Quick Word on Price Action

The EU Summit results are the main driver of the capital markets.   Expectations had rightfully been depressed.  The fact that it appears that Germany and the creditors blinked caught the market leaning the wrong way.  

Secondarily, the softness of the US personal consumption in May and the back month revisions of real PCE (implied too by the GDP revisions) warns of relatively sharp downward revisions in economists' forecast for Q2 GDP.  Personal consumption was previously expected to rise 2.3% in Q2.  The current pace, even assuming a slightly better PCE figure for June would put personal consumption at a little more than half the previous expectations.  This could see GDP forecasts cut to around 1.5%.

Word of the Day: Sovereignty

Here is an under-appreciated irony:  One of the underlying themes of the European summit is the erosion of sovereignty for the sake of integration.  In the US today, the Supreme Court decision on President Obama's national health care program, reinforces if not strengthens the power of the sovereign (in this case, to tax).  The US state may have gotten stronger, while the European state is set to weaken.  

Speaking of irony, enjoy this video:

The first day of the European summit contained a few surprises.  First, many understood Germany's Schaueble's comments about being about to accept some mutualization of euro zone debt and would support short-term measures to deal with the financing problems effecting some governments (Spain and Italy), to be a shift in policy.  It was not.

Great Graphic: Affordable Health Care Act

My brilliant and wise beyond her years webmaster decided that the the decision to uphold the Affordable Health Care Act was reason enough for a Great Graphic on the issue.

Here are some more facts and figures from CNN:

• 49.9 million Americans were uninsured in 2010, roughly 16.3% of the population.
• 7.3 million children (9.8% of all the children in the country) don't have health insurance.
• 24.6% of Texas residents who don't have health insurance (highest of any state).
• 5.6% of Massachusetts residents who don't have health insurance (lowest of any state).

Okay now back to the things that matter, namely Kate Middleton's outfits:

Europe: Three No's Revisited

Currency in Crisis

The EU Summit will feature some growth measures, but little that will boost confidence that European officials will act to arrest the financial crisis.  Even the road map to greater economic and monetary union appears to really be a road map of the road map.  

Concrete proposals may not be formally presented until the end of the year.  Even the growth measures are less than meets the eye.  It appears that most of the 120-130 bln euros agreed upon will come from freeing up unused funds.   There is little of what used to be called "real water" when discussing Japan's pubic works spending. 

Narrow Ranges Prevail; Waiting for Godot

The US dollar is trading in narrow ranges against the major foreign currencies in quiet turnover.  Today's settlement the last for the month, but outside of some related flows, activity is uneventful ahead of the EU summit.  Expectations were marked down at the start of the week and Merkel's colorful comments drove the point home.  

There is little to excite the market and shake it out of its slumber today.  Headline risk for ahead of the summit seems modest at best.  The US reports May durable goods orders.  There is some risk of an upside surprise to the consensus expectation for a 0.5% increase that stems from the new orders component of the ISM surveys. 

Why Not To Expect SMP or LTRO from ECB Next Week

The ECB meets next Thursday, July 5. Although a few members wanted to cut rates earlier this month, they did not represent a majority. Expectations are running high for some action next week. The ECB did announce last week a relaxation of collateral standards and a liberalization of criteria. We have suggested this should be understood as just as important, if not more so, than a rate cut itself. Given financial crisis, access to credit is critical and, within reason, is important than the price (or interest rate).

Maltese central banker Bonnici warned earlier today that an interest rate cut would have only limited economic impact. Some read his comments as playing down the likelihood of a rate cut next week. We demur. Instead, the comments should be understood as warning against expectations of a quick fix. In addition, by suggesting that impact of monetary policy was limited, Bonnici keeps the pressure on European officials to take stronger actions to address the crisis.

US, Ireland, and Italy: Quick Survey of House Prices and Sales

The recent data suggests the US and Irish housing markets are stabilizing, while news from Italy has been poor.

The April reading from S&P/Case-Shiller showed a 1.9% year-over-year decline in property prices. This is the smallest decline since late 2010 and was a smaller decline than the 2.5% expected by the consensus. New home sales reported yesterday are at their highest level since before the crisis. Vacancy rates of single and multi-family units are falling. It is not that the housing market is going to offer the US economy much of a lift, but the fact that it will not be much of a headwind is itself a positive development.

Marking Time, Dollar Softer

The US dollar is softer against most of the major and emerging market currencies as players await for fresh incentives as month-end and quarter end approaches.  

Of note, the dollar has surrendered more of last week's gains against and has returned to the 20-day moving average around JPY79.25, after finishing last week above its Bollinger Band.  The short-term speculative market was leaning the wrong way.  That said, the dollar is approaching trend line support, drawn off the June 1 low near JPY76.65 and the June 18 low near JPY78.65 and the June 20 low near JPY78.80.  It comes in today near JPY79.11.  It may be toyed with, but the area is likely to hold initially. 

Great Graphic: US Public/Private Employment

Here is a Great Graphic from Joe Weisenthal at Business Insider.  It compares the jobs creation in Bush's first term to Obama's first term.  The red line is private sector employment.  The blue line is state government employment.  The green line is local government employment. 

The argument is that while private sector employment snapped back quick under Obama, the real difference is the government sector.  

Critics argue that the government employment under Bush was partly a function of Homeland Security issues after 9/11.   Joe and others respond by noting that such arguments actually then support the claim that it took some extra-economic developments to "jump start" private sector job creation.   

Thoughts about Mexico's Election and Peso Outlook

Mexico holds presidential and congressional elections on July 1.  The polls suggest the PRI will recapture the presidency for the first time since 2000.   Since 2000, the PRI has tried to reinvent itself as a reform party.  It is expected expand its control of the Senate, but it may not secure a majority in the lower house.

PAN, which has controlled the presidency since 2000, is likely to suffer the steepest losses.  In fact, its presidential candidate may come in third place behind the PRI and PRD candidates. PAN's Calderon barely won the presidency in 2006 with less than 1% margin.

