The Danish Dilemma: What the Euro Crisis has Wrought

Denmark, like Switzerland, offers negative interest rates.  This is not just bills either, but in Denmark's case, rates are negative through the 2-year tenor.  Swiss rates are negative through the 4-5 year sector.  The Danish situation is similar to Switzerland's.  

As money seeks refuge from the uncertainty in the euro zone, especially with the newly discovered redenomination risk, Denmark has experienced a surge of capital inflows.  The central bank says offshore holdings of Danish bonds has risen 2.6% in the past month to DKK242 bln (~$41 bln), which is about a third of Denmark's debt.  

Concrete Example of Potential Compromise in EMU

I have characterized my understanding of the euro zone investment climate as three no's:  No ECB backstop for sovereigns.  No joint bond.  No euro zone break-up.  That implies a prolonged period of slow growth.  It risks chronic political instability.

It also follows from this that I don't expect Greece to leave or be ejected from monetary union.  I think the market exaggerates those risks, perhaps at the encouragement of German officials who have tried to turn the election into a referendum on EMU.  Ironically, some of them were the same ones critical previously when Greek prime minister tried doing something similar and then, well, changed his mind.

Redenomination Risk: Is the Genie Out of the Bottle?

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We have argued that the German effort to make the Greek election into a referendum on the euro was misguided. Greece made its decision to join more than a decade ago. Opinion polls indicate that this is still the case: Greek people, by an overwhelming majority, want to stay in EMU.

Currency in Crisis

The memorandum of understanding has been renegotiated already and we are convinced that even if the ND and PASOK is able to put together the next government, the infamous memo will be renegotiated again given the drop in tax revenues and tourist receipts.

The SNB is Preventing Needed Adjustment

The Swiss National Bank does not miss an opportunity to remind market participants that it is determined to cap the Swiss franc's appreciation. The cost of imposing its will appears to be rising. The Financial Times today reports estimates of the magnitude of its intervention range from CHF20 bln to CHF100 bln in recent weeks. Such a wide range illustrates the lack of transparency of the central bank's operations and the willingness of some participants to simply guess.

Swiss sight deposits have risen about CHF18 bln in the past two weeks and this would lend credence to the lower end the range of estimates. Some observers may also be confusing private sector activity for official intervention.

There is an important question though that the discussion about how much the cap on the franc is costing the SNB does not address. Simply put, why should a country such as Switzerland, with a net international investment surplus position and a trade and current account surplus, act to avoid currency appreciation?

Month-End Adjustment Gives Brief Reprieve

The US dollar is mostly softer against major and emerging market currencies today.  Many observers will talk about the string of better than expected data from Europe and the polls that suggest the ND are ahead in Greece and that the Irish will easily support the fiscal pact in today's referendum.  Yet the risk is that the firmer tone in the foreign currencies, equities and commodities is but a brief reprieve from the persistent selling pressure seen recently, more related to technical factors and month end than a reversal.  

Tomorrow's PMI readings from the euro zone will offer a more current reading of the economies and the new orders component are more forward looking and this will remind participants that the euro zone economy is appears to be contracting this quarter.   Moreover, the debt crisis still seems to be overwhelming European officials. 

In fact, the bounce in the major foreign currencies in Europe is also leading to over-stretched intraday momentum indicators warning that the bulk of the bounce is likely behind us and North American players may very well see the bounce as a new selling opportunity.  The $1.2440 area in the euro and the $1.5550 area in sterling may provide the near-term cap, while the $0.9780-$0.9800 area may limit the Aussie's gains, especially ahead of the Chinese PMI early Friday in Asia.  

Great Graphic: The Billion Dollar Question

Here is a great graphic from the Institute for International and European Affairs on the potential cost of an Irish Bailout.

Creditors and Bureaucrats Push Back

Currency in Crisis

The financial crisis has called into question political and economic orthodoxies. In Europe, EU officials and the ECB President have encouraged new bold thinking. Anything seems possible. Moreover, the push-back against austerity, which began prior to the French elections, perhaps when Draghi endorsed calls for a growth pact, also has re-open the debate about more support for the debtors in Europe, including joint bonds, EU wide deposit guarantees and maybe even direct bank access to ESM funds.

In today's Financial Times, Martin Wolf is critical of Germany's refusals...its blanket "nein". The judgment may be premature. The creditor nation, led by Germany, are preparing a response.

Flash: EU Head Fake?

 EU says it will consider allowing banks borrow directly from the ESM.  This is a head fake.  The ESM does not exist yet.  It is not ultimately the EU's decision.  The ECB and Germany will also have a say.  The reason that banks are unable to borrow directly from the ESM is that it lets the sovereign off the hook.  Borrowing from those facilities requires conditionality--austerity and/or structural reforms.  It may even require a treaty change even though not all countries have approved it yet.

There has been a quick bounce in the euro and other major currencies, but if my analysis is correct these gains will be short-lived.  Initial resistance in the euro is seen near $1.2480.  Sterling meets its hurdle near $1.5620.  The Australian dollar, which is also getting punished after disappointing with a 0.2% fall in retail sales may meet resistance near $0.9800.

One Driver: European Crisis

There is one main driver in the capital markets today and that is the heightened anxiety coming from the European debt crisis.  It is not that a significant new development took place, but rather investors appear to be struck by the paralysis of policy makers.  The Greek and French elections are still a couple weeks away, Spain seems nearly rudderless as its banks and regional woes give it little breathing room with the depressed economy and demand for dramatic austerity.  Meanwhile, the second significant Italian earthquake in a month and poor environment made for a dismal auction today, as the Italian government seems likely to seek some adjustment in its fiscal target, which it already says it can't meet.  

The US dollar is broadly higher and the yen is gaining on the dollar, though thus far the rumored JPY79 barrier remains intact.  The euro slumped to about $1.2420.  Look for new selling to emerge on a bounce toward $1.25 now as previous support turns into resistance.  After finishing the New York session yesterday at $1.5640 closing support, it has been sold off sharply, even though the UK reported relatively constructive mortgage lending data and M4 money supply figures.  The next immediate target is near$1.55.  

