Why Portugal

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The periphery bonds have generally rallied this year. Ireland's 10-year bond yield is off 138 bp and Italy's is off 179 bp, for example. The Iberian peninsula stands out as an exception. The Spanish 10-year benchmark yield is down only 4 bp and that includes today's 5 bp decline. Portugal is the real outlier. The 10-year yield is up 203 bp.



Currency in Crisis

Why Portugal? It is implementing the agreed upon reforms. That is both good news and bad news. It is good news in that is offers a contrast to Greece and make for easier relations with the Troika. It is bad news because the reform are insufficient to put Lisbon on a sustainable debt path.

Great Graphic: Why We Should Be Glad We Didn't 'Let Detroit Go Bankrupt'

Yesterday was the great state of Michigan's primary and we took the opportunity to explore what the state is know for: football and cars. We weren't the only ones, President Obama spoke at the UAW:

In his speech he reminded everyone of Mitt Romney's 2008 NYTimes OpEd Let Detroit Go Bankrupt. This great graphic from Think Progress illustrates why we should be glad we didn't let Detroit go bankrupt.

Euro Gyrates, but Doesn't Break

The euro fell amid a mild bout of buy the rumor sell the fact on news of the LTRO.  800 banks took down 529.5 bln euros, slightly above consensus but within expectations. A little more than 200 bln euros reflects the rolling of other borrowing facilities into the three-year tenor. 

That more banks participated (800 vs 525) this time is not surprising as the relaxed collateral rules in seven countries, including Spain and Italy, were partly designed to help smaller institutions.   While the greater participation would suggest the lack of stigma, a more telling indicator will be the relative performance of the shares of those banks that participated and those that didn't.  In lieu of this data, it is noteworthy that financial shares among the strongest sectors in Europe today. 

Last Thoughts on LTRO

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At this late date there still seems to be a great deal of misunderstanding and uncertainty surrounding Wed's 3-year LTRO by the ECB.

Currency in Crisis

Ironically even the size of the first LTRO is unclear. Many observers and the media continue to cite the take down as 523 bln euros. That is true, but is misconstrued. The bulk of that amount reflected the rolling over of other borrowings. The net injection was about 191 bln euros.

The second LTRO will similarly be inflated. There are approximately 150 bln euros in ECB lending maturing in the next couple of months that will likely be rolled into the 3-year facility. In addition, Tuesday's 1-day fine tuning tender for 134 bln euros, while the 7-day tender drew slight interest (29.5 bln euros) would seem to point to a roll-over component of LTRO II to be on par with LTRO I, perhaps a little less (332 bln euros rolled into LTRO I).

Great Lakes Great Times: All Eyes on Michigan

The Michigan Primary is today and with the winner poised to be the GOP front runner all eyes are on this majestic state with its 64,980 inland lakes (which is over five times the amount that Minnesota, "Land of 10,000 Lakes" has), 3,126 miles of freshwater shoreline (which is more than any other state has), and 19,000,000 acres of forest cover. So I thought we would take a look at what the state is most well known for:

Okay besides the glory of the team with the all time most wins and highest winning percentage in college football history, Michigan is know for cars. President Obama will be touring a Detroit Auto factory today. So along that theme here are several great graphics from Shop Auto Week on the US auto industry in 2011:

Collective European Bonds Exist

There are many voices that continue to clamor for a European bond; one that is backed collectively by the various members. Germany and the other creditor nations are understandably skeptical especially without greater fiscal unity.

We have argued that Europe is constructing a fiscal union in a similar way that a skyscraper is built. Scaffolding comes first. Such scaffolding exists for a collective bond. The basis for such a bond exists though; not in theory, but in practice.

Waiting for LTRO

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The consolidative tone that was seen yesterday in the foreign exchange market has largely carried over into today's session as the market awaits tomorrow's 3-year funding operation by the ECB.  The major currencies are largely confined to yesterday's trading ranges.  

The market took that S&P downgrade of Greece to "selective default" in stride as it was expected once the PSI got underway.  In addition the negative outlook for the EFSF follows S&P's decision to put France and Austria, triple-A countries, on negative watch.

A Crude Put?