Dollar Bounces Back, Pessimism Persists in Europe

The US dollar is broadly firmer, with the recovery of the yen the only main exception. The key fundamental drivers are the recognition that this week’s EU Summit is unlike to resolve the protracted debt crisis and that the Federal Reserve seems restrained compared with the actions of the ECB and BOE. 

Growth and policy concerns have weighed on global equity prices. The MSCI Asia Pacific Index is off 0.6%, led by a 1.6% decline in the Shanghai Composite to new 5-month lows, on weaker growth fears, with industrials and basis materials the weakest sectors. New measures to encourage foreign investment in India helped stabilize the rupee but did little for the stock market which lost about 0.5%. 

FX Positioning and Outlook: Correction Over?

The upside correction of the major foreign currencies we have been tracking since the disappointing May employment report on June 1, when the euro and Swiss franc posted key reversals, appears to be complete or nearly so.  

The latest CFTC Commitment of Traders report for the week ending June 19 showed a large reduction of net short euro, Swiss franc and Australian dollar futures.  Positioning in the other currency futures was little changed.  

CNBC Video Clip: Euro Upside Correction Over

Europe: Jockeying for Position

The numerous meetings of European officials is best understood as jockeying for position ahead of heads of state summit at the end of next week. Domestic political considerations are often an under-appreciated factor in the formation of a country's position in international forums.

This is a material point in Germany. Merkel depends on the opposition (SPD and Greens) to secure approval for ESM and the fiscal pact. Yesterday a deal was reached in the lower house of the German parliament, the Bundestag. Merkel had to make few concessions. Although the SPD and Greens are seen to be somewhat more pro-growth than the CDU/CSU, their demands for measures to foster growth do not go beyond what Merkel had already seemed committed to. Moreover, they did not object to growth measures being financed from revenue not credit (borrowing).

Dollar Consolidates Gains

The foreign exchange market, and the capital markets more generally, are subdued after several days of dramatic moves.  The attempt to extend yesterday's dollar gains in Asia was limited and seemed to bring in some profit-taking ahead of the weekend.   

The North American session will begin with the major foreign currencies near the highs for the European session.  There may be a bit more upside, but North American players have seemed more bearish the foreign currencies this week and it would not be surprising to see them make another run at the lows.  Yet without fresh incentives or news developments, look for a largely range bound session. 

Thoughts on Spain's Stress Tests and ESM

Currency in Crisis

Spanish officials will likely find comfort in the results of the latest stress tests.  They can still feel as if the 100 bln euro line from the EFSF/ESM will be more than sufficient.  In fact, a formal request for the funds may be made within days.  

Recall that the IMF's stress test was based on 4% economic contraction and a 20% decline in property prices, with a core Tier 1 capital of 7% (the Basel III requirement by 2019).  It concluded that under such conditions Spanish banks would need about 37 bln euros.  

What Not to Expect from the European Meetings Today and Friday

The Euro group of finance ministers meet today and tomorrow there is a heads of state meeting for Germany, France, Italy and Spain. These meetings should be understood as preparing and positioning for the EU Summit at the end of next week.

Recent comments have shed light on what is not likely to happen. It is unlikely that there will be an agreement on direct bank lending by the EFSF/ESM. There is unlikely to be an agreement on a banking union. There is unlikely to be an agreement to get the ECB to resume its sovereign bond buying. There will be little pressure for another LTRO.

Dollar Firm, but Mostly Range Bound

The US dollar is somewhat firmer, but still largely confined to recent ranges.  Its strength against the yen is an exception.   The greenback neared JPY80 for the first time since May 23.  The dollar's gains against the yen may be partly a  function of the Fed opting for Operation Twist over QE.   The US-Japan 2-year interest rate differential is slightly above 20 bp for the first time since early April. 

There is not much expected from the Eurogroup of euro zone finance ministers meeting today or the meeting tomorrow between Germany, France, Italy and Spain.  These should be understood as negotiating ahead of the EU Summit at the end of next week.  Headline risks stem from the meetings, but no revelations are likely.  The market will also be watching for the Wyman and Berger independent audits of Spanish banks.  A formal request for aid by Spain (and possibly Cyprus) is anticipated in the next day or two. 

Fed Twists and Shouts, but No QE

The Federal Reserve signaled disappointment with the economic performance and announced an extension of Operations Twist that was set to be completed this month. It will do another $267 bln selling of short-end and buying of the long end through the remainder of the year. There was no MBS twist on twist, so to speak

The Federal Reserve acknowledged the slowing down in the job growth and a slower rise in household spending. The Fed recognizes significant downside risks to the economy and, of course, promises to act as needed.

Marking Time Ahead FOMC

The US dollar is little changed as the foreign exchange market awaits the outcome of the FOMC meeting and further developments in Europe, where a Greek government may be announced.  Most of the major currencies are trading within yesterday's ranges.  Global equity markets are higher.  

Of note the MSCI Asia-Pacific Index gained 1%, despite losses in China and reached its best level since mid-May.  MSCI emerging markets index is at 5-week highs.  European bond and CDS markets are subdued.  Of particular interest, Spanish and Italian bonds yields are lower as are CDS prices.  To be clear, though these seems to be technical in nature and does not reflect a shift in underlying conditions.

Why 100 bln euros for Spain Won't be Enough

Currency in Crisis

In the five sessions through today, the Greek stock market has rallied 25%. Equity traders seem to have anticipated the election outcome. A new government is not yet in place, but many are still confident it will be announced in the very near-term (today or tomorrow). At the same time, European officials seem to be much more supportive than they were prior to the vote. They seem more willing to modify Greece's program than if Syriza won, underscoring our sense that the bellicose rhetoric was simply the start of negotiations.