Risks of ECB Rate Cut Next Week: Underestimated

The ECB meets next week. We suspect the market is underestimating the risk that the ECB responds to the string of poor economic data. Recall that after contracting in Q4 11 the euro area economy stagnated in Q1 12. It was Germany's 0.5% expansion in Q1 that allowed the area to avoid a second consecutive quarterly contraction. 

The recent data warns that the German economy has lost some of its sizzle. The economic downturn in other parts of Europe seem to be deepening and this will likely be reflected in the PMI readings later this week.

CNBC Interview with Sue Herera: Euro Outlook

Euro and Yen and the S&P 500: Correlations Revisited

We continue to track the correlation of foreign currencies and the US S&P 500. There are two noteworthy developments we bring to your attention today. Methodologically we look at percentage change of the foreign currency and the percentage change in the S&P 500. The result is the correlation of returns, which is what is important to investors.

Over the past 60 day's the correlation of the euro to the S&P 500 has fallen to its lowest level in a year at just above 0.41 today. Recall that the correlation reached a record high late last year a little above 0.85. The 30-day correlation is still lower at 0.34, which indicates the relationship is even weaker more recently.

Spain: Serving Too Many Masters

In recent weeks, we have been highlighting the twin challenges Spain faces: the banks and the regions. Separately either could force Madrid into the arms of the Troika. However, Prime Minister Rajoy appears to have staked his political credibility on not seeking international assistance. This hubris will prove his nemesis, and this is an area in which postponement will likely produce a larger bill, when the piper calls and rest assured the piper will call. 

Spain, recall, is the world's 12th largest economy. This means that the magnitude of its problems are going to be substantially larger than Greek, Irish and Portuguese challenges. If the Spanish economy was going, the bank and regional problems would be severe, but the fact of the matter is that the Spanish economy is contracting. Moreover the pace of contraction may be accelerating. The 9.8% year-over-year contraction in April retail sales, reported earlier today, is a record pace and on a price adjusted basis, is even worse (-11.3%). The PMIs due out in the coming days may underscore the deepening Spanish recession.

Greece and Spain Compete for Limelight

Spain is giving Greece a run for its money in terms of who can generate the most stress.  Recent polls suggest that the New Democracy and PASOK can lead the next government in Greece  Greek bonds are slightly firmer on the day.  Spain's support for Bankia raises more questions than it solves and Spanish bonds continue to trade heavily and Spanish stocks are down almost 2% with financials down even more near midday in London.  

Spain appears to be proposing that the government injects 19 bln euros into Bankia via a bond issuance.  Bankia can then take those bonds to the ECB for cash.  While the ELA facility has received much attention recently as a less obvious way banks are receiving assistance (especially in Greece as the bank recapitalization process continues), Spain's proposal is arguably more significant.  Spain's government would determine the extent of the money creation, while ELA requires in most cases ECB approval.  

Greece: The Unvarnished Truth

A series of weekend polls in Greece showed some movement in the electorate and put the New Democracy ahead of Syrzia.  This is important because which ever party comes in first gets an extra 50 seats in the 300-seat chamber.  The polls suggest the New Democracy and PASOK could retain the reins of government.  

Yet a false dilemma has been presented.   It is most assuredly not Schaeuble's way or the highway.  It is not a choice of austerity or leaving monetary union.  It is not adherence to the memorandum of understanding or being isolated in Europe.

Memorial Day Update

The US dollar is broadly lower in relatively subdued activity. The major development over the weekend that has encouraged some reduction of risk averseness is several polls in Greece that showed the New Democracy pulling ahead of Syriza. Global equity markets are mostly higher, with the MSCI Asia Pacific Index gaining about 0.75% and the most European bourses are up the same or more.

Spain’s IBEX is the exception to the generalization. Modest losses are being recorded, with the financials the largest drag, following news before the weekend that Bankia needs not 4.5 bln euros, 9 bln euro, or even 15 bln euros that had been hinted at, but rather 19 bln euros.

Speculative Positioning and Technical FX Outlook

The intensification of the European debt crisis continues to overwhelm all other considerations in the global capital markets. The corrective bounce we anticipated on May 17 largely fell shy of the technical objectives as the European officials appeared to continue to drift toward a Greek exit. In addition, the flash PMI readings from the euro zone and the German IFO warned that the regional economy cannot count on German locomotive here in the second quarter.

Regardless of the particular policy response by officials, stronger growth in the core (fueled by domestic demand) and a weaker euro would provide a more conducive environment for addressing the crisis. Although the wishes of officials do not drive currency prices, weakness of the euro should be understood as both the symptom of the crisis and also an attempt to cure, like a fever in person.

Note on Spain: Regions and Banks Compete for Attention

NOTE:   after this post, S&P announced it was cutting the ratings of 5 Spanish banks--and affirmed the ratings on nine others, keeping a negative outlook on five.  A couple ( Banco Popular and Bankia) are below investment grade.  

News that Spain's Catalonia region is seeking support from Madrid provided the headline trigger to the euro's slide and risk-off in North America after a quiet European morning. The euro slipped through the $1.25 level, triggering some stops and optionality only to bounce quickly back, which seems to be frequently the case after barriers are triggered.

The news is a useful reminder of one of our larger points. The flash points in Europe are extend well beyond Greece, which has captured everyone's imagination. Spain problems may be partly exacerbated by the tensions over Greece, but rest assured they are primarily home grown.  It also follows that ejecting Greece will not solve Europe's troubles and arguably exacerbate them. 

Seeking Redemption in Europe

Currency in Crisis

Last November, the Germany's economic advisor council, known as the Wisemen, recommended a redemption fund in the euro zone as an alternative to joint bond proposals and as a strategy to put the region's debt on a sustainable path. At the time, proposal seemed to die an ignoble death, but it has been resurrected this week. Reports suggest that just yesterday Merkel conceded she would re-examine the proposal.

