%. This does represent an increase from Q1 10 when the yen's share was 3%. Sterling share ticked up to 4.1% from 4.0%. It was 4.3% in Q1 10. The euro's share rose to 26.6% from 26.2% in Q4 10, but is a lower than the 27.2% of Q1 10. The "other category" which includes the Australian and Canadian dollars, rose to 4.7% from 4.4% in Q4 10 and 3.6% in Q1 10.

Tankan and Beyond

The European debt crisis has commanded investors' attention. The yen appears to have been largely sidelined. The dollar has been confined to exceptionally narrow trading ranges against the yen and 3-month implied volatility has ground lower and now is within striking distance (within 0.5%) of the multi-year low set just before the earthquake struck.

Supply disruptions and the rise in commodity prices are doing for Japan what policy makers have failed to do and that is arrest deflation. Core CPI (excludes fresh food) turned positive in April for the first time in two years and it is likely to have remained positive in May. Excluding fresh food and energy, the loosening of the deflationary grip is also evident. The year-over-year rate is likely to be zero in May having been as low as -1.6% a year ago.

CNBC: Did QEII Really Work?

CNBC: Post QEII Market Strategy

Now What?

As had been anticipated, the Greece parliament approved the austerity measures along party lines.That it had been anticipated in the currency market is evident in the euro's appreciation in recent days from almost $1.41 on Monday to almost $1.4450 today. The peripheral bonds have also rallied over the past 36 hours. As we warned, the euro is vulnerable to a "buy the rumor sell the fact type of activity. Support for the euro is seen in the $1.4340-50 area now. Resistance is pegged near $1.45.

The parliament will vote on the implementation bill tomorrow. This may be a bit stickier, but it too is likely to pass. Assuming so, attention will turn again to Greece second aid package. There are a number of plans being discussed, and although the French plan may form the basis of discussion or the terms of the debate, it is not clear that the details will carry the day. In particular any kind of guarantee using EFSF does not seem to sit well with the ECB. The 30-year extensions do not sit well with many banks. The roll-over itself has been cautioned against by Fitch.

Update: Correlations between Selective Currencies and S&P 500

(This is an update from this post.) As the Q2 winds down, it may be useful to review the recent correlations between some of the major currencies and the US S&P 500. The correlation calculations are conducted on the basis of percentage change of the currency and the S&P 500. What follows are the highlights.

Greece and the French Proposal

Currency in Crisis

When it comes to heading up the IMF, the French position is that Largarde should be supported not because of her nationality, but because of her experience.  Fair enough.  Mexico, now joined by Chile, Peru, Australia and Canada seem to be making the same case for Carstens. The three countries with the most votes (US, Japan and China) have not tipped their hand.

Given the failure of the IMF's efforts in Western Europe, ironically whose financial stability was its first mandate, insofar as it has not stabilized interest rates in Greece, Portugal or Ireland, a case can be made that if there is to be the head of the IMF not from Europe, this is that moment.

US Money Markets--Another Channel of Contagion

New earlier this month that Moody's was placing 3 French banks on review for a possible downgrade renewed investors focus on the potential contagion through US money markets. It appears that European banks secured dollar funding through issuance of commercial paper and other short-term instruments that US money market funds purchase.

Fitch estimates that 10 of the top 15 issuers of such short-term paper are European banks and Moody's estimates that of over half of that is accounted for by Frenchbanks. There has been a net withdrawal from US money market funds and it appears that the funds have moved to strictly US Treasury or US high grade money market funds. This, coupled with new regulations/fees, and a reduction of bill offerings from the Treasury as it approaches its debt-ceiling, has weighed on US bill yields. The 4-week bill yield appears negative and the 3-month bill is at about 1 bp annualized yield, for example.

CNBC: Euro Higher on Greece Bailout

Some Thoughts on Europe

Currency in Crisis

The last few days have been very significant and will likely shape investors views in the weeks ahead.  While Greece remains at the epicenter of the European debt crisis, the issue is much bigger.  It has begun bleeding over not just into Ireland and Portugal, but Spain and Italy as well.

China: Strong and Fragile

Many seasoned observers exaggerate China. Some do it to demonize it; others to celebrate it. They speak of China as the factory of the world when it is really an assembler rather than producer. Recognizing its $3 trillion of reserves (and growing), we are told that China is the banker of the world, yet its financial system is fragile. In fact this fragility appears to have begun to hamper the projection of China’s financial power in recent weeks.

Reverse Mergers

One of the most dramatic developments has been the collapse in the share price of a number of Chinese companies list in the United States. The shares are accessible not as American Depository Receipts, the way say Petrobras trades. Instead these companies bought small marginal businesses in the US that were already listed.

