Initial Reaction to Bernanke: USD and US Assets Firm

As the draft of Fed Chairman's Bernanke speech at Jackson Hole made the rounds, the US dollar as pared back some of its earlier losses, US yields have eased and equities retraced part of the opening losses.   

However, the dollar quickly was sold and many of the major currencies have made new highs on the day, though stocks and bonds are maintaining their initial reactive gains.    

Bernanke's speech appears to justify past asset purchase programs.  He cited one study that suggests these efforts may have helped boost GDP by 3% and help create 2 mln jobs.  He recognizes the risks of additional purchases, but believes those risks are manageable.

Dollar Heavy While Waiting for Bernanke

The US dollar is trading softly in the lead up to Fed Chairman Bernanke's speech at Jackson Hole.  The price action is still one of position adjusting.  While the euro and Swiss franc have made new multi-week highs against the dollar, sterling ad the Australian and Canadian dollars have moved through yesterday's highs only in early North American activity, dragged up apparently by the euro. 

The dollar has made a marginal new low for the week against the yen, by around 4 ticks.  The range for the week is now JPY78.40-JPY78.84, according to Bloomberg.  Participants are also aware of month end adjustments and the long-holiday weekend in the US as factors impacting the price action.  Our views have not changed, but see that a Reuters poll finds our views are not in such a minority any more.  The poll found 44% expected QE to be announced at the next FOMC meeting,  down from 70% last month.  

Great Graphic: Green Monster

When you think green and wicked big in Massachusetts you probably don't think jobs. But you should. This Great Graphic comes from Green Tech Media. In the past year Clean Tech jobs in Massachusetts grew 10 times faster than the overall economy.

Is this the Price Signal We have been Waiting For ?

The dollar is finding firmer footing today. It does not appear that it is in response to any fresh fundamental development.  That the Slovakian Prime Minister sees a 50/50 chance of EMU collapsing is hardly significant and matches up well with what some predictive markets see by the end of next year.   

The dollar rally began at the tail end of the European session after it had been under some mild pressure earlier. This strikes us as important.  The most compelling explanation is that it is position squaring, and in the current context, that means covering short dollar positions, ahead of Bernanke's much awaited Jackson Hole speech tomorrow.

Great Graphic: US Banks Flush with Deposits

This Great Graphic was posted on Sober Look. It shows the increase in deposits at US commercial banks.  It is based on Federal Reserve data.  These deposits are hitting a record high here in late August.  

Clearly the problem is not that US banks do not have sufficient capacity to lend.  The rise in deposits is partly a function of the increase in US savings which has risen from about 1.7% on the eve of the crisis to about 4.4% at the end of Q2 12.  

Short Note on Significance of the Price Action

The euro is leading the charge against the dollar today.  There was some talk of reserve manager interest, but the price action must largely be understood as position adjusting ahead of Bernanke's Jackson Hole speech.  News that Draghi is not going to attend the confab after all, generated much grist for the rumor mill, but substantively, we argued that there was not much new he would say in the US about the future of ECB policy.  

The euro is enjoying a strong bounce off the four-day low seen in Asia that entered the support zone we identified here in the $1.2420-60 area.  Although the intra-day momentum studies are stretched, there is scope for additional follow through gains over the next couple of days.  We continue to see a break of $1.2600 spurring euro gains toward $1.2700.  

Draghi: Call Me Maybe

ECB President Draghi appears to have gotten as much as he can get with his word play.  He has been fairly successful.  The pressures that were threatening Europe via Spain and Italy in late July were reduced and summer holidays were still enjoyed by his well placed suggestive comments.  

Spanish 2-year yields fell from over 7% before Draghi to about 3.35% last week.  Italian 2-year yields fell from about 5.25% to just below 2.90% last week.  In recent days, the yields have consolidated 15-20 bp above those lows.  

Great Graphic: CPI under Gold Standard and QE

This Great Graphic was developed created by Matthew O'Brien of The Atlantic.  It illustrates that the gold standard that some want to return to did not generate price stability in the US in the 1920s.  It also illustrates the superior record of the Federal Reserve to anchor prices under the post-bubble conditions.