The redemption fund proposal has a few components. Countries would segment their debt. That which is over 60% of the countries' GDP would be placed in the fund. It would be mutualized (jointly and severely guaranteed) in exchange for very aggressive commitments to retire that debt in 20-25 years and would only be open to countries not yet receiving funds from the EFSF/ESM.

Calmer Tone Ahead of the Weekend

A nervous and fragile calm has settled over the global capital markets.   The dollar has been thus far confined to yesterday's ranges against sterling and the euro, and attempts to push the dollar higher faltered against the yen and Swiss franc, leaving the greenback is narrowly mixed on the day.  European equities are mostly slightly firmer, though of note the financials are outperforming the broader market.  Most bond markets are firmer as well.  

 

As German rate have collapsed--illustrated by the 2-year offering this week with a zero coupon that was oversubscribed--there has been increased talk of fund managers moving into Belgium, France and Austria markets to secure somewhat better yields.  Ironically the divergence in the periphery is produced a type of convergence in the "core",  The French premium over Germany in 10-year yields has come in from about 146 bp on May 17 to 101 bp earlier today.  While hardly his doing, Hollande must be quite pleased with this market development.  

The fundamental news stream from Europe remains poor, but the technical tone and extreme market positioning suggests a more cautious stance.  The break to new lows yesterday in the euro failed to be confirmed by the relative strength index.  This divergence suggests short-term participants will have a better opportunity to sell the euro.  The same is true of the Swiss franc, where the dollar pushed through the CHF0.9600 level for the first time in a year briefly earlier in the session.  Against the yen, the dollar faltered at the 20-day moving average (~JPY79.80).  It has not closed above this average since March 30. 

Great Graphic: Greece and Euro Zone Macros

Here is a Great Graphic from Thomson Reuters depicting the Greek economy in comparison with the overall euro zone.  The fact that Greece so under-performed Europe since on set of the crisis is well known and appreciated.  However, it is noteworthy that Greece was generally under-performing even prior to the crisis.   The crisis has exacerbated the divergence. 

 In addition, it seems that the difference between Greece and the euro zone is a question of degree not kind.  Admittedly, a sufficiently quantitative difference can have a qualitative difference. 

The differences between Greece and the euro area tend to get most of the attention.  Investors may also find it helpful to consider what the two have in common.  The common element of Greece and many other countries in the euro area is the lack of international competitiveness.   The debt seems to be "simply" be an expression of that fact. 

It seems somewhat politically naive to think that Greece can be removed like a tumor and the rest of the body politic will be saved.  It is not the case that the Greek problem metastasized and that is what ails the rest.  Portugal, Ireland, Spain, Italy and France have their own home grown imbalances.   Unfortunately, if Greece was not serving as the lightening rod, some else would. 

Yen Drivers and CPI

Japan reports April CPI on Friday. The national headline rate is expected to be 0.4-0.5% after the 0.5% reading in March. This was the highest since November 2008. The BOJ's target is 1%. No one really expects the target will be achieved in this year or next. The fall in commodity prices and the rise of the yen (nearly 8% on a trade weighted basis since mid-March) warns that deflationary pressures may be rekindled.

Tokyo reports May inflation figures and the headline rate was last positive (0.1%) on a year-year-basis in July 2011 and before that November 2010 (0.2%). Price in Tokyo are expected to have fallen by 0.3%, the same pace as in April.

Dollar Stabilizes, Europe News Stream Poor

The US dollar is little changed is little changed against most of the major foreign currencies, European equities have higher, gold and oil prices are firmer.  It is as if investors are taking a breath after recent aggressive activity.   The dollar initially extended its gains before the momentum faded in the European morning. 

It was not the news stream, which was poor to say the least.  The flash European PMI and German IFO warns that even the German economy may be fizzling.  UK Q1 GDP was revised down.  Yet by the news hit the euro selling appears to exhaust itself in near $1.2520.  The $1.2600 area remains the proximate ceiling and needs to be overtaken to stabilize the technical tone. 

EU Summit Dinner Ends: No Dessert

The euro came off in a knee-jerk fashion following the conclusion of the EU Summit dinner.  The press statements indicate that nothing concrete came of it, but it did raise the stakes for the end of June formal summit. Since midday in the US on Wednesday, the euro has been in a clear $1.2550-$1.2600 range.  The euro went from the top end of the range to the bottom after the European officials spoke and then quickly rebounded again.   A move above $1.2600 gives $1.2650, but the $1.2700 area is the important hurdle which needs to be surmounted to begin stabilizing the technical tone.  

There does seem to be a consensus emerging for a larger more active European Investment Bank and project bonds.  Details have to be worked out.  There also is a consensus for making it easier for countries to access cohesion funds.   The ECB clearly came under stronger pressure to do more to support European bonds, but it was quickly added that the central bank's independence was respected.   This is the eleventh consecutive week that that ECB does not appear to have bought sovereign bonds (but who's counting?).

EU Summit Dinner Menu: Indigestion

The EU informal summit will be held over a dinner and despite the attention it is receiving, it still seems unreasonable to expect anything concrete. Negotiating positions will be staked out, but most of the issues will require greater negotiations. June or even July seems a more likely time frame for yet another "comprehensive solution." 

A so-called Latin-bloc of France, Italy and Spain cannot force Germany to accept joint bonds. Germany has the treaty on its side. The current treaties bar joint bonds. The agreement that establishes the ESM also seems to rule of direct lending to banks. 

Dollar Snaps Back

The US dollar is broadly higher in Asia and Europe.  Comments by Greece's Papademos put the cat among the pigeons and the euro, and the foreign currencies more broadly, have been unable to recover.  We had anticipation a correction and although we got it, we had expected it to continue a bit longer and deeper.  The speed of the reversal is leaving many, including ourselves a bit off balance.  That said, the short-term momentum readings are stretched and it appears to require new negative news to keep the upward momentum intact. 

Few probably are as surprised as Papademos by the impact of his comments.  Essentially he seemed to say that a Greek exit is possible but disastrous, and acknowledged some preparation.  The alternative is years of austerity, he said.  The only exception we would take with that assessment is that austerity of some magnitude will be necessary even if Greece leaves the EMU and repudiates all of its debts, including to the official sector.   That is the point.  