At the same time, it raises issues of the real meaning about sovereignty, that officials seem to determined to preserve. Recall that Italy's Berlusconi was pushed out not so much by the opposition in Italy as by European officials including Merkel. There has also been some intimation that European officials were more tolerant of the Greek excesses prior to the PASOK victory in late 2009 because of the government was center right. In the recent election, European officials as much as Samaras tried to portray it as a referendum on EMU itself, even though Syriza claimed to remain committed to EMU membership.

Great Graphic: Understanding the Europe Crisis Now

Here is a great graphic from the NY Times on the European Crisis.

Yahoo Finance Video: Greek Election and the Way Forward

Unlike many observers, I argue that the only way truly forward is greater integration.  Disintegration of monetary union would be ruinous of both creditor and debtor countries.  EMU is the culmination of the post-WWII strategy in Europe that sought integration on various levels and in numerous spheres as a way to bring peace to the war-ridden peninsula of the huge Euroasian landmass.  

Calmer Markets, No Resolution

The global capital markets are calmer today, but there has been no resolution of key outstanding issues.  There is still no agreement over the configuration of a new Greek government.  The full extent of Spain's banking needs are still not known and there is speculation that a full-blown assistance package is needed.  Peripheral bond yields are somewhat lower today, but the underlying pressure remains the ECB reluctance to act (to buy Spanish and Italian bonds) has spurred reports that Italy may press for a semi-automatic mechanism to force its hand.  

After yesterday's potential key reversal in the Euro and Swiss franc, there was no follow through selling, which would seem to mitigate significance of that price action.  Some times the rejection of a technical signal is noteworthy.  However, the minor gains recorded in Asia and Europe today have left the intra-day momentum indicators a bit stretched for the start of the North American session.  Nearby resistance for the euro is seen in front of $1.2660.  Support for the dollar against the Swiss franc is seen near CHF0.9500.

Quick Note on Price Action: Close is Important

The euro reached its highest level in four weeks in Asia today, but how it closes the North American session may be more important.  

At the start of June, the euro and Swiss franc posted key outside up days following the poor US employment data.  We recognized it as such here and our confidence grew as follow through action materialized. Our weekly technical outlooks have indicated the upside correction, after the dramatic losses in May, was still underway.  

Today's price action could be a key downside reversal in the euro and Swiss franc.  Recall, this is when the price of an instrument makes a new, in this case, high, for the move, sells off, and closes below the previous day's low.

Euro Struggling, Deja Vu All Over Again, Except...

In price action eerily reminiscent of last week's reaction the the EU's offer of a 100 bln euro line for Spanish banks, the euro rallied initially and subsequently gave it all back plus some.  The euro's advance carried it to almost $1.2750 and has now fallen to a low of about $1.2580 in the NY morning.   The other major currencies are taking their cues from the euro. 

Peripheral yields are soaring, except Greece, where the Troika is sounding as flexible now and there has been some talk that Greece could be given an extra couple of years to meet its deficit targets.  Would it have been so flexible if Syriza won?   Spain's 10-year is up almost 30 bp and 2-year is up nearly 50 bp.  Over the past 60 days, the direction of the euro and Spanish 10-year yields are 90% correlated.  The correlation with the 2-year is almost 95%. 

Monday Funday: Jon Stewart Nails It

For years my brilliant webmaster said if she were to have father issues resulting in crushes on older men they would be directed at the witty and wise Jon Stewart. (Then she learned he had a daughter by the same name and it got creepy.) In honor of a belated fathers day here are two great clips from last week:

and part two...

Great Graphic: Target2 and German Bank Claims

Here is a Great Graphic that Felix Salmon at Reuters picked up from Jonathan Carmel of Camel Asset Management.  It shows that as German banks have reduced their exposures to the periphery in Europe, the Target2 exposures of the BBK have grown.  

The two seem to be independent.  The German banks have consciously decided to reduce exposure to the periphery.  The increase in Target2 imbalances are the result of various and decentralized decisions.  

 The Target2 imbalances reflect trade and current account related transactions as well as purely financial transactions, such as shifting deposits. 

Four Observations to Start the Week

The US dollar initially sold off on news that the New Democracy Party came in first place in the Greek elections, but has since recovered as the market recognizes that the euro area problems remain profound. Spain is still on the forefront and ahead of this week’s bill and bond auctions, the Spanish 10-year yield is up through 7%. Italian bond yields are also higher. The immediate positive reaction to the Greek news was seen in Asian equities where the MSCI Asia-Pacific Index advanced 1.3%. Of note, India’s shares declined amid disappointment that the central bank left rates steady (8%). 

There were widespread expectations for a 25 bp cut. The early gains in the Dow Jones Stoxx 600 were given back before a more stable tone emerged in late morning European turnover. However, Spain and Italian bourses are under-performing and financials are a drag. Greek bonds and Greek shares are broadly higher.

Video Explaining Risk of Reversible Union

Entertaining short piece that captures the challenges that face Greece and Europe.  It comes via the Economist.  It underscores a point we made:  European officials did themselves a disservice by even suggesting that monetary union is reversible.  See here:

FX Positioning and Technical Outlook on Eve of Greek Election

Between the Greek and French elections, the G20 meeting and an FOMC meeting that follows a string of disappointing data, next week promises to be among the most significant from a fundamental point of view as one can imagine. At the same time,  speculative positioning and the technical condition of the market offer an alternative (sometimes complimentary and sometimes competing) framework to anticipate future price action.

Although there is much talk about the Greek election leading to the disintegration of the euro zone, and many pundits see no outcome that is supportive of the euro, technical factors warn that the correction of the foreign currencies' sharp losses in May is not complete.

FT Interview on Greece and Europe

Yesterday I originally posted a link to this interview I did for Financial Times. Alas I am not as technologically savvy as my brilliant webmaster. So here is the actual video:

Great Graphic: Target2 Imbalances

Here is a Great Graphic of Target2 imbalances.  Target2 is the real time payments settlement system in Europe.  I stumbled on it looking for something else and there was no source to identify its origin.  