EMU May Not Be Cooked in Greece

Currency in Crisis

The ebb and flow of reacting to headlines over the Greek crisis appears to be largely dictating the ebb and flow of the capital markets. It may come to a head on Tuesday as the government, fresh from a modest reshuffling to appease the coalition that makes up the socialist party, tries to jam through its new austerity program.

The approval of the austerity measures appear to be the key to the IMF and EU releasing the next tranche of funds, or some part thereof. One of the key facts in is that the government has a five seat majority in parliament. A failure of the vote of confidence or the austerity program (vote for which is likely next week) against the government would lead to a collapse of the socialist government. The other key fact is through maturing debt and coupon payments due next month (July 15 and July 22) amount to about 7 bln euros and there are maturities in August (Aug 19th and 20th) of about 8 bln euros.

Thinking about Sovereign Credit Default Swaps

The Depository Trust and Clearing Corp provides a central register for credit default. A recent report indicated that there are about $5 bln of outstanding Greek sovereign CDS. Greek debt in dollar terms is about $483 bln, meaning the CDS covers about 1% of Greece's sovereign debt. This is considerably smaller than one might suspect.

The size of the sovereign CDS market is much smaller than one might expect. Consider Italy DTCC says estimates its sovereign CDS market is about $25 bln. The outstanding debt is around $2.3 trillion. The corporate credit default swap market appears more developed. It is less unusual to buy credit default swap protection on corporate bond exposures than it is on sovereign debt.

CNBC: Early Look at Trading

Darkest before the Dawn

Currency in Crisis

It looks bleak. The European debt crisis has pushed peripheral yields, premiums and credit default swap prices to new highs. The situation looks intractable. And now on top of the dire situation, the political backlash in Greece is forcing a change of government.

The brinkmanship game ends when some one blinks and one of the reasons why so many are so pessimistic is they can't see who is going to blink first. The irresistible force meets the immovable object. A Greek default is understood to increase the risk of Portuguese and Irish default. The firewall that has thus far protected Spain will come under attack. Italy may not be that far behind. Martin Feldstein once warned of the risks of war should EMU fail.

Greece is in the Cross Hairs, but Don't Forget About Ireland



More on Ireland Here



The devolution of the Greek financial crisis into a political crisis is the main focus. There have been signs of contagion through the euro zone. However, even if the situation in Greece was not deteriorating, developments in Ireland would draw investor interest.

Currency in Crisis

The new Irish government has been in office for 100 days. Its position on bank bond holders has wavered since the campaign, but Finance Minister Noonan is making a clear bid for senior bond holders of Anglo Irish and Irish Nationwide to share in losses.

CNBC: Debt Contagion Spreading to Ireland

Greek Developments and the Euro

Currency in Crisis

The euro suffered its biggest decline in six weeks as the financial crisis in Greece is (finally) creating a political crisis.  Many in the market were caught leaning the wrong way on Wed, expecting the euro bounce beginning in Europe and Monday and continued Tuesday, to see some follow through.  This seemed to serve to exacerbate the euro's slideas the weak longs cuts triggered additional stop loss selling.

What Brinkmanship Means

The June 14 meeting of European finance ministers did not resolve the dispute that is splitting the euro zone. This outcome is hardly surprising.  The logic of brinkmanship tactics say it is too early to blink and in this environment, the euro looks particularly vulnerable.

One one side is of the game is Germany, Austria, Finland and the Netherlands.  They seem to be pushing for bond holders to share in the adjustment process and appear to agree with the German proposal of having bond holders roll out their holdings of Greek sovereign bonds for seven years.

Another Stakeholder in Europe

There are so many moving parts in the European debt crisis, it is difficult to keep track of them all. Der Spiegel reminds us today of another stake holder that might have slipped by most observers and that is the German Federal Constitutional Court. A hearing early next month (July 5th) to hear complaints that the year-old Greek aid package violates the EU Treaty. The case is being brought by an MP from the CSU (part of the governing coalition CDU/CSU/FDP) and a group of constitutional lawyers.

The key issue seems to be whether the Greek aid violates the treaties that prohibit a transfer union or a bail out of sovereigns and if the role of the German parliament has been abridged.

Foreign Exchange Fever

There were big moves in the foreign exchange market on Monday, but little in the way of fresh developments.  The euro bounced smartly off the 1.4300 area and was back above the $1.44 area by midday in North America.  This despite S&P slash of Greece's sovereign rating to CCC from B and a blowing out of peripheral spreads against Germany and new highs in credit default swaps.  LCH Clearnet, a major platform, raised the margin for Portuguese and Irish bonds to 65% and 75% respectively.  