This type of evidence, however, will not put the gold argument to rest (sorry Mr O'Brien).  One of the purported virtues of a gold standard is that is, well, a standard as opposed to the whim or discretion of a handful of unelected individuals.  Some argue, in effect that a poor standard is better than no standard over time.

Two Non-Starters to Begin the Week

Two ideas percolated last week.   Although widely different, they will have the same fate.  Ignoble deaths.  Yet, an understanding of their brief lives may help shed light on the current investment climate.

In the US, a draft of the Republican Party platform calls for the establishment of a commission to look into re-linking the dollar to gold.  In Europe, there was some talk of a possible temporary Greece exit from the monetary union.  Neither is very practical.

Great Graphic: Big Companies Domiciled in Small Economies

This Great Graphic is from The Economist.  There are several ways to understand it.  It may suggest how some small economies can be dominated by a single company, such as Finland's Nokia and Taiwan's Hon Hai   It may also draw attention to where a company chooses to be domiciled, locate headquarters, such as Arcelor Mittal.  In part, this is a function of the quest for economies of scale and globalization.  

Where a company is domiciled is necessary but insufficient information to understand its role in a country's economy.   Often much of the value-added work is done elsewhere.  The share of the nation's taxes, or employment accounted for by these companies do not appear to be well correlated with revenues as a share GDP.  

FX Technical Outlook and Futures Positioning

There are two main drivers behind the price action in the foreign exchange market and they will likely persist in the days ahead.  First, there continues to be position adjustment ahead of the what promises to be eventful few weeks.  Second, the release of the minutes from the August 1 FOMC meeting has increased the perceived odds that QE3 is launched at next month's meeting.  Both of these drivers generally weighed on the dollar and extended the month-long downside correction.

Ahead of Bernanke's Jackson Hole speech, these forces may continue to dominate.  However, we think that underlying fundamentals remain dollar positive and expect them to begin reasserting themselves shortly.  Below, we draw your attention to two potential early warning signs.  The first is that although the next speculative futures position swung to the long side in sterling, we note a potential reversal pattern late last week.  Often it seems that sterling leads euro moves.

Great Graphic: Thoughts about Income Distribution in the US

This Great Graphic comes from the Real-World Economics Review blog.   It is from Pew Research Center latest study.  Essentially it divides America by income into three groups.  The lower income group draws income that is less than 67% of the nation's median.  The middle income group earns income that is between 67% of the nation's median and 200%.  The upper income denotes households earning more than 200% of the median.  

The results are hardly surprising.  The middle class in America has, in the first decade of the new century, fallen in size and moved backwards in terms of income and wealth.  In Pew's research, this is the first time this has happened since the end of WWII.

Time is Money and other Fetishes

Doesn't the idea that "time is money" capture the spirit of modernity?  Yet the Greek Prime Minister is suggesting that all Greece needs is some breathing room, given the depth of the economic contraction.  It does not need any more money, he tries to reassure.  

The Troika will not find this believable.  Press reports suggest the IMF projects that even without the 2-year extension that Samaras is pleading for, Greece will need another 13-14 bln euros to cover the 2015-2016 period.  If a 2-year extension is granted, the IMF reportedly projects Greece needs to be  twice this.

Great Graphic: Labor (Im)Mobility

This Great Graphic comes from Zero Hedge, which posted this article from Azizonomics.  It provides some numbers to the well appreciated fact that the US enjoys greater labor mobility than does Europe.

While this is helpful, there are a few caveats to keep in mind.  First, mobility of state lines (US) or cross-border (Europe) is only one kind of mobility.   A fuller analysis of mobility would include movement between industries and even jobs within the same industry.

Second, the data is almost 4 1/2 years old.  How has the economic and financial crisis impacted labor mobility?  It seems that some countries, like the periphery of Europe, rely extensively on the family for economic support.  This may, in part, be a function of the type of welfare system has emerged.  It often features more limited unemployment compensation.  The market for support services, including child care, for example, may also be less developed; further encouraging reliance on the family.  Third, countries that have experienced a sharp drop in housing prices may also experience less labor mobility as households are tied to the depreciating asset.