ELA Does not Stand for Exaggeration, Lies and Assumptions

ELA is the acronym for Emergency Lending Assistance. This is direct lending by the national central bank, with ECB authorization to local banks with more liberal collateral requirements. The national central bank is responsible/liable for the funds not the euro system.

Last week when the ECB announced that four Greek banks were no longer able to borrow from the ECB, this forced them to borrow from the Greek national central bank's ELA facility. This in turn created confusion and all sorts of imaginary thinking.

Feint and Parry and the Three No's

In the diplomatic dance in Europe, investors are rightfully confused what is a feint and negotiating tactic and what is parry or strategic principle. A new French president and changing tone in Europe appears to have re-opened debates that had previously seemed closed. The range of possibilities all of the sudden seems large again--joint bonds, recapitalization of banks from the ESM, more aggressive ECB support for the sovereign bond markets. 

Yet there is more and less here than meets the eye. In order for Hollande to maximize his negotiating position, he must press ahead with elements he knows full well that Germany cannot accept. By pressing ahead he can win concessions in other areas. 

Correction within the Correction

The US dollar is broadly higher today.  The key question for market participants is whether this is the beginning of the resumption of the greenback's bull move or is it a simply part of the market churn.   Given market positioning and the fact that the Greek election is still a month away, we are viewing today's price action is as correction within the correction. As long as euro holds above $1.27  (equates to dollar resistance near CHF0.9450) this more benign view of the price action should be preferred.  

Last Friday and yesterday, the dollar weakened in the North American session.  Today has the makings for a three-peat.   The intraday technical show the dollar's bounce in Asia and Europe has left it over-extended and while additional modest gains are possible, the bulk have likely been scored.  

Shifting Agenda and Ideological Rigidities

Over the weekend, Germany's I.G. Metall reached an agreement with employers in Baden-Wuerttemberg for a wage increase that will likely set the tone for other regions and industries. The 4.3% pay increase covers the year from May 1. However, the previous contract expired at the end of March, so the new deal really covers 13 months, which puts the annual pay increase at just below 4%. Initially I.G. Metall demanded a 6.5% pay increase.

German officials, including Fin Min Schaeuble called for stronger pay increases. The I.G. Metall deal follows the Ver.di (the largest non-manufacturing union) deal that got state workers a 6.3% pay increase over two year.

FX Outlook

The week begins off with a consolidative tone.  It was the alignment of technical and fundamental factors following the election results earlier this month that allowed for the strong trend moves in the foreign exchange market.  Arguably the most important consideration is that the divergence between the two has emerged.  While a resolution of the European crisis is not imminent, the combination of extended positioning, the price action before the weekend, and official attempts to talk the market away from the edge of the abyss, warns the short-term momentum and trend following participants may be further squeezed, creating a new opportunity to medium term investors.    

Since the middle of last week,  we have warned of heightened risk of a technical correction.   We see the euro having scope toward $1.2850-$1.2900.  This gives sterling space toward $1.5880-$1.5930.  Provided the JPY79 are holds, the dollar can recover toward JPY80.00-JPY80.50.  The initial pullback against the Canadian dollar can see CAD1.01, while the Australian dollar already tested initial resistance near $0.9880.   

FX: Speculative Positioning and Technical Outlook

The heightened risks to the European monetary union following the election results in both Greece and France earlier this month continued to drive the foreign exchange market. In the week through May 15, speculative participants in the currency futures generally either added to shorts or cut longs.

Although the fundamental drivers have not changed, the technical condition of the market has. We began warning of the risk of an upside correction for  the major currencies in the middle of the week. On May 18, the euro and the Swiss franc posted what is technically a potential key reversal. Both currencies traded below the previous day’s low (and when doing so, made new lows for the move) and then rallied above the previous day’s high and managed to close above those highs.

Spain: Double Barrel Disappontment

The fact that Spanish bank shares have rallied today (3.1% at pixel time) and have easily outperformed the market (IBEX up 0.3%) following Moody's downgrade of 16 Spanish banks should be understood as a bit of a fluke.   Some observers will use this price action as evidence that rating agencies are laggards.  While there can be little doubt that the epithet is true, it is also true that today's correction comes despite some other bad news as well.  This was in the form of the Bank of Spain's latest assessment that bad loans in the banking system rose in March to 8.37%.  

That means that another 8.2 bln euros in loans soured in Q1.  In turn this means that the 30 bln euro that Spanish banks are being required to add to their loan loss reserves will not be sufficient to cover this year's deterioration if it does not slow down.  And there is no reason to expect it to slow as the recession deepens and real estate and house prices do not appear to have bottomed.  

Half Dozen Observations as Week Winds Down

This has been an important week in terms of price action throughout the capital market.  The down draft in the equity markets, most foreign currencies, most commodities, is both a cause and effect of rattled investors.    

Often it seems that market sentiment tends to overshoot in one direction and then the other. Sentiment is clearly in one direction.  It remains to be seen if it is overshooting.    There are six observations that we'd like to share as you think about not only this week but next week.

Them Are Fightin' Words

Currency in Crisis

The debate about Greece's future in the monetary union is mis-framed and this leads to faulty analysis by investors and policy makers.     Even if European integration is incomplete, and there is no fiscal union, members of the monetary union should be thought of as if states in the United States in many important ways.  Joining EMU should be just as irrevocable as joining the USA.  

If New Jersey's inflation runs above New York's, we don't say that the New Jersey dollar is over-valued against the New York dollar.    We do not say that New Jersey should devalue.  When a US state has financial difficulties, such as when several states defaulted in the 19th century, or when the largest state in the union issued its own IOUs more recently, there was no effort to evict them from the union.

Late Dollar Longs Vulnerable

Perhaps it is the California air, where I am on a business trip, but it seems that the euro bears have run their course for the time being and a corrective phase may be unfolding.   The late buyers of dollars against most of the major and emerging market currencies look vulnerable.