Target2 facilities cross-border movement of capital Europe.  Local banks go through their central bank, while the central bank itself has an account at the ECB that is credited or debited.  

The problem arises because the imbalances are getting larger and the risk of that a country leaves, or the entire union disintegrates, has risen.

UK Eases, Greek and French Elections, US Data

The US dollar somewhat firmer in a relatively subdued foreign exchange market as last minute position adjustments are made in waning hours ahead of what many expect to be a key weekend with Greek and French elections.  Greek exit polls are expected to begin around midday (ET) with official results out prior to the opening of the Asian session Monday.  The threat of coordinated central bank action has rekindled ideas of potential BOJ intervention and this seems to largely account for the yen’s strength today, following the BOJ’s decision to keep policy on hold, but upgrade the economic assessment.  

Global equity markets are mostly higher, with the MSCI Asia Pacific gaining almost 1%, for highest close since mid-May, while the EuroStoxx 600 is up about 0.8%, led by a nearly 2% gain in financials near midday in London.   The US reports industrial production and there is some risk that manufacturing contracted.  The Empire State survey may attract some interest as it is the first report for June.  However, the market’s ability to forecast it is poor and the consensus has badly missed the past two months.   The April TIC data will also be released but does not typically elicit a market response. 

Sentiment Turning on Germany?

It has been a difficult week for Germany.  Instead of attributing the intensification of the crisis to the debtors, some officials and observers, as well as the media, are blaming Germany for not opening its purse more.  Germany, we are told, is isolated, but it is not.  The key division in Europe is creditor and debtor.  For much of its resistance to a joint bond or a transfer union, Germany is joined by Austria, Finland and the Netherlands, the other creditor nations.

 

Another reason it has been a difficult week for Germany is that the safe haven bid for its debt seemed to evaporate even though Spanish and Italian yields rose sharply.    The German 10-year yield finished last week near 1.33% and rose 20 bp by mid-week.  The 2-year reached 15 bp yesterday up from 4 bp at the last week.  This reversal is also evident in the credit default swaps market.  The German 5-year CDS peaked near 120 bp in Q4 ’11.  It fell back to around 70 bp in Q1 and this week has flirted with 110 bp.

FT Video Interview on Greece and Europe

Currency in Crisis

Here is the link to a video interview I did earlier this week with John Auther's of the Financial Times.  Authers' pens the Long View column at the FT.   The interview gave me an opportunity to highlight my some what non-consensus views on Greece.  

First and foremost, contrary to what many observers have suggested and what the German finance minister encouraged, the election is not a referendum on Greece's euro membership.  Greece chose to join years ago and the polls show an overwhelming majority favor keeping the euro.  It is not the binary situation some have suggested.

Great Graphic: US Per Capita GDP--the Big Picture

Here is a Great Graphic putting US GDP growth in a different context then we are accustomed to seeing it.  It comes from Professors William Easterly and Yaw Nyarko-led Development Research Institute at New York University.  

Of course it does not lessen the importance of the end of the secular credit cycle or the seriousness of the economic, financial and social challenges we face.  However, it does suggest a certain resilience beyond the cyclical vagaries and quarterly GDP prints.  

FX: Little Movement, Much to Digest

The US dollar continues to sport a soft profile as market position adjustments ahead of the Greek election continues to dominate.  As anticipated, the market has mostly looked beyond Moody's three step downgrade of Spain's creditworthiness to Baa3.  Spanish 10-year yields pushed through 7% briefly, but rumors that ECB officials may have "checked prices" helped stabilize the situation. 

In North America today, euro has potential to test the $1.2610 area seen yesterday, but strong gains through there are unlikely.  Similarly the dollar could test the CHF0.9520 area, but a break of CHF0.9480-CHF0.9500 is unlikely.   Sterling had finished the NY session yesterday on its lows and saw some follow through selling in Asia.  It has stabilized and there is scope toward $1.5570 today.  The Australian dollar brief and shallowly penetrated $1.00 level yesterday as we warned was likely.  Provided the $0.9920 area continues to hold, another test may be forthcoming.   The Canadian dollar is comfortable within yesterday's ranges.  Support for the US dollar continues to be seen near CAD1.0240.  Lastly, support in the JPY79.20-30 area is being tested as the North American session gets under way.  Look for this area to hold.  

Moody's Joins Party, Slashes Spain's Rating

Currency in Crisis

Shortly after the US markets closed, Moody's announced it was slashing Spain's sovereign debt rating three notches to Baa3.  This is one step above junk status.  The euro, which had generally traded higher in North America, was softening going into the close.  The announcement pushed it down further, but it still managed to finish the day above its 20-day moving average (~$1.2540) for the first time since May 1.

Moody's had warned before the weekend that it could downgrade Spain and following Fitch's move, Moody's was the laggard.  On Monday, I warned that this was the immediate risk and I even repeated it on Bloomberg TV.  It was hardly surprising then and I think that the technical factors favor a continuation of the corrective-cum-consolidative phase.

Ugly Consolidation/Correction in FX Continues

The US dollar is broadly weaker today as the messy consolidation ahead of the Greek election continues.  The market positioning still appears stretched.   The price action seems to be more a result of market positioning and the failure to rebuild the downside momentum in the foreign currencies as last Friday's lows remained intact on the test.  This is a prerequisite for the continuation of the correction cum consolidation phase.   

Short-term market participants cannot be sure that the Greek election is the binary event it has been portrayed to be.  If Greece's Syriza wins, it does not mean that Greece is out of EMU the next day or week.  We continue to believe the election denotes the beginning of a new negotiating phase.  The key difference between Syriza and ND/PASOK is the importance of the current memorandum of understanding.  ND/PASOK say that it can serve as the template for a new agreement.  Syriza says it cannot.