When the Inevitable is Evitable

In recent weeks, the market had appeared to be scaling back expectations of another round of asset purchases by the Federal Reserve.   US 10-year Treasury yields rose nearly 40 bp since the August 1.  The reconsideration was spurred by a single word:  Data.

Consider what investors and policy makers have learned since the FOMC last meeting concluded on August 1.  Private sector non-farm payrolls posted their strongest growth since February.  The four-week moving average of weekly initial jobless claims has fallen back to levels last seen in March.  Consumption increased, as retail sales (roughly 40% of personal consumption expenditures) rose by the most since February.  Industrial output and manufacturing continue to expand (the latter increased at an annual pace of more than 6% in June-July).  Consumer confidence has increased and forward looking data suggest the economy is accelerated as Q3 got under way.

Bloomberg: Weak US Retail Sales Gives Yen Advantage

Here is an interview I did last month for Bloomberg. I really need to get better about telling my brilliant webmaster about these things so she can post them :)

Great Graphic: Euro and Sterling Testing Key Levels

These Great Graphics are from my Bloomberg.  The one on the left is the daily bar chart of the euro.  It shows that the strong gains on August 21 have carried the single currency to its highest level since July 5 and is testing a trend line off the June 20 and June 29 highs.  The single currency finished the North American session just off its intra-session highs.  Technically, a break of that trend line could see follow though gains toward $1.2600-$1.2700.  

The euro has surpassed the $1.2440 area suggested here, but our argument about the euro was based on both time and price.  We recognized the scope for additional market positioning ahead of what promises to be an eventful September.   Our big picture view has not been changed by the recent price action.

Great Graphic: US Private Sector Job Growth

Here is a Great Graphic that caught our attention.  It comes from Matthew O'Brien of The Atlantic courtesy of Business Insider.   It provides in convertible proof that there has been private sector job growth over the last four years. In fact, during the Obama Administration there have been a net creation of 427k private sector jobs.  I suspect this number can more than double before the next inauguration.  Of course, from a political, economic and social point of view this is hardly sufficient.   

The total dollar value of the goods and services (GDP) the US produces has never been higher, but it is being produced with fewer workers.  This job creation record appears to be actually somewhat better then the other so-called jobless recoveries.  As noted before, a key way this recovery is unique is that government  employment continues to decline.  

Of course, even if the President of the United States is among the most powerful people on the planet, he cannot control all the forces that impact private sector employment.  During the eight years that preceded the Obama Administration, the US economy lost a net 170k private sector jobs and it cannot all be put at the feet of the last president.  The FIRE industries, that is finance, insurance and real estate were the previous engine of private sector job growth and that is precisely the sectors at the heart of the crisis.  

Dollar Bends, but Doesn't Break

The US dollar is broadly lower against nearly all the major and emerging market currencies.  Its firmer tone against the yen is the main exception.  Risk-on is the general theme de jour.  Equity markets are mostly higher in Asia and Europe.  Peripheral bond markets are also firmer, as the Spanish and Italian rally continues.  Core bond yields are mostly higher.  

The advance in the foreign currencies has left them a bit over extended at the start of the North American session.  Day traders have to decide whether its a trend day or a consolidative day.  Given the choppiness of conditions and the lack of important fresh developments, we are more inclined to see the latter.  Look for the dollar to stabilize and claw back some of its losses.  However, as we noted in our weekly positioning and outlook report some adjustment in positioning is likely ahead of key events next month.  

The Churn Burn Continues

It looked as if foreign exchange operators were going to take heart from the weekend reports that seemed to play up the possibility of unlimited ECB action in terms of both time and scope to target interest rate spreads in the euro area.  The euro looked poised to extend its recent gains, and drag the other European currencies with it.  The risk-on environment was going to lift the dollar-bloc currencies.  The yen was to stay out of favor.  The dollar did make new highs for the move against the yen, but this was not sustained and the greenback has been confined to last Friday's ranges against the other major currencies, including the euro.  