Nor has there been any resolution of the stand-off as it were among European officials.  This is much more than Germany vs the ECB, as many commentators suggest.  Rather, Germany can count on the support from Finland, Austria and the Netherlands.  On the ECB's side is France, EU and most of the finance ministers.

Limits of Monetary Policy

Buying $600 bln worth of US Treasuries, the Federal Reserve has flooded the market with liquidity and driven up asset and commodity prices.

Its Treasury purchases reduce the quantity of risk free assets, forcing investors to buy riskier assets. Commodities are among those risky assets.

By monetizing the debt, the Federal Reserve is debasing paper money and investors are seeking for tangible assets, things that hurt when you drop them on your foot, as one colorful commentator put it.

US Household Net Worth

US household net worth rose 1.7% in Q1, according to the flow of funds report just out.  This is a net figure.  It is the household assets minus liabilities.  In Q1, household equity and pension funds increased in value and this offset the decline in real estate.

The increase in household net worth was modest in percentage terms, it rose $943 bln in Q1 and now stands at a little more than $58 trillion.

Europe Needs to Shock and Awe, but...

Various news wires are reporting leaks of the IMF/EU/ECB review of Greece. Apparently they are concluding that the implementation of the conditions for last year's aid package have ground to a halt.

They are also concluding that the Greece economy is weaker than they had previously thought. Earlier they had assumed Greece would contract 3.5% this year and now 3.8%. Next year's growth was also revised down to 0.6%, roughly half of what they had previously forecast. Weaker growth of course has a knock-on the fiscal situation.

Trichet Holds Key

The US dollar is largely within yesterday's trading ranges against the major currencies ahead of Trichet's press conference.  The big moves are in the antipodean currencies where softer than expected employment data has weighed on the Australian dollar, while a somewhat more confident New Zealand central bank sent the kiwi more than 1% higher.  It has enjoyed some extra play recently amid talk of it being added to reserves. 

Before turning to the ECB, consider the environment in which it is meeting.  The credit default swaps of the peripheral countries have set new record highs today as the risk of a credit event have appeared to increase following the letter, leaked to the press, by the German finance minister, calling for substantial private sector participation--beyond the Vienna Initiative-like approach.

Is Schauble Calling for Restructuring or Posturing?

German Finance Minister Schauble has written a letter earlier this week to the ECB, IMF and euro zone finance ministers that appears to be putting the proverbial cat among the pigeons. The latter has been leaked to the press. He seems to be tacking a course that runs into direct opposition to the ECB, IMF and France.

Until recently Schauble seemed to argue that a restructuring of Greek debt needed to be avoided because of the systemic risks. However, the letter suggests a different assessment. Schauble essentially argues that the EU/ECB/IMF plan has failed. Full stop. It failed because Greece cannot go back to the capital markets next year as initially envisaged and if Greece needs funds for not only next year, but 2013 and 2014, estimates suggest as much as another 100 bln euros may be needed (1st package 110 bln euros.

Dollar Chops Higher

The US dollar is mostly firmer, though the yen is a notable exception, amid position squaring.  Global equities are lower on growth concerns and the failure of the US markets yesterday, which extended the losing streak in S&P 500 to the fifth consecutive session.   Growth concerns also seem to be weighing on commodity prices and emerging market currencies. 

The euro tried again the $1.4700 level in Asia and a weaker attempt in Europe and has been pushed back again.  The break of the $1.4640 area warns of a further drop in North American toward the $1.4560-80.  However, be careful of claims about the relationship between stocks and the euro.  The 30-day rolling correlation (on percentage change) has fallen from 0.71 at the end of May to less than 0.47 now. 

CNBC: Ford Pays Down $2.3B Debt

Dollar Surrenders Yesterday's Gains

The US dollar has given the gains scored in North America yesterday.  New highs for the move was recorded in the euro for the advance.   Sterling was first sold through yesterday's lows on soft BRC sales, but then recovered to trade through yesterday's high.  After nearing $1.6475 sterling pulled back half a cent.  Still, in bigger picture, I expect further dollar weakness. 

For the day, though, I think it is noteworthy that the euro failed to make new highs on the back of the very strong German factory goods orders data, which should blunt some of the negativity emanating from the soft PMI data.   Aprice factory goods orders rose 2.8% rather than the 2.0% the consensus expected.   Moreover, the March data were revised to show a 2.7% decline, not the 4.0% decline initially reported.   It warns too of upside risks to tomorrow industrial output figures. 