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Arguably the rise in oil prices pose a new threat to the world economy. If oil prices stay elevated, it risks a policy response. Strategic reserves could be tapped as they were last year in a coordinated fashion. In addition, the risks of a new round of Federal Reserve asset purchases would seem to increase with the price of oil. Bernanke delivers his semi-annual testimony later this week and will likely get peppered with questions along these lines. It is possible that the rise in oil prices serves as a new form of the so-called Bernanke [Greenspan] put.

The first important point about the rise in oil prices is that there has been a genuine supply shock. Between Sudan, Yemen and Syria, nearly 750k barrels per day(bpd) have been taken out of production due to political instability. On top of this, Libyan oil output is about 600k bpd below pre-civil war levels.

In addition, the Iranian confrontation and its response (to cut sales to the UK and France) has also taken supply out of the market. The bellicose rhetoric and fear of an escalation raises the risk premium as well.

Monday's Blues

The US dollar is broadly higher against the major and emerging market currencies to start what promises to be an important week, with several parliaments due to vote on Greek 2.0, the second and possibly final LTRO, and PMI readings. Eurogroup head Juncker’s admission that a third package for Greece cannot be ruled out may also be taking a toll on sentiment. The main exception to the generalization is the Japanese yen, which has seen initial losses reverse amid talk of Japanese exporter offers.

Global equities are mostly lower, though the Shanghai Composite bucked the move to close at new 3-month highs, building on last week’s 3.5% gain, amid expectations of further easing of monetary policies. The MSCI Asia-Pacific Index fell 0.8% and the Dow Jones Stoxx 600 is off about 1% near midday in London, with technology, health care and financials leader the way lower. Telecoms is the only sector ahead today.

Great Graphic: Why Germany, not China is the Solar Powerhouse

Sorry I had to have that pun. Now I've previously discussed (or rather my brilliant young whippersnapper of a webmaster has discussed) the potential of solar energy in the United States and how it can be a great investment. Now let's look at it from an international perspective. Here is a great graphic from Smart Planet on the top ten countries producing solar energy. Despite the current shaky economic climate in Europe over 60% of the solar energy currently produced is done so in Euro Zone countries.

Note on CFTC Commitment of Traders

The foreign exchange market is overwhelmingly a over-the-counter market. Yet the lack of transparency there relative to the considerably smaller but more somewhat more transparent futures market encourages investors and analysts to watch the weekly Commitment of Traders report.  

Positioning, as we have previously discussed is one of two kinds:  commercial, with the underlying business interest, and a non-commercial, which is associated with speculation.  It is the non-commercial positioning that is thought to contain the most important information about positioning, as a large part of the commercial positions are believed to be related to hedges or other business-related issues and not necessarily a view of market direction.  There are non-reportable positions for which are not included here.  

As we look at the latest weekly report, remember the data covers the week through February 21, so the euro's push higher in the second half of the week and the yen's decline is unlikely to be fully captured yet.

G20: Little Room for Fresh Initiatives

Currency in Crisis

The G20 will meet in Mexico this weekend. There seems to be three key issues: IMF funding, replacement for Zoellick who will step down as head of the World Bank and the oil shock. It is unlikely that any of these issues are resolved this G20 meeting, but important groundwork could be laid for future decisions. 

The European debt crisis remains the most important issue. The euro area countries have committed about $200 bln, but want other G20 members to contribute. However, several G20 countries, including reportedly, the US, China and Japan want to see Europe do more to strengthen its own firewalls. In particular, this refers to strengthening the resources of the European Stability Mechanism (ESM).

Dollar Ends Week Like It Began

Currency in Crisis

The week is winding down.  The two main features of the week's activity and today's are euro strength and yen weakness.  

The euro has moved to new highs for the year and has pulled the Swiss franc along for the ride.  There has been some talk that the Swiss National Bank has quietly intervened today, but confirmation is lacking.  The euro's strength comes as investors accept official intent of building firewall around Greece.  Moreover, ECB President Draghi hinted that there will be not more collateral liberalization.  The market has priced in next week's liquidity provision under the LTRO and suspects that could very well be the last one. 

A Few Miscellaneous Thoughts

Currency in Crisis

The G20 meeting this weekend is shaping up to play an important role in addressing the European debt crisis. A senior conservative German member of parliament indicated that the German vote on Greek 2.0 is partly a function of the IMF`s involvement. In earlier euro zone packages the IMF was good for a third of the funds.