Just like I brought to your attention the importance of the gaps in the euro and Swiss franc created by the sharply lower opening on May 7, I warn that the price action following the news about the ECB cutting of credit to a few Greek banks was important and revealing.  

US Economy Update: Still No QE3

The recent string of US economic data does not change our view that renewed asset purchases by the Federal Reserve as early as next month as some have suggested  remains unlikely.  The data does warn that Q1 GDP is likely to be revised lower, toward almost half of the Q4 '11 3.0% pace.

The data suggests the economy is likely back in the middle of the 2-3% range that the economy has averaged since the recovery began and is consistent with the Fed's base line forecasts.  

Great Graphic: Future of the Workforce

My brilliant webmaster found this great graphic on the demographics of the workforce of the future. I thought it would be interesting following April's disappointing jobs report.

Fear Overwhelms Everythng, Drives Dollar Higher

There driver of the capital markets today has a name:  Fear.  It has overwhelmed nearly every other consideration and is driving the dollar higher against all the major and emerging market currencies.  

Even the Japanese yen is not match today.  Despite narrow interest rate differentials and heightened anxiety, the dollar is trading at its best level against the yen since May 3.  In fact, although the euro is at the epicenter, and made new lows for the move as it approaches the year's low set in January near $1.2625, it is gaining modestly today against both sterling and the yen.

Greece, Versailles, and the Future of EMU

Currency in Crisis

No last minute miracle has the Greeks headed to new elections next month. Syriza's Tsipras appears to believe he has much to gain from a new round of elections. Polls put Syriza in first place, though the margin of error makes it look more like a dead heat with the New Democracy, led by Samaras. Samaras was a significant obstacle to reaching agreements earlier but now has been outflanked by Tsipras. Tsipras apparently did not drink a sufficient amount of the kool-aid that made Samaras more of a realist.

Many observers are confusing the Greek opposition to austerity regime with a desire to leave monetary union. Judging from the electoral results, a majority of Greeks are critical of the EU/IMF/ECB demands in exchange for assistance. However, polls show that 80% or more Greeks want to keep the euro.

Bloomberg Surveillance: Greece

Here is an interview I did a few days ago for Bloomberg Surveillance.

Great Graphic: GDP Performance

Here is a Great Graphic of how many of the major European economies and the US have performed over the past four years.  The US has pursued unconventional monetary and fiscal policy.  The UK has pursued unorthodox monetary policy and orthodox fiscal policy.  Europe has pursued a bit of an unorthodox monetary policy (3-year LTROs, limited SMP and covered bond purchases) and orthodox fiscal policy.  It is not that growth will solve the structural problems the US undeniably faces, but it will make it easier. 

Muted Turn Around Tuesday

A more stable tone it evident in the global capital markets today.   Risk aversity is being pared, it appears, across the board.   Asian equities followed suit after the US indices fell on Monday, but European equities are firmer, with the French market leading the way.  

Bond markets are mostly lower.  Commodities steadier after both oil and gold made new lows for the year yesterday.  The US dollar itself is mostly softer, but is firmer against sterling, and to a lesser extent against the Japanese yen. 

There may be two factors that have contributed to the calmer markets today.   

Germany: Does a Leopard Change its Spots?

There has been much buzz in the markets that Germany is on the verge of its most important shift since the crisis began. Two official comments have captured some imaginations. The first is that Jens Ulbrich, the head of the Bundesbank's economics department, told parliament's finance committee that going forward, Germany may have inflation rates "somewhat above the average within the euro area". The second is that Finance Minister Schaeuble, who is most likely to replace Juncker as the head of the Eurogroup of euro zone finance ministers, backed wages demands to help reduce imbalances.

This is not far from the IMF's advice. It not only has called on the ECB to cut rates, but last week, it also recommended that Germany accept some wage and asset price inflation as part of the process to re-balance growth.

Nevertheless there are good reasons to be suspicious of the arguments that Germany is casting aside its traditional strategy. One need not make gratuitous references Germany's experience in the 1920s and 1930s. One need only to return to the post WWII situation, the high inflation, the lack of monetary credibility (American cigarettes as a means of exchange?) and the ideological response (ordoliberalism).

Dollar Least Ugly

The US dollar is broadly higher against the major and emerging market currencies to start the week. Of note, the euro broke $1.30 last week and is breaking $1.29 today.  Sterling is near its lowest level in a month and barely held above the $1.6050 area.  The Australian dollar has busted through parity for the first time since late December '11.  Global equities are broadly lower, core bonds higher, and peripheral European bonds under pressure. Oil and gold prices are at the lows for year.

There are three main impulses shaping the investment climate, each emanating from one of the three largest economic areas. The economic data from the US due out this week should show that the economic moderation is modest. China responded to the recent signs that its economy continues to slow and has yet to “land” by cutting required reserves, maintaining the pace of a 50 bp cut every other month.  Events in Europe, however, continue to dominate the macro-environment.  What makes the week ahead important is that there are a multiple of potential flash points. They are not limited to the periphery, but events in Greece continue be unsettling.

China Cuts Required Reserves

The People's Bank of China reduced the amount of money banks must hold by about CNY350-CNY400 bln (~$60 bln).  It is a 50 bp reduction in the required reserve ratio (RRR), effective May 18.  It is the third cut in six months.  The precise timing is always impossible to predict, but it was widely expected. 

In fact, two consideration was behind our warning that it was coming soon.  First, China reported soft economic data 24-hours before the RRR cut was announced.  The disappointing economic data included weaker than expected industrial production (slowed rather than increased) and fixed asset investment, which is an important engine of China's growth, which continued to slow and now is growing at its slowest pace in nearly a decade. 

Commitment of Traders and Technical Outlook FX

In the week ending May 8, speculative players generally bought dollars against the major currencies in the futures market according to the latest Commitment of Traders report.  There were two notable exceptions, the yen and sterling.  Short yen positions were reduced and long sterling positions were added.  