More Thoughts on Spain and Italy

More details of the bank aid to Spain have been proposed. The details seem to show an evolution in the thinking of officials. Spain would be given a considerably longer repayment schedule than the other aid recipients, fifteen years and a five year grace period.  Spain, when it finally asks for the funds, will be charged 3%.  

However, the old tension between wanting to support the banks and wanting to punish remains unresolved as the reports suggest the banks will charged 8.5% for the aid.  Besides getting past the Greek elections, the next big event for the Spain saga is the private auditors bank assessment due next week.  

Bloomberg TV: Spain and Italy

Here is a short Bloomberg TV interview from June 11. I discuss why the EU offer of aid to Spain is a down payment to what will likely prove to be a larger bill. I also suggested why Italy may come under more pressure.

US Import Prices and this Week's Data

Import prices fell 1.0% in May in line with expectations. The drop can be fully accounted for by food and energy imports. Excluding them, prices were flat. Tomorrow the US reports producer prices and the headline is expected to fall 0.6%. There may be some downside risk to the headline. 

The key point is that headline price pressures are, as one might expect with the decline in commodity prices, softer but core prices are stable to firmer. Some observers may also put more emphasis on the dollar's appreciation as a factor curbing import inflation, though given that most of the goods are denominated in dollars, I tend to be a bit skeptical.

Great Graphic: Italy's GDP Components

Here is a Great Graphic from Rebecca Wilder.  Her latest missive is in a similar vein as my note on Italy.  While the external sector had helped Italy recover from the 2008 slide, the momentum has faded and has actually been a net drag for the past couple of quarters.  The private domestic economy--consumption and investment, never did recover and the government's austerity continues to also be a drag.  The poor growth prospects can only be exacerbated by the financial pressures and the rise in yields. 

Euro Pressure Subsides for the Moment

After extended yesterday's reversal to $1.2450 in pre-Asian activity, the euro has recover and near midday in London is at making session highs near $1.2525 and initial potential extends toward $1.2560-70 in the North American session.  The pace of yesterday's slide, even for the die hard euro bears, was surprising.   In order to keep the technical correction that we favored, last Friday's low near $1.2435 needs to remain intact. 

This applies to the other major currencies too. The dollar made a high at the end of last week near CHF0.9660. Though approached, this area has held today.  A comparable low was set in sterling just above $1.54. It may be a messy correction, but the correction seems still intact.

Why Italy

Featured On
Business Insider

There is a perverse logic unfolding.  Spain is the fourth of the euro zone members to require external assistance.  Cyprus is likely to be next, especially if Russia does not come to its aid as it did last year with a $2.5 bln loan.  

Currency in Crisis

That leaves Italy as the last of southern debtor countries to be standing on its own in the face of the end of a global credit cycle.  Italy's problem is not a deficit.  It is likely to be near 4% this year.  It is also the only debtor to be running a primary budget (excluding debt servicing costs) surplus.

The Implications of Spain's Deal

Featured On
Business Insider

Investors ought not let the recovery in the global capital markets, that has been seen in response to the broad brush strokes of an aid package for Madrid, obscure the fact that the underlying quagmire just got deeper.  The favorable market response is largely technical in nature and related to extreme positioning and the out-sized moves in May.  

The weekend produced not so much a Spain request for aid as the EU offering Spain up to 100 bln euro to support its banks.  Rajoy appears to have won most of his demands.  The IMF is not included.  It cannot provide assistance for a strictly bank recap program, so it may have been an easy concession to make. This is especially true because Rajoy also refused to consider additional conditions in the form of additional deficit or debt targets.

EU/Spain and China Spur Collective Sigh of Relief

The US dollar is broadly weaker. However, after being marked down sharply in Asia it is clawing its way back in Europe. Global equities’ sigh of relief to both the EU-Spain aid and China’s slew of data has sparked among the best gains of the year in the MSCI Asia-Pacific Index (+1.8%), though India did not participate (0.25%) and S&P’s warning that it could become the first BRIC to lose investment grade status will not help. The gains in the Dow Jones Stoxx 600 are on par with Asia. Of note, near midday in London, Spain’s IBEX is leading the charge, gaining more than 3.5%, helped by the 5.25% rally in financials. The bond market reaction is as one might expect, with peripheral bonds trading firm (Spain’s 10-year yield is off 5 bp), while other bond markets are trading softer. Commodity prices are generally higher, with gold and the precious metals lagging.

It is not much of an exaggeration to suggest that the world economy and financial system was on the verge of plunging headlong into an abyss. The most important thing to be aware of now is that an important step back has taken place. The Federal Reserve assured investors that it is prepared to do what is necessary and the latest weekly jobless claim figures were better than expected. The world’s second largest economy cut interest rates last week and the weekend data dump was mixed, and in any event, should bolster confidence in the soft-landing scenario.

Positioning and FX Technical Outlook: More Correction Ahead

The latest CFTC Commitment of Traders report covers the week ending June 5.  We assume that the report's coverage of speculative positioning is  representative of short-term trend followers and momentum players.   There were several noteworthy developments among speculative participants in the futures market.  

The highlights include:

• New record short euro position
• A switch from net short to net long yen
• A switch from net long to net short sterling
• New record short Australian dollar position

Great Graphic: Queen Elizabeth

Here is a great graphic on Queen Elizabeth. (Even though we all know the real focus is on what Kate wore...)

Spain's Negotiating Position: Five No's

Featured On
Business Insider

As recently as May 28, Spanish Prime Minister Rajoy was claiming that "there will be no Spanish bank rescue".  He miscalculated.  He had hoped the ECB would come to his rescue.  Not only has the ECB not resumed its sovereign bond purchases, but it did not even throw Spain a bone by cutting rates, which surely is justified based on the trajectory of the euro zone economy, where conditions have deteriorated markedly since the end of last year and the last time the ECB rates, and the easing of price pressures.    

There are only two issues now.  How much money does Spain need and under what terms?

Great Graphic: Selected Euro Area Credit Ratings

Here is another Great Graphic. It comes from Thomson Reuters and it provides a useful table to compare the ratings of the major agencies of several key countries in the euro area.