In Greek 2.0, the preliminary figures suggested a considerably smaller role. The may be pressure from a greater role for the IMF, but itself may be linked to greater contributions. While Japan and to a lesser extent China appears sympathetic, many other countries, including the US, do not seem prepared. Instead look for some push back on Europe's official sector to do more.

Dollar Weakens, but Doesn't Break

The US dollar is sporting a soft profile, with the euro making marginal news high for the year. The single currency's push higher met offers just shy of $1.3350 level, which is thought to hold a large option barrier. Above there, offers are seen near $1.3375 and then $1.3435.

The main catalyst appears to have been better than expected economic data after yesterday's disappointing PMI data. For Germany it was the IFO report that showed a further recovery, with the expectations component rising to 102. For its part the expectations component rose to 102.3 from 100.9 and the current assessment rising to 117.5 from 116.3.

Yahoo Finance: European Crisis - Next Stop Portugal

Four Developments and Implications

Currency in Crisis

There have been four noteworthy developments today that will shape the investment environment.  

First, HSBC flash PMI for China came in at 49.7 from the final January reading of 48.8.  This will support those who expect a soft landing in China. Technology and consumer services led today's 1% advance in the Shanghai Composite, which  now sits at its highest level since early December 2011.  The soft landing scenario in China helps lift sentiment in the region.

Second, the minutes from the Bank of England meeting was a bit of a dovish surprise.  There were two dissents to the decision to increase gilt purchases by GBP50 bln.  Both Miles and Posen favored a larger purchase program.   Sterling is clearly under-performing today, though gilts are outperforming.  

Yen Moves

While European drama continues to command attention, the yen has quietly depreciated and is now at its lowest level against the US dollar since last July and is at four month lows against the euro.  

There are several factors that appear at work.  Today's push lower corresponds to talk of strong Japanese demand for Thai baht related to insurance payouts from last year's floods.  The yen has declined about 8.5% against the baht since mid-January. 

Great Graphic: Church of Baseball

Now that spring training is offically underway I thought it was time for another great graphic on baseball.

Now we all learned from Bull Durham that there should constitutional amendment outlawing astroturf and the designated hitter (though I am not sure how such an amendment would impact the Blue Jays).

But if the wisdom of Crash Davis isn't enough for you here is another reason why the National League is better: They are more efficient.

Greek Default Risks Remain

Currency in Crisis

European officials moved the proverbial can down the road, but not very far and there are bound to be unintended, though foreseeable consequences, of the new deal.  

The next immediate focus is on the private sector involvement (PSI) and the debt swap.  Essentially, the IIF, representing the banks, accepted a 53.5% haircut on notional value and what appears to be about a 74% haircut on a net present value basis.  It is not clear how much the IIF really represents the private sector.

Greece Deal, but No Closure

Currency in Crisis

A Greek deal has emerged from the marathon meeting of European finance ministers, but it is far from clear that it ends even this chapter of the saga.  Attention will turn to the participation in the PSI.  The agreement struck appears to be more onerous than initially anticipated, with a 53.5% loss of notional value rather than the 50% previously agreed and well above the 22% envisioned initially and lower coupons on the new bonds.  

Part of the deal also includes reduction in the interest rate on the previous international assistance and there is not reason why those lower rates should not apply to Ireland (which is seeking relief on promissory notes used to recapitalize its banks) and Portugal.  Perhaps most importantly, the package does not give confidence that this solves Greece's problems, even if PSI is acceptable and Greece actually does implement the agreements.

Great Graphic: Smart Meters in Europe

Here are two great graphics from Green Tech Media on smart meters in Europe. You can see in the first graphic that Italy is clearly leading the way in terms of implemented smart meter hot spots. This is not surprising when you see the second graphic, which illustrates that Italy has a very strong regulatory push for smart metering.

Markets Like What They See and Hear

The combination of a 50 bp cut in China's required reserve ratios and anticipation that the European finance ministers sign off on the second aid package for Greece has lifted equity markets and most of the non-US dollar currencies.

The MSCI Asia-Pacific Index rose 0.8%. Hong Kong's Hang Seng Index was the lone exception in Asia, slipping 0.3%. Higher than expected inflation (6.1% vs consensus of 5.8%) may have played a role, but losses were widespread, led by oil and gas (-2.2% consumer services (-1.9%) and technology (-1.85). European bourses are higher with the Dow Jones Stoxx 600 up 0.8% near midday in London. Basic materials, industrials and financials are leading the advance.