Last week, we noted that after a period of divergence, our reading of both technical and fundamental factors aligned in the US dollar's favor.  That continues to be the case.   The gaps left on the euro and Swiss franc's daily and weekly bar charts are important.  One need not be a technician to appreciate that 1) that gaps in the major currencies are rare and 2) they reflect an important shift in market psychology.  Prices in the most liquid currency pair in the $4 trillion a day market adjust incrementally.  A gap is a break of that incremental adjustment.  It is a mark down.  

The news stream and marginal new information that will hit the market in the week ahead are likely to underscore the weakness of Europe, outside of Germany.  It will offer stark contrast to the anticipated evidence that the US economy continues to expand at a modest clip and the Japanese economy, which likely expanded at the fastest rate in the G7 in the Jan-Mar period after contracting 4 of the past five quarters.  

Great Graphic: International Home Ownership

Here is a Great Graphic from Bank of America  on the extent of home ownership in a number of countries.  The chart is from last year, so it likely picks up 2010 data. 

I know I was surprised, and you might be also, to learn that Singapore and China had wider home ownership than the US.  That Ireland and UK did may not be so surprising as home ownership in Anglo-American economies tends to be high.

As is often the case, the one must question the data and charts do not speak for themselves.  That some 80% of Chinese own homes seems like a stretch.  The US figure is also quite high and subsequent data has shown it to be back to the 65.4% in Q1 2012, the lowest since 1997. 

At its peak, US home ownership was just shy of 70% in 2004, according to the census bureau.  Economists often refer to the cyclical expansion being kept in check by structural forces.  The structural forces they refer to is de-leveraging.  There is another structural force at work: demographics.  Employment and housing seem to be impacted by this structural force. 

Some (Belated) Thoughts about Canada's Jobs Data

Canada reported April jobs data earlier today.    Canada grew 58.2k jobs after 82.3k in March.  Unlike what we have seen in the US, the participation rate actually rose as 72.5k people joined the workforce. 

The actual jobs growth was 6-fold greater than expected and the March-April period was the strongest in 30 years.  Yet, perhaps there is less here than meets the eye, The employment data is so volatile that taking a slightly longer view suggests Canada's employment data is not really much better than we have in the US proportionately. 

Spain's Pain Endures, Bank Reform 4.0

This is not a good day for Spain. The day began with the EU Commission revising its estimates for the Spanish economy. The contraction is now expected to be considerably deeper. Rather than contract 1% as the EU previously projected, now it is expected to shrink by 1.8%. The deficit this year, which was originally supposed to be 4.4% and PM Rajoy said would be 5.8%, before accepting a 5.3% target, is now likely to be 6.4%, according to the EU. The government is denial and even today is claiming the 5.3% goal is achievable this year and 3% next year.

Spain unveiled its new efforts to address the banking problems. It is the fourth one since the crisis began and the second one since Rajoy became PM. It is not likely to be the last either, as it seems largely to have failed to get ahead of the market expectations. In fact, today could mark the first time that the (generic) 10-year bond yield finishes the week above the 6% threshold in six months.

Dollar Mixed, Market Digesting Developments

There are conflicting impulses for the capital markets today and this is contributing to the mixed dollar tone.   News from JP Morgan initially triggered risk-off tactics and the euro re-tested the $1.29 level, making new lows for the move.  It recovered later in the session, perhaps helped by some reports suggesting some potentially encouraging developments in Greek politics.   The Italian bill auction was well received, with better bid-coverage and essentially flat yields, which may help have helped stem the rot.  The market awaits the unveiling of Spain's new banking reforms. 

The euro briefly fell through the GBP0.8000 level, but subsequently bounced back sharply.   It is challenging yesterday's high near GBP0.8045.  A move above there, and especially a close above there, would be a positive technical sign (potential key reversal).  This is not uncommon price action.  After a barrier is triggered, stops run, it is not unusual to see prices snap back. 

A Thumbnail Sketch of US Economy: No QE3

The US reports April PPI Friday and after the unexpectedly large decline in April import prices (-0.5%), there is downside risk to the Bloomberg consensus estimate of no change on the month. Import prices are up 0.5% year-over-year, the smallest increase since late 2009.

The trend lower in commodity prices is likely to be picked up in the PPI figures. Headline PPI has been trending lower since last September. The more worrisome impulses for core inflation is emanating from rising unit labor costs. Headline inflation converges with core and core itself appears to track unit labor costs fairly closely.

The Comity of Europe: Ten Points

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With increased talk of a country leaving the euro zone, or even of the end of the whole project, it is worth sketching out our view. Here are the main points of our view of Europe.

1. EMU itself is a culmination of two trends: 1) the integration of western Europe since the 1950s and 2) efforts to keep Germany wedded to the fortunes of Europe. The elite, and it is an elite project, knows no alternative strategy.

Great Graphic: Why Solar Energy is at a Tipping Point

Here are three great graphics from Think Progress on Solar Energy.

Is It Time to Stop Fighting Mumbai?

The rupee and Indian shares responded positively to new central bank measures to steady the currency, which has fallen more than 7% over the past three months and is the worst performing Asian currency. While recognizing the positive short term impact, we remain concerned that the domestic and international environment may not be conducive for a sustained recovery.

Yet much of India's bad news already seems discounted. S&P cut the outlook for on its BBB- rating last month. The trade deficit peaked in January and had fallen for three months through April. The drop in the price of oil should reduce pressure on both the trade front and inflation.

Calmer Tone Unlikely to Last

A somewhat calmer tone is evident in the global capital markets, but the underlying tone is fragile and the market appears merely to be catching its collective breath.  The Bank of England did not change interest rates not did it announce a change in its asset purchases, which means it joins the ECB and Fed on the sidelines. 

The major currencies are largely confined to yesterday's ranges against the dollar and showing little momentum presently.    Benchmark 10-year bond yields are mostly little changed.  The MSCI Asia-Pacific Index was down fractionally, but European shares are a bit heavier, with basic materials and consumer goods leading the way lower.  Of note Spain's stock market is bucking the down draft with technology, oil and gas and telecom, leading the way.  Financials are up on the day following news that the government took a 45% stake in Bankia, helping fuel ideas that a larger program will be unveiled tomorrow. 