After this week's move by Fitch on Spain, it leaves Moody's A3 rating as looking out of sync.  What does seem a bit surprising though, is Fitch now rates Spain below Ireland.  S&P rates both Ireland and Spain the same at BBB+. Looking at the CDS pricing, the market does not agree. 

First Round French Elections: Preliminary Thoughts

The first round of the French parliamentary elections will be held Sunday. Although the Greek election on June 17 has received more attention, the French parliamentary election is also important. Since Hollande was elected in mid-May, he has remained in campaign mode to boost his chances of having a parliament that will enact his program.

There are 577 seats at stake, meaning 289 seats are needed to secure a majority. If Hollande's Socialists do not achieve this by themselves, their first call for an ally will likely be the Greens. The Left Front may poll higher than the Greens, but would make more difficult governing partners, for numerous reasons, but a Socialist-Green government could draw parliamentary support from them.

Great Graphic: Germany's Target2 Exposure

Here is a Great Graphic from ZeroHedge.com that captures the Bundesbank's exposure within the intra-European payments clearing system called Target2.   

When a depositor takes money out a a Spanish bank, for example, and brings it to a German bank, in effect the Bundesbank credits the German bank, but is owed the money by the Spanish central bank, which is owed the money by the Spanish bank. Target 2 also picks up costs of financing current account deficits.

More Thoughts on Spain-Lite

Currency in Crisis

Greece has been the model for Portuguese and Irish aid.  This may or may not have been fair and appropriate.  After all, the nature of the Portuguese and Irish problems were dissimilar from Greece and each other.  Spain's is more like Ireland's.  The key differences include Spain's size, officials have progressed on a learning curve, and the now perceived greater vulnerability of the whole EMU project. 

Spain will offer a new model.  Despite the claims made by the Rajoy government, it will borrow funds to help it recapitalize the banks.  What appears to be being worked out is the dimensions of the aid and the terms.  If Greece was the model and Spain would be given aid sufficient to keep it out of the capital markets until the end of 2014, it would need 375 bln euros, which assumes around 100 bln for the banks.  This would make a major dent  the 500 bln ESM that is to be launched next month. 

Bernanke and Europe Boost Dollar

The US dollar has been boosted by expectations that Spain and Cyprus are close to requesting aid and Fed Chairman Bernanke’s reluctance to tip his hand to the US Congress yesterday. This coupled with reports that the euro area finance ministers will hold a conference call over the weekend, following on the heels of French-owned Fitch’s 3-step downgrade of Spain, has forced the euro to give back half of the gains seen since the low prior to the disappointing US jobs data a week ago.

The market fears that yesterday’s rate cut by China, the first in several years, is not as much a reflection of the past string of soft data, but a forewarning of poor data to be reporting in the coming days. The MSCI Asia-Pacific Index fell by 1.3%, but still managed to finish the week fractionally higher to break the five week losing streak, though foreign investors appear to continue to pare holdings. European bourses are lower, with the Dow Jones Stoxx 600 off about 0.6% near midday in London, led by basic materials, resources and financials. Notable Spain is an exception, with the IBEX up about 0.3% headed into the weekend. Financials are only slightly lower.

Thoughts on Japanese and Swiss Reserve Figures

Japan and Switzerland released May reserve figures earlier today. They are both noteworthy, but for different reasons. Japanese reserves fell yet the BOJ did not intervene. Switzerland's reserves rose sharply as the SNB had to step up its intervention to defend its franc cap.

Japan's currency reserves fell by about $6.9 bln to $1.278 trillion. We can use the reserve data to do a little thought experiment. Let's assume that Japan holds only euros and dollars in reserves. Let's also assume that there were no interest payments or other increases in reserves. The euro lost about 6.6% of its value against the dollar, which is the currency that Japan's reserves are reported in. A 6.6% decline in the euro's value can translate into the $6.9 bln loss if the Japan held about 8.6% of its reserves or $104.4 bln in euro denominated securities.

BOE Doesn't Surprise, China Does

The BOE lefts rates unchanged and chose not to increase its gilt holdings.  The UK did report a better than expected service PMI today, but there was some thought it would respond to a series of other data that warns that stagnation was morphing into outright contraction.  

Yet China stole some of the thunder.  Just before the BOE announcement, China announced its first interest rate cute since 2008.  Both deposit and lending rates will be cut by 25 bp.  The 1-year lending rate will also be cut by 25 bp.   

Once again China moves ahead of the G20 meeting.  This is its modus operandi.  Take action or make some announcement prior to international gatherings such as IMF meetings or G20 meetings.   Some might link the rate cut to pre-knowledge of the upcoming data stream.  While many expected China to ease policy, most had focused on required reserves ratios.  The timing too would catch players by surprise.  

The China move sparked a quick risk-on trade that seemed to fade, though the Aussie and Kiwi remain firm.  Large liquid resource EM currencies, like the South African rand is also doing well.  Sterling quickly spiked up, but like the euro it appears to be struggling to hold on to the China-inspired gains. 

Position Adjusting Continues--Before the BOE

The dollar is mostly marginally softer against the major foreign currencies as corrective position adjusting continues.  Many suspect that one way or the other, Spanish banks will get the necessary funds and that some how the government will be able to avoid a full burden of conditionality.  The New York Times  is emphasizing the sheer size of Spain.  Simply put, it ain't tiny Greece, and that it says gives it a stronger hand. 

Spain's bonds were well received in today's auction.  Bid-to-covers were firm and while yields rose, investors were relieved that they did not go up more.  For example, the 10-year was auctioned at 6.04%, up from 5.74% at the last auction but below the 6.14% that was in the secondary market.  Moreover, Spanish bonds have rallied strongly in recent days.  Recall the 10-year yield peaked last Wed around 6.7%.  Today, it briefly dipped below 6.10%.  