Implications of Weekend Developments

Currency in Crisis

There are two sets of important developments over the weekend that will influence the global capital markets. The first is in China and the second in Europe.

China

China cut reserve requirements and Foxxconn, the Taiwan-based outsource company with extensive assembly work in China, announced an immediate 16%-25% wage increase. In Europe, Greece’s cabinet took the necessary steps that will likely pave the way for the Eurogroup of European finance ministers to press ahead with a second aid package.

ECB Greek Bond Swap

Currency in Crisis

News that the ECB will swap its Greek bond holdings to avoid being subject to collective action clauses that the Greek government is expected to seek parliamentary approval for early next week has stopped the euro's recovery in its tracks.   The euro reached a high of just below $1.32 before the next broke, extending the rally that began yesterday off the $1.2975 low.  Initial support now is pegged near $1.3100.

The euro is still showing resilience and remains up on the day.  However, the European markets are closing and the US markets are closed on Monday, which could be contributing to the mute market response. 

Great Graphic: Europe GDP Explained

Following up from last week's post on US Metropolitan GDP here is a great graphic on the GDP of European countries, comparing the GDP of each country to various things of equal value from the United States. (To see it better click on the image and zoom)

Rome Returns

Audrey Hepburn in Roman Holiday

There has been a watershed in Europe even if the debt crisis remains unresolved. Since Monti became the technocrat prime minister of Italy an important change taken place. Simply put, Italy has taken significant steps away from the abyss.

Part of the rise of Italy under Monti is a function of how far it had slipped under Berlusconi. Another aspect of Italy's improvement is a function of the Monti's fellow countryman Draghi, who at the helm of the ECB has reversed Trichet's tightening and accelerated the expansion of the ECB's balance sheet with 3-year funding.

(Not Very) Freaky Friday

There are a couple of noteworthy developments today, but the major currencies are confined to fairly narrow ranges in mostly unremarkable price action. 

German Prseident Wulff resigned amid a scandal.  He is the second president to resign in two years.  It is said to be a blow to Merkel, who has been seeing her support grow even after her party lost almost every state contest last year.  The immediate effect is that the Chancellor has to cancel/postpone trip to see Monti.  Nevertheless, the fact that the trip was planned--a bilateral discussion--lends credence to the view of presented here of the high-level emergence of Italy's Monti as a check/balance on Germany as Sarkozy's political future is not certain. 

Great Graphic: Tracking How a World Guzzles Water

Here is another great graphic from Business Idea Research on world water use.

Monday Euro Group Yes, but March 1-2 Summit more Important

Currency in Crisis

The Euro group of European finance ministers will meet on Monday. There are to important decisions for it to make. First is whether to approve the private sector involvement initiative. The second is to decide to recommend the second aid package. However, many key issues will remain and it may not be until the heads of state summit March 1-2 before there is a greater understanding of what is really going to happen.

The euro's recovery in North America today reinforces the sense that the single currency remains range bound. The lower end of the range was frayed by the brief dip below the $1.2980-$1.3000 area. On the upside, $1.3150 may offer initial resistance now, with the $1.3200-50 offering a tougher ceiling.

China and Europe: Where to Look for Support

Currency in Crisis

China President Hu Jintao was very polite in pubic comments as the 14th Sino-EU summit began yesterday. He made pleasant remarks about China's willingness to support Europe. The foreign exchange market initially bought euros on the headlines, but alas the twists and turns of the Greek saga exert the stronger pull. Still, it seems that many observers misunderstand what is happening.

China has about $3.2 trillion in reserves. It is one of the few countries that do not reveal the currency composition for its reserves. Economists assumes that around 25% of the reserves are invested in euro denominated instruments. That means that China holds roughly $800 bln of European bonds. For numerous reasons it seems unlikely that it is about to increase its holdings of peripheral bonds and to the extent it buys core bonds, like German bunds, it aggravates the pressure by widening the intra-European spreads.

Thursday's Musings

Currency in Crisis

The euro has seen its recent losses extended as the news stream from Europe is poor, even though Spanish and French bond auctions were well received.  Concerns about the dragging out of the Greek negotiations undermines the euro which has now fallen about 2.5% since Feb 9 and has traded below $1.30 for the first time since January 25. 