Pressure in Europe Continues, Underpins Dollar and Yen

The US dollar and Japanese yen continue to be the biggest beneficiaries of the heightened tensions emanating from Europe.  Many see the seeming inability of the Greece to form a new government as increasing risk that it leaves monetary union.  With some a large asset manager and an investment bank claiming the Fed is going to resume its asset purchases next month one may be surprised that gold is off more than 1% and near the lows for the year.  

The policy market web site, www.intrade.com, currently places the odds of a country leaving the euro zone at 31.5% by the end of this year; 49% by the end of next year, and 62% by the end of 2014.  Yes these "contracts" are thinly traded compared to the turnover in the capital markets, but does offer a "second opinion" to claims in the press that the odds are seen at 90%. 

Greece is Worrisome, but Don't Forget about Spain

Greece's difficulty in putting together a government is weighing on euro sentiment. Although Belgium went without a government for more than a year, Greece does not have that luxury. The Troika is set to visit Athens next week for the periodic progress report. Another 11.5 bln euro in savings in needed to be identified by the end of June, otherwise is may not receive the next tranche of aid. While this may seem like deja vu, the important difference is that this time creditors are in the official sector rather than the private sector. Even more telling and incestuous, the Troika themselves are overwhelmingly Greece's largest creditors. At the same time, there is concern that without the next cash infusion, the Greek government may run out of money by the end of next month, two weeks after the next election, should that prove necessary.

Developments in Spain are also worrisome. The economy is collapsing. On a work day adjusted basis, industrial output is 7.5% below year ago levels and the contraction is accelerating. At the same time, the bank that was a combination of seven institutions and is the largest holder of real estate loans on its books, Bankia is on the proverbial bubble. Reports that is has been nationalized have been denied, but the stock is still bleeding. Talk that the government would inject at least 10 bln euro into Bankia, with an announcement by the end of the week failed to stabilize sentiment.

Uncertainty High, Dollar Firm

The US dollar remains mostly firmer against major and emerging market currencies.  Things are still up in the air.  Soft UK housing price data and BRC sales figures have gotten the chins wagging again about the possibility that the BOE extends its gilt purchases at Thursday's MPC meeting.  Wider than expected Australian trade deficit (A$1.59 bln vs A$754 mln--initially A$480 mln) has underpins speculation of a another rate cut next month after the surprisingly large 50 bp move last week. 

The gaps noted yesterday in the euro and Swiss franc have not been filled.  The gap in prices in the euro now extends from $1.3067 the high set in early Asia to $1.3080 the low from last Friday.  The gap in the dollar against the Swiss franc extends from CHF0.9195, yesterday's dollar low to CHF0.9185, last Friday's dollar high. 

Review of Gap Theory and FX Outlook

In a 24-hour a day market like foreign exchange and especially a currency pair like the euro-dollar exchange rate where daily turnover is estimated at nearly $1 trillion a day, gaps in the price action are rare.

There are different types of gaps and they are associated with different market conditions. Given that the euro and Swiss gaps remain unfilled, it may be helpful to review what market technicians refer to as gap theory.

Greece's Future Remains within EMU

The electoral outcome in Greece appears to be producing a fragmented parliament and will likely increase the platform for those parties that are more hostile to additional austerity and perhaps even the euro zone projected.

Nevertheless, we suspect much of the talk today about a Greek exit is exaggerated. The policy "prediction" web site, www.intrade.com shows a little less than a one in four chance of a country leaving the euro zone this year, rising to almost 49% next year. These odds are only slightly higher than prior to the weekend.

Initial Anxiety Stemmed, More Later and 6 Observations

The mostly as expected election results sparked a quick but dramatic bout risk-off activity. Equities have been sold (with Greek equities crushed, off more than 6% late in the local session, with a 13% loss in financials) and core bonds are firm, including French bonds.   In fact, the French premium over Germany in both the short (2-year) and long (10-year) end has actually narrowed today and this may embolden Hollande. 

Several of the major currencies gapped lower and have mostly recovered, with sterling and Australian dollar even turning higher on the day in Europe. The opening gaps in the euro and Swiss franc have not been filled, but look for selling pressure to re-emerging as the gaps are narrowed. The top of the euro gap, which should now offer resistance, is near $1.3080. A similar level against the Swiss franc, which should off the dollar support, is near CHF0.9185.

We identify six considerations for participants in the global capital markets for the week ahead.

Currency Futures Positioning and Technical Outlook

The new Commitment of Traders report covers the week through May 1 and it shows that the dollar was sold by speculators across the board.  The net short euro, yen and Swiss franc positions were pared, while the net long sterling, Canadian and Australian dollars and Mexican peso positions were extended.  However, the dramatic price action in the days after the reporting period ended warns that some of the late positioning was in weak hands and may have been squeezed out.  

Over the last couple of weeks, we have argued that the technical tone for the major foreign currencies was more constructive than our assessment of the fundamental backdrop.  The price action following the larger than expected Australian rate cut, the disappointing euro zone purchasing managers surveys, and soft US employment data have weakened the technical condition.  The Japanese yen is the main exception and it has strengthened as anxiety levels increased, reflected in the worst week for oil and the S&P 500 for the year (thus far).

A Little Color on the Disappointing Jobs Data

There is little that can be said about the disappointing US employment data.  Yet given the weakness of the ADP report and the softness of many of the regional Fed April surveys, the disappointment might not be as great as the stale surveys would have suggested. 

There is little positive in the report except perhaps that the back month revisions were higher and these typically are in the direction of the underlying trend.  March was revised up by 34k.  If you add the March revision of 45k private sector jobs to the April 130k increase and it does match consensus forecasts.

Some Interesting Developments by SNB and Norway's SWF

The Swiss National Bank reported its reserve figures yesterday and the increase in its sterling holdings are notable and may help explain the its relative strength, despite data a soft real sector reports, culminating in the news last week that, defying expectations, the UK economy contracted in Q1, the second consecutive quarter that the British economy shrank.