As the North American session began, the ECB denied that it has discussed what Italy's Monti has called a "spread shield".  This hit the euro, although Spanish bonds remain broadly higher on the session, extending their recent advance.  The Bundesbank's monthly report reiterated the reluctance of the German central bank to support ECB bond purchases.   Asmussen, the German representative on the ECB governing council tried, over the weekend, to bridge the gap and argued that neither the BBK nor its president, Weidmann are isolated, but the BBK's monthly report plays up  strident, even if understandable, stance.

Does Making Sense of the Dollar still Make Sense?

Today is the third anniversary of the publication of my book, Making Sense of the Dollar:  Exposing Dangerous Myths about Trade and Foreign Exchange.  The book presented big picture and long-term arguments about the future of the dollar and, more generally, the US commercial expansion strategy.  

The thesis of the book is simply that the dollar and that expansion strategy is more durable than many--both friend and enemy--suspect.  I place it among the early responses to the current iteration of declinists, who believe the United States and the dollar are in an inexorable decline.

Great Graphic: Value of College Degree

This Great Graphic comes from The Atlantic.  It provides evidence in the ongoing argument over the market value of a college degree.   In the US, expenditures on higher education are considered consumption.  However, a more compelling case can be made that such expenditures are an investment and that such an investment is associated with a higher income stream.  The US spends a higher share of its GDP on higher education that other countries and if these expenditures were "properly" accounted for, US internal imbalances would not appear as extreme is by conventional optics.  

Of course, this says nothing about how a college tuition is paid for (the growing problem of student loans) or that college tuition continues to rise faster than inflation (when will that bubble pop?).

There is also a non-market value of college education.  It has to do with understanding, as in understanding one's society and history, its literature and it understanding of itself.  One also has an opportunity to learn about other societies, their history and culture.  One can learn the latest understanding of the natural world.  But it is not just content, it is also learning how to think critically and how to express one's self in writing and speech.

One of the transformations of education is that in high income areas and countries, it is becoming a life long process.  Adult education, which does not necessarily lead to a degree, but allows one to formally explore interests, appears to be a growth industry. 

Currency Positioning and Outlook

The market is like expectant parents who don't know the gender of the fetus.    They know something big is around the corner, but they don't have enough information to make some important decisions.  They can contemplate the future, but they are not sure of any scenario.    

Perhaps former US Defense Secretary Rumsfeld was not always wrong.  There are some known unknowns.  The event risk is palpable and outcomes are important.  Yet, the implied volatility of all the currencies looked at here are near multi-year lows, except the Mexican peso, which is low, but still a 1 percentage page above the year's low.  The volatility of the S&P 500 (VIX) is also at lows for the year. Typically, large moves take place in low vol environments.  The market's spring is coiling and may coil further.  With volatility so low, participants may be find that buying options are a cost efficient way to express views.   

In the mean time,  the Commitment of Traders report shows speculators in the futures market continue to shift funds into the Canadian, Australian and Mexican peso.  There seems to be less of a clear pattern in the other currency futures.   However, there are a few points to share.  Although they have been pared, the speculative community still have a substantial short euro position.   In addition to the high yielding dollar-bloc and peso, speculators have continued accumulating yen positions.  They have lost much interest in trading the Swiss franc and the bulls and bears are near equilibrium in sterling.  

Summary of Big Picture Views

In golf, it is said "drive for show and putt for dough".  In learning to drive an auto, one is often advised the exact opposite.  "Aim high in steering", one is told, which means that rather than look a few feet in front of the car, look further down the road. 

Given current market conditions, summer vacations and the numerous key events in September, investors are better served by the auto advice than the golf advice.  To facilitate this, we summarize our main G10 views here: 

Great Graphic: FX Deposits in China

This Great Graphic comes  from the Also Spracht Analyst blog.   It decomposes the strong shift into foreign currencies from the yuan by Chinese businesses and households. 

 In July,  the household demand for foreign currencies was largely flat.  It has increased by about a fifth from a year ago.  Foreign currency deposits from from non-financial institutions was up to US$287 billion and now is up almost 85% from a year ago.   