It has retraced about half of the short-covering rally off of the $1.2625 low on January 13th.  A break of the $1.2970 could spark another quick cent decline.   Yet the very short-term technical indicators suggest the likelihood of a bounce in the North American morning that may prove a better selling opportunity.  Resistance is seen near $1.3050. 

CNBC: Greek Drama and the Euro

Letting it Ride on LTRO

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It appeared that the brinkmanship tactics had pushed Greece over the edge on Feb 12 as Athens was set ablaze in protest. Now it appears that the European finance ministers are slipping over the edge. Strong doubts remain, and are being expressed, about whether a second aid package is throwing good money after bad.

Currency in Crisis

Papademos has failed to deliver. As former ECB vice president, he was expected to deliver two things: new austerity and implementation. He has, after much fanfare, agreed to the new austerity demands. The rub, according to the creditor nations, is the commitment.

Europe Still Dominates (the headines)

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The vagaries of Europe's debt crisis continues to be the most important driver of the short-term price action in the foreign exchange market.  Indications that Greek New Democracy leader Samaras would sign a letter of commitment to the aid agreement helped the euro stabilize after the sell-off in response to the postponement of the Eurogroup meeting all the Greek elements weren't in place.   However, it is clear that his rhetoric has been such that the key creditor nations in the euro zone remain skeptical.  



Currency in Crisis

The euro is trading inside yesterday's range.  In broader terms it remains confined to a $1.30-$1.33 trading range.  Market positioning meets anxiety about the debt crisis. 

In terms of the debt crisis, there are numerous moving parts and incongruous--such as the PSI seems to have to be completed before the second aid package can be approved, but it requires funds from the second aid package to complete.  Huh?   The faltering confidence in Greece is occurring at the same time and, perhaps, because, (some) European officials, like Germany's Schaeuble, argue that Europe is less vulnerable to a Greek default.  Others continue to fear  a "Lehman-like" event--a highly disruptive financial shock. 

Economic Valentines

Happy Valentines Day Marc to Market Readers! Here are a few Economics Valentines for you:

Bloomberg Radio: Greece and the Euro

Currency in Crisis

Here is an interview I did yesterday for Bloomberg Radio on Greece and the Euro.

 

Quick Thoughts on US Data

Business inventory data reinforces the note yesterday warning of sharp upward revision to Q4 US GDP.  We already knew that factory inventories (+0.1%) and wholesale inventories (1.0%).  The new info today is retail inventories (+2%). 

Sales rose 0.7% on the month and that laves the inventory/sales ratio as the lowest since in nearly a year (march 2011).  This means that the build up of inventories in Q4 will not need to be shed in Q1.  This should encourage some optimism that the US may maintain some of the upside momentum seen at the end of last year.

European Debt Markets Look Past Moody's, but No Closure in Greece

Currency in Crisis

Moody's cut the ratings of 6 euro zone sovereigns late yesterday and gave negative outlooks to the UK, France an Austria.  The euro itself fell a little more than half a cent before stabilizing in late Asia, but the debt markets have taken it in stride. 

There were several sovereign auctions today and the supply was easily absorbed.  Spain's bill auction saw slightly lower yields.  Italy's bond auction went off without a hitch.  The borrowing costs are the lowest since March 2011.  This follows yesterday's bill auction that produced the lowest yields since last June.   Given the advance in European equities (mostly 0.2%-0.5%) the slightly heavier tone to the core bonds cannot really be attributed to Moody's. 

The BOJ Surrpises, Weakens Yen

Central banks' ability to surprise the market remains even in these trying times.  It was the Bank of Japan's turn today.  It surprised the market in two ways.  First, it expanded its asset purchase plan by JPY10 trillion ($128 bln).  Second, it set an inflation goal of 1%. 

As noted yesterday, the BOJ has come under more pressure locally to do more to arrest deflation in light of the weak performance in Japan and the more assertive action taken by the Federal Reserve and European Central Bank.   It is the first expansion of its asset purchase program since October.

French Elections Potentially More Momentous Then Greek Vote

Currency in Crisis

There is much talk today about a Greek election in the wake of the parliament approval of the latest austerity measures and PSI. There is concern that the election will result in ascension of Samaras, the head of the New Democracy Party, as prime minister.