Does the New Jersey Dollar Need to Depreciate?

Featured On
Business Insider

Here is a provocative Great Graphic from Joe Weisenthal at Business Insider.  It compares New Jersey and New York GDP performance.  The under-performance of NJ since the Great Recession is noteworthy, but it appears that it began actually earlier. 

While this may be interesting in its own right, it is noteworthy that not a single pundit is calling for a devaluation of the New Jersey dollar against the New York dollar.  

It is not simply because there is factor (labor, capital) mobility, but also because the union is irrevocable and is understood as such,.  As we have argued, European officials willingness to talk about Greece leaving or the disintegration of EMU has done immeasurable damage to sentiment.  Once that toothpaste is out of the tube, it is very difficult to push it back in.

Count Draghi: Ten Points

1. The situation is not as bad as the immediate post-Lehman environment, but "alarmed" by recent market stress.

2. Market concerns are real, but under-estimate the political resolve.

3. Per current treaty, ESM cannot lend directly to banks. If treaties change, not clear if desirable for ESM to own shares in banks.

ECB Left Rates Steady, Draghi Keeps Door Open

The ECB kept rates on hold, as the consensus had expected.  Draghi's press conference has kept the door open to further action.   The euro has responded by shedding its earlier gains, ostensibly on signs that the ECB does not recognize the sense of urgency.  

Draghi make a couple of minor tweaks in policy.  He confirmed the continuation of full allotment refinancing until at least mid-Jan 2013 and that three-month funds will be available to then as well.  He recognized the downside risks to growth in the current quarter and the downside risks to the outlook. 

Great Graphic: Int'l Comparison Quality of Life

A Great Graphic from the Economist providing an international comparison of a broader measures of the quality of life than GDP figures capture, with some attention to distribution.  These type of composites are more provocative than substantive.   As one might expect, there seems to be a strong correlation between different international comparison. 

Dollar Eases, Australia Surprises, ECB Awaited

The US dollar is broadly lower amid less dismal developments and the collective sigh of relief has not only lifted the major foreign currencies, but also equity markets, commodities and peripheral European bond markets.  Some of the momentum has eased as the market now turns its attention to the ECB.  

If the odds of an ECB rate cut were being under-estimated by the market, as I have argued, today's German industrial production data makes an even more compelling case.  April industrial output fell 2.2% offsetting in full the revised gain in March (initially 2.8% now 2.2%) and more just as importantly pushes the year-over-year rate into negative territory (-0.7%) for the first time since Dec 2009.

The State of Confusion and the ECB

This time last year the ECB was raising interest rates, though it was still purchasing sovereign bonds in the secondary market.  Under Trichet's leadership, the tight monetary policy reinforced the fiscal austerity during a period of deleveraging.  The seeds of those decisions are still being harvested now.   

The ECB meets a day earlier than usual due to the Corpus Christi holiday.  The overwhelming majority of market participants does not expect the ECB to do anything, but perhaps build the case for additional accommodation later.  We have suggested that the market is under-estimating the risk of action by the ECB. 

It is not Just Spanish Banks...

Currency in Crisis

There has been great concern about the state of Spain's banks. The Rajoy government has been slow in recognizing the needs of the sector. As recently as Feb, Rajoy was maintaining that no extra funds are needed. Now it continues to resist pressure for it to seek funds from the EFSF. Instead the Rajoy government is seeking to avoid the stigma and conditionality such borrowing entails.

It wants the ECB to buy more of its bonds. It wants the banks to be able to borrow directly from the ESM, which does not exist yet and even when it does, it is mandated to lend to sovereigns not banks. The pressure to change the ESM may make it more difficult for Merkel to secure a majority of her party to support it, forcing her to rely on the opposition. Even assuming that the treaty can be modified, it hardly can take place soon enough for Spain.

Atlantic Council Interview: Is the Euro Zone Really In Danger

Here is an interview I did for the Atlantic Council on the Euro Debt Crisis and future of the Euro Zone.

Memo of Understanding and other Red Herrings

Featured On
Business Insider

A red herring is a rhetoric ploy to divert attention from the issue at hand by introducing some irrelevant topic. The framing of the Greek election around the memorandum of understanding is such a red herring. There has been such deterioration of the economic conditions in Greece that the conditions and terms of its international assistance will have to be re-crafted in any event.

Consider Greece's two main sources of revenue. Shipping and tourism. The world's largest shipping fair opened in Athens yesterday. It is held every two years. Reports indicate there are some 1870 exhibitors from 87 countries. China is among the few countries that took a booth. China is squeezing Greece's shipping industry, which accounts for 16% for the global merchant fleet. It is the world's largest by tonnage. However, China's rise (and South Korea's prowess) has boosted global capacity at the same time that global economic weakness has lowered trade volumes.

Economic Data Saps Euro Strength

The euro correction hit a wall after reaching a five day high in Asia near $1.2540.  The wall was in the form of poor data and the ongoing policy paralysis in Europe.  European officials are acting analog in a digital world.  They are moving to toward something, but it is not for several weeks and their track record does not instill confidence.  

The economic data was poor and can only increase the pressure on the ECB to do something at tomorrow's meeting.  The euro zone service PMI came in at 46.7 from 46.5 at the flash reading at 46.9 in April.  Yet, the German and French readings deteriorated from the flash report.  The composite reading came in at 46.0 down from 46.7 in April.  The forward looking new orders component fell to 44.6 from 44.8.  This is the lowest since level since July 2009.  

Leaning Green or Hey Baby is that a Prius you're driving?

My brilliant webmaster (who is off saving the world doing energy analytics for a clean tech company) came across this great podcast on the economics of 'leaning green'. 

Quick Note on Today's Price Action

The euro briefly poked through the $1.25 level, but has run out of steam.  It completed a 61.8% retracement of the losses since the last correction ran out of steam on May 28th near $1.2625.   On the short-term momentum studies I use for intraday movement, there are bearish divergences emerging.  There is initial potential toward $1.2450.  