Careful about Private Participation in Greek Aid

Currency in Crisis

Many people in the market have concluded that new Greek aid is a done deal. The EU/IMF/ECB concluded their review before the weekend and it is expected to lead to Greece being able to draw down its next tranche of aid under the existing program. This in turn augers well for the second aid package, the one that just a few hours ago a German official suggested does not necessarily need the EFSF.

The second aid package innovates in terms of the privatization efforts and more emphasis on getting current holders of Greek obligations that mature in the next couple of years to roll-over into longer maturities.

QEIII: Why Not (!?)

The recent string of US economic data has been simply dreadful. Estimates for growth are being revised down. The Federal Reserve’s purchases of Treasuries, under what has been dubbed QEII, are coming to an end in a few weeks. The discord that is preventing raising the debt ceiling reflects disagreements over the pace of fiscal consolidation. It is not clear what kind of policy response to further economic weakness can be delivered.   

The rating agencies recent warnings and the political considerations suggest that the scope for a fiscal response is minimal at best. Instead of talking about a new fiscal compromise, like the unexpected one for this year, talk of a monetary response, QEIII, has begun. To help further the discussion, let’s consider three aspects here: efficacy, probability of QEIII, and other potential actions.

Dollar Consolidates Losses

The US dollar briefly extended its pre-weekend decline, but has settled into a consolildative tone.  Additional modest dollar gains may be seen in North America, but selling into bounces is likely to dominate as a full blown crisis in Europe is avoided for the time being and this allows near-term focus to shift back to weakness of the US economy and the divergent monetary policy paths. 

The central banks of Australia and New Zealand meet.  The former is likely to maintain signal that further tightening is needed, while the latter may express concern about the currency strength.  In Europe, the BOE and ECB meets.  The BOE will not do anything, and unlike other central banks, when it doesn't do anything it doesn't say anything.  The ECB is a different kettle of fish.  The OIS Swaps market has nearly fully discounted a July rate hike.  The market expects Trichet to use word cues to confirm expectations.

Portuguese Politics Morphs into Technocrat Choice

The debt crisis in Europe is having political ramifications. Ireland elected a new government earlier this year and Portugal will do so this weekend. The latest polls suggest the most likely outcome is a coalition government between the Social Democrats and the People's Party.

The crisis renders party platforms nearly irrelevant. The terms of the recent aid package are generally agreed upon. That is the agenda. It is a 3-year plan to cut the deficit through a combination of spending cuts, tax increases and privatization. The deficit is projected to fall from almost 6% this year to 3% in 2013.

Consolidative Tone, Except for Sterling and Yen

The US dollar is largely in a consolidative mode ahead of the US jobs data, service ISM and more developments from Greece, where as noted previously in this space, European officials drove the situation to the edge of the abyss and now are pulling back.

The euro zone service PMI came in a t 56.0, which represents an improvement over the 55.4 flash but still softer than April and is the slowest since Jananury.  Nevertheless, Trichet is still likely to use word cues next week that will boost the market's confidence of a rate hike next month, though of course he does not pre-commit.  

Dollar Yields to Euro, Sterling Recovers

The main development today has been the full recovery of the euro from yesterday's North American slide, which was in part fueled by Moody's rating slash of Greece.  The euro recovered through Asia and then accelerated in a holiday-thin (Ascension Day) European session.  A relatively healthy reception at a Spanish bond auction and reports that Greece will have a medium term fiscal plan to show Juncker tomorrow.  The euro has moved through the $1.4455 area, which represents a 50% retracement of the euro's decline begun in early May.   The $1.45 area is the next psychological level while the $1.4570 is the next retracement objective. 

Kan Can Survive Vote of Confidence, but...

Japan Prime Minister Kan faces a vote of confidence as early as tomorrow. It will not cause a split in the Democrat Party of Japan (DPJ). It is a reflection of that split, begun over the ousting of former power broker Ozawa from the DPJ over financing scandal. The DPJ have been divided since this has undermined the government's ability to respond to the crisis.

The DPJ and their allies hold 309 seats in the 480 member lower chamber of the Diet. The vote of no-confidence called by the opposition parties need 240 votes to pass (the speaker does not vote). One incomplete poll in a local paper suggested that some 53 DPJ members by abandon Kan.

Data Theme: Economic Moderation

The US dollar is mixed.  The euro is consolidating its recent gains, despite softer PMI data.  

The UK reported a much weaker than expected PMI data and sterling dropped a cent after earlier testing $1.65.  Switzerland reported stronger PMI and retail sales data and this offset the impact of yesterday's somewhat soft Q1 GDP report.