Samaras has been quite critical of the various austerity measures, even though he supported the government in the most recent vote and enforced party discipline by removing from the party rolls those parliamentary members in his party who failed to support the new austerity.

Ten Observations To Start the Week

Currency in Crisis

1. The approval by the Greek parliament of the latest austerity package now shifts the focus to the Eurogroup meeting of finance ministers on Wednesday for their support. The new austerity proved too much for the Greek government and a cabinet reshuffle is needed. Political pressure will mount to set a date for the elections. The successful Greek vote helped the foreign currencies, but the yen and Swiss franc, recover from the pre-weekend slide.

2. With the ECB focused on liquidity provisions (another 3-year LTRO in two weeks and new collateral rules), and some data suggesting euro zone contraction is not accelerating, a rate cut is unlikely next month. Draghi himself offered a small word clue last week. He previously said there were “substantial downside risks”. Last week he dropped the “substantial” to say that there were “downside risks”.

Schrodinger’s Cat in Athens

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The Austrian physicist Erwin Schrodinger offered a thought experiment to illustrate the incompleteness of the Copenhagen interpretation of quantum mechanics and sub-atomic particles in 1935. In the experiment, Schrodinger’s cat is placed in a box with a device that is triggered by a single particle’s behavior. If activated, the device kills the cat, but quantum theory holds that the particle’s behavior is indeterminate until it is observed, which is when its “probability wave” collapses. The cat then can be considered both alive and dead at the same time until the box is opened and the cat observed.

Currency in Crisis

Does this not capture the essence of Greece?

When the Socialists were swept into power in late 2009, the dire condition of state finances were observed and thereby triggering a debt crisis that remains unresolved at this late date. That said, reports suggest that some European officials knew or should have known the state of Greek finances prior to the election. Perhaps, like Schrodinger’s thought experiment, it matters who is observing the cat.

Reflections on the New Collateral Rules

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It is not just that a Greece deal continues to prove elusive that is challenging the euro.  Market participants are also digesting the implications of the ECB collateral rule changes.  While it appears more likely that the ECB will not cut the main repo rate in March, as previously appeared to be the case, the collateral rule changes mean that the ECB's balance sheet is likely to expand significantly in the period ahead.  

Currency in Crisis

In recent months, there has been a clear shift in focus from interest rates per se to central bank balance sheet considerations.  In this respect, the fact that many observers remain convinced that the Federal Reserve's balance sheet will expand under a third round of asset purchases in a few months is a significant barrier to stronger US dollar sentiment.  The greenback's recovery in latter part of last year is understood by many as more a function of a weaker euro than a stronger dollar in its own right. 

2010 Metropolitan GDP Explained

The GDP of the Denver, CO area was about $157 bln, slightly less than the enterprise value of Google.

The GDP of Tallahasse, FL was only 1% more than the net worth of facebook founder Mark Zuckerberg.

Thursday Promises to be Important

Currency in Crisis

There are three key events on Thursday and each has potential to impact the global capital markets.  

First the Bank of England meets.  It is most likely going to announce plans to extend its gilt purchase program.  It will indicate that is has bought about GBP275 bln worth of gilts and will signal intentions on buying at least another GBP50 bln and perhaps as much as GBP75 bln.  

There is some debate over whether there is a limit to the amount of gilts that the BOE can buy.  As of  the end of last year, there were almost GBP800 bln of conventional gilts outstanding and roughly another GBP200 bln of inflation-linked instruments.  

Great Graphic: Regular Season Performance vs. Post Season Performance in Post Wild Card Baseball

In honor of the offical start of spring training being just around the corner we post this great graphic my brilliant webmaster found shows how adding the wildcard team has changed post season performance. Check it out here.

Has the Euro Broken Out?

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The euro has risen to about $1.3270 today, the highest level since December 12th.  Some observers are attributing the euro strength to creeping optimism that a Greek deal is nearly at hand.  Color me skeptical.  

Currency in Crisis

Fed Chairman Bernanke's comments, the first since the employment report, remains decidedly dovish and this seems to be a better explanation of the dollar's weakness.  He argued that the 8.3% unemployment rate understates the weakness in the labor market.

Tuesday Surprises

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The US dollar remains confined to recent trading ranges against the major currencies as the European session gets under way.  The Asian session already had two surprises for the market.  The first, that the Reserve Bank of Australia defied expectations and left rates on hold was a genuine surprise and produced a market reaction.  The Australian dollar was bid through the the $1.08 level for the first time since early last August.