That said, following Friday's key reversal, where the euro fell to new lows for the move and then closed above the previous day's high is a constructive technical development and there was some follow-through today.  The daily momentum indicators are constructive and the MACDs are poised to cross.  However, the sentiment remains poor and the fundamental backdrop in Europe is hardly supportive.  

Spain and Banking Union

Currency in Crisis

Reports suggest that Spain is coming under increasing political pressure to seek assistance. Yet the stigma is too much and Spanish officials recognize that if asks for assistance, many investors will conclude that the country is insolvent and would aggravate the economic and financial pressure it is already facing.

Instead Spain has a two-prong strategy. 1) Seek to pressure the ECB to resume its SMP program of sovereign bond purchases. The ECB has not bought sovereign bonds since March. 2) Join forces with others, including Italy and France seeking to allow banks to borrow directly from the ESM. ECB's Draghi also supports efforts for governments (funding ESM) to support banks rather than the central bank.

Beware The New STD: Sovereign Transmitted Debt

Gallows humor perhaps, but Mark Fiore's satirical promo of a fictional pharmaceutical company pushing its cure for the sovereign transmitted debt, was shown at last week's NYU/Moody's Credit Risk Conference to broad appeal. 

Six Observations to Start the Week

The US dollar is little changed against the major foreign currencies and showing a slightly heavier bias against many of the emerging market currencies. The dollar is largely trading within the ranges seen last Friday, with the holiday in the UK (today and tomorrow) sapping some liquidity. Asian equity markets are broadly lower, with the MSCI Asia Pacific Index off 2.25%. Europe bourses are mostly higher, though the DAX is 1% lower. Of note, Spain’s IDEX is up about 2.5% with financials leading the way (+3.7%). Core bond markets are under pressure, while European peripheral bonds are higher. We share six observations to begin the week.

1. The latest string of data confirms a slowdown in many part of the world economy. In emerging markets, China and India growth has weakened. The drop in oil prices is not good for Russia. Among major developed economies the news has not been good. After avoiding a contraction in Q1 due nearly solely to Germany’s 0.5% expansion, the euro area is unlikely to be as lucky in Q2. The weakness in Europe and in its non-European export markets warns that the German engine is tiring. The economic downturn in Q1 in the UK is greater than expected. Forward looking indicators are not very promising even if the Olympics provide some brief fillip. In the US, Q1 GDP was revised down and the most important economic report, non-farm payrolls were dismal and were coupled with downward revisions of almost 50k in the March and April series. The Japanese economy has been bolstered by the recovery from last year’s tragedy and reconstruction efforts. However, weakness in its major export markets may remove a key support for the economy.

Commitment of Traders Report and Technical Outlook

The latest Commitment of Traders report covers the week ending May 29.  Generally speaking non-commercial participants in the futures market were dollar buyers, either by adding to net short foreign currency positions, such as the euro and Australian dollar, or by reducing net long positions, as was the case in sterling and the Canadian dollar.   However, in the yen, Swiss franc and Mexican peso, the net short positions were reduced.  

Unlike most analyses of this weekly report, we find that drilling down into the gross speculative (non-commercial) positions sheds light on important shifts which just focusing on the net position misses.  Moreover, we think there is an important distinction between new buyers coming into the market and old shorts covering, yet the conventional interesting in the net position obscures.

Great Graphic: Bank Exposure to European Debt

For those of you who (unlike my brilliant webmaster) are not off to the American Craft Brew Fest today, here is a great [interactive] graphic from Reuters on bank exposure to European Debt. You'll have to click on the link to see it. Happy Saturday!

Great Graphic: European PMI Readings

Here is a Great Graphic from the Financial Times.  It captures the weakness in the core, as in Germany, France and the Netherlands.  It also underscores the problem Spain faces.  Its PMI was below Greece's.  The prospects for such a weak economy can only make its regional and banking problems more acute.  Ireland is the strongest, but given the weakness in its major trading partners and the US, the risk seems on the downside. 

Dollar Comes Back

The US dollar is recovering from the earlier QE and G7 speculation.   The dollar's price action is a bit like a beach ball brought underwater.   Even if I am wrong about QE (that it is unlikely), the fact of the matter is that China, Australia, the ECB and the BOE will respond before the Federal Reserve.  

In addition, while the US employment data adds a new twist, the overriding factor for investors remains the existential crisis in Europe.  The distinction between urgent and important is key.  The US is important, but Europe is urgent.  

Shockingly Poor US Employment Data

The US employment report was simply terrible. Adding insult to injury, the April data were revised lower as well. The dollar initially firmed, but as participants consider the risks of QE3, the upside momentum stalled.

Non-farm payrolls rose 69k, less than half of what was expected and the April job growth was cut to 77k from 115k initially. The private sector added 82k jobs vs 87k in April. For the first time since 2011, the unemployment rate ticked up (to 8.2% from 8.1%). Hourly earnings edged up, but by only 0.1% and not the 0.2% the consensus forecast. The year-over-year pace of 1.7% is the lowest since Dec 2010. The work week slipped and this is also important in terms of full time equivalent output. Manufacturing added 12k workers, while construction lost 28k. Retail added 2k and the government lost 13k.

News Stream Poor, Look Out Below

It is difficult to envisage a poorer stream of news that the market received earlier today.   Weak reports increase the prospects of a policy response soon.  China could cut reserve requirements this weekend.  Next week the RBA, ECB and BOE meet and the risks have increased for for action.  The issue in Australia is between a 25 and 50 bp cut.  The ECB, as we have noted, could deliver a rate cut.  The BOE may resume its gilt purchases. 

The poor China PMI (50.4 from 53.3 in April and consensus of 52.0) got the ball rolling, sending the major currencies, including the Australian dollar, lower.  A modest bounce was seen in late Asia, but the news stream from Europe triggered new selling and new lows for the euro, sterling and Australian dollar.