Separately, Norway's sovereign wealth fund, the Government Pension Fund Global, indicated it has sold off its Irish and Portuguese bond holdings, pared its Spanish and Italian holdings and increased its exposure to Mexico, Brazil and Indian bonds.

Services, Jobs and Politics Dominate FX

There are three main considerations in the foreign exchange market today.  The weaker than expected euro zone services PMI, the US jobs report and that spate of European elections.  The US dollar is slightly firmer, but largely within yesterday's ranges. 

There is nothing good that can be truly said of the euro zone service PMI.  It fell sharply and the slide accelerated since the flash.  The April reading was 46.9.  The flash was 47.9 and the March final was 49.2.  That gap between the flash and the April reading was the biggest since October 2008.  The service sector news follows the poor manufacturing PMI earlier in the week and produces a composite of 46.7 vs 49.1 in March.  

Draghi Sparks Euro Recovery

The euro has recovered from the brief dip below $1.31 to rise through yesterday's North American high.  Draghi has not sounded as dovish as the market expected.   He recognizes that the economic outlook is less certain, but did not seem to be an in hurry to take more action. 

He indicated a rate cut was not even discussed today.  The impact of the LTROs is still not fully known as the last one just settled in early March.  Draghi still refers to its monetary stance as accomodative. 

Short Note Before ECB

The US dollar is modestly higher against the major foreign currencies, but there is not much momentum as the market awaits the US data and the ECB press conference.  Well received French and Spanish auctions have helped lift peripheral bond markets and European shares are firmer, with financials also participating today.  

Market developments are modest today and there does appear to be some position adjusting ahead of the weekend elections.  Because Sarkozy, who continues to lag in the polls, did not deal a significant blow to Hollande, in last night's debate, the Socialist candidate would have to be recognized as the victor.  Polls show waning support for the Socialists and the New Democracy Party in Greece. A fragmented parliament, just as strong leadership is needed, is the likely outcome.  Germany holds a state election and the poorer the showing the of FDP, the more likely a grand coalition between the CDU/CSU and SPD next year.  

Latam Nationalizations: A Dog Bites Man Story?

That a couple of Latin American countries have recently announced the expropriation of foreign investors in the energy sector seems hardly like new news. After all, cycles of nationalization and privatization have unfolded for more than half a century. Moreover, the expropriation simply marked the latest illiberal measures by Argentina and Bolivia, the two protagonists here.

There is significant risk that others will follow Argentina and Bolivia. Ecuador comes to mind quickly, for example. Yet even if there is not a new wave of energy nationalizations, as some more doom-and gloom prognostications suggest, other developing countries are dealing with many of the same forces that led to the recent nationalizations.

Bloomberg: Interview with Megan Greene on Spain

Here is an interview I did last week with Megan Greene on Spain. If you like dem apples you should check out this interview for Bloomberg Taking Stock.

Dollar Recovers, Euro Area PMI Doesn't

The US dollar is broadly firmer against the major and most emerging market currencies.  The weaker than expected euro zone PMI data is triggering a position adjustment ahead of US jobs data on Friday and the weekend elections in France and Greece.  The poor economic data and Germany (both the BBK and Fin Min) call for no dilution of fiscal efforts can only exacerbate voter anxiety and desire for an alternative to the Berlin Consensus.  

There is really nothing good that can be said of the European PMIs.  For the euro area, the manufacturing PMI came in at 45.9, just below the flash reading of 46.0 and well below the final March reading of 47.7.  Output is at a new five month low and new orders fell as well.  It offers stark contrast to the US figures out yesterday that were stronger than expected in the headline and details, including new orders.  

What is Up with the Yen and Why it may Not Last

The Japanese yen was hands down the best performing G10 currency in April, gaining about 3.3% against the dollar and 4.2% against the euro. It appeared to start the new month on a strong note, with the dollar falling to 2 month lows in early Asia. However, in a holiday-thin European session and then in the North American session, the yen was sold off. There are several considerations that we briefly sketch here.

1. The fact that the yen strengthened underscores a key point we have made. Knowing that a country is pursuing unorthodox monetary policy (quantitative easing), does not help forecast foreign exchange prices. The BOE and BOJ are the only two major central banks still increasing the size of their balance sheets. Their respective currencies have been among the strongest.  The BOJ's mid-Feb QE announcement was different than last week's in that 1) it was unexpected; 2) it was larger and coupled with a formal inflation target, and 3) it took place amid a broader risk-on theme as the markets digested the ECB's second LTRO.

US Manufacturing Surprise

The US manufacturing ISM surprised the market in a favorable direction.  Rather than soften like the consensus expected, the diffusion index rose to 54.8 from 53.4.  This represents the strongest showing in eleven months.  The debate in the market has been over a soft landing in China, but this data (and the auto sales figures later) point to a soft landing in the US economy. 

The details were also constructive.  Measures of output and the forward looking orders were at the highest levels in a year.   Output rose to 61 form 58.3 and new orders rose to 58.2 from 54.5.  Fifteen of the 18 industries reported growth in orders and output.  None indicated a decline.  Even though Europe is contracting and China has slowed, US export orders rose to 59 from 54. 

Bloomberg: Spain Debt, US Economy, Currencies

Now that my brilliant webmaster is off saving the world she has to seek out my interviews. Here is one I did last week for Bloomberg Taking Stock:

May Day Surprises, Dollar Mixed

The May Day holiday has limited market participation, but has not prevented surprises.  The Reserve Bank of Australia kicked it off the celebration with a 50 bp rate cut. 

Although after the recent series of soft price data there was some risk (about a 1 in 3 chance according to market indications) of a 50 bp move, most observers, like ourselves, thought  central bank would move gradually as is its modus operandi.  However, in hindsight, what seemed to be a important factor is that, as we had noted at the time, Australian banks had increased mortgage lending rates despite the RBA's rate cuts.  The 50 bp move increases the likelihood that lower rates are passed on to the consumer and more the overall economy more broadly.