An Update on Italy and Spain

On January 5th I wrote on building a case for the relative out performance of Italian bonds (Why Spain may be more Worrisome than Italy). This was a contrarian view as many feared that the combination of Italy's own poor debt dynamics and the contagion from the periphery were putting the third largest country in the euro zone at risk. Various commentary and analysis played up the under-performance of Italy compared with Spain in the bond market, rising cost of insurance (in the CDS market) and the threat of more action by the rating agencies.

Since January 5th note through today, the Italian 10-year yield has fallen 147 bp to 5.62%. The Spanish equivalent yield has fallen 66 bp to about 4.98%. Similarly, Italy's 2-year yield has fallen 192 bp to 2.95%, while Spain's 2-year yield has fallen 107 bp to 2.58%.

The markets have rewarded Italy for two reasons:

The Problem with Success

Failures are humbling and costly, but ultimately it is success that is more challenging.

The strains which broke the back of the economic and financial system emanated from its successes. Years of economic growth produced surpluses in Asia after the 1997-1998 financial crisis, and emerging markets more generally, that could not absorbed. These surpluses were exported.

The financial deregulation can be traced to the late 1970s and accelerated in 1980s and 1990s. This widened the financial pipes, broadening capacity and multiplying the number of financial instruments, while weakening the walls of those very pipes.

Six Observations about the FX Market

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1. Of the three central banks that meet next week, Australia, UK and euro zone, the first two are expected to ease monetary policy (rate cut and new asset purchases respectively) but those two currencies have easily outperformed the euro over the past week, suggesting monetary policy expectations is not the only driver, or even a significant driver.

2. The market had appeared to be gearing up for a test on the resolve of the BOJ and SNB to cap their respective currencies, but now appears to be backing off.

Monster Jobs Report Pits QE3 Risks Ease Against Stronger Economy

The US jobs data blew away market expectations with the private sector posting 257k job gain, more than 50% more than the consensus expected. Manufacturing added 50k jobs, more than 4x more than expected. The unemployment rate fell to 8.3% from 8.5%. Hourly earnings rose 0.2% and the work week remains at 34.5, where the Dec figure was upwardly revised to from 34.4.

The significance of the data is two-fold.

Friday's Thoughts and Seven Investment Themes

The US dollar is softer ahead of the employment report, but largely within yesterday's ranges, which themselves where inside Wednesday's ranges for the most part. Prior to the jobs report, the euro is the weakest G10 currency, off about 0.4%. The strongest has been the New Zealand dollar, up 0.7% and the British pound up 0.65%, followed by the yen which is up 0.55%.

Great Graphic: Energy Use in New York

Check out this great graphic my webmaster found from Columbia University

Great Graphic: 2011 Ninth-Warmest Year on Record

The current heatwave in New York is more proof of global warming climate change. Check out this Great Graphic on Global Warming from NASA.

In this animation of temperature data from 1880-2011, reds indicate temperatures higher than the average during a baseline period of 1951-1980, while blues indicate lower temperatures than the baseline average.

Having trouble viewing? No fear. Click here.

Swiss Miss: 2011 Trade Surplus Jumps, Market Careful of SNB

Switzerland reported a CHF2.07 bln trade surplus in December. Although this was somewhat less than expected, the trade surplus for the year was about CHF24 bln which is almost 20% larger than 2010. Of note, half the export growth appears to be accounted for by German demand. Also luxury watch exports to Asia were up strongly.

The strength of the franc did not hurt exports, but the domestic economy is in poor shape as yesterday's PMI illustrated. It fell to 47.3 from a downwardly revised 49.1 (was initially 50.7). In addition, deflationary forces appear to be strengthening.

Changing Rules of Engagement

(For more on this topic check out this piece I wrote about what Europe can learn from the Mets)

Europe has set some difficult targets for itself in terms of fiscal targets, all the more challenging given the recessionary conditions, and bank capital requirements. There is increasing pressure on officials to relax the targets. Investors need to be aware of the changing rules of engagement.



Currency in Crisis

The Bank of Italy, for example, issued new regulations in recent days regarding bank buyback rules of hybrid securities. The apparent technical adjustment is worth about 25 bp of Tier 1 capital, according to some industry estimates.