When the yuan was strong, Chinese officials sought to ease some of the pressure by liberalizing--making it easier--to export savings.  There has also been a change in yuan's outlook.  Previously appreciation was expected, but as the economy has weakened and growth rather than inflation is the main policy challenge, modest depreciation is more widely anticipated.   The yuan is off about 1% this year against the dollar.  The 12-month non-deliverable forward implies about a 1.5% appreciation of the yuan, though this is also a function of supply and demand offshore. 

Market Update and Thoughts on the Canadian Dollar

 The US dollar is narrowly mixed as North American traders return to finish out the week.  The euro and Swiss franc are the strongest majors on the day and week.  Continued recovery in Spanish and Italian bonds and stocks has helped lift the euro.  The rise in core interest rates (15-17 bp this week for US, UK and German benchmark 10-year bonds) appears to have been one of the key drivers weighing on the Japanese yen.

After moving convincingly through the 200-day moving average yesterday, the dollar has stayed above there (~JPY79.20) , while the euro is trading at one month highs against the yen as well.  The antipodeans and Scandis join the yen in under-performing this week.  Unwinding of crosses against the euro seems like a common thread.  Weak iron-ore prices, some weak sentiment readings and concerns about China also may have weighed on the Australian dollar.

The pullback in the yen continues is helping underpin Japanese equities.  With the 0.8% rise in the Nikkei today, its weekly gain is 3%, which is more than a third of the year's rise.  Despite good foreign buying this week, the Korean and Taiwan equity markets were uninspiring with today's losses leaving both up about 0.3% for the week.  After testing last month's multi-year low near 2100, the Shanghai Composite recovered to close fractionally higher.  European bourses are higher, with the Dow Jones Stoxx positing 0.5% gains near midday in London, led by Spain and Italy.  Technology and financials are the strongest sectors in Europe today.

Is it Shuttle or Shuffle Diplomacy in Europe?

Currency in Crisis

There is one main feature of the euro zone economic data next week. Yet the flash PMI readings are unlikely to be sufficiently different from the July readings to prompt a reassessment of the trajectory of the regional economy. More important than the economic data will be the political maneuverings.

There will be a flurry of meetings between Samaras, Merkel and Hollande. Nearly three years after the Greek crisis began, Greece is still not on a sustainable path. After agreeing to new austerity measures, despite the economy contracting for its fifth year, Samaras appears seeking some breathing space of its official creditors after having given the private creditors a significant hair cut earlier this year. Samaras is seeking a two-year extension of it fiscal targets. Such a request is not completely unprecedented. Recall the EU granted Spain a 1-year extension after Prime Minister Rajoy unilaterally lifted its own fiscal target.

Great Graphic: Wind Infographic

It's National Wind Week and to celebrate Obama tweeted the following:

I could not agree more. (And neither could my brilliant webmaster who left the finance industry to go work in clean tech). Here is a great graphic she found from the DOE on Wind Energy in the US:

Great Graphic: Nominal Effective Exchange Rates

This Great Graphic comes from an email I received from Thomson Reuters.  It charts the nominal effective exchange rates (NEER)of the dollar, euro, Swiss franc and Australian dollar.  It is weighted by trade partner, but is not adjusted for inflation.  Some economists take the NEER measure and adjust for inflation.  This generates a real effective exchange rate (REER).  Both capture a dimension of general competitiveness.   

The strength of the Australian dollar and to a lesser extent, the Japanese yen is underscored here.  The fact that the euro is weaker is not surprising.  What is noteworthy is the softness of the US dollar. There have been some reports suggesting that the rise in the dollar will curb US exports.    Yet, US exports are at record highs and the latest data (June) puts them up 7% from a year ago.  

As we noted yesterday, Obama's goal of achieving a 50% rise in US exports during his term has been nearly reached.  US exports have risen 48% since early 2009.   At the same time, when ever one thinks about US exports, keep in mind that US companies service foreign demand primarily by building locally and selling locally.  Sales by majority owned affiliates of US multinationals sell 4-5 times more goods abroad than the US exports.  The US has pursued primarily a foreign direct investment strategy rather than the more traditionally export strategy. 

UK Goes Shopping (sort of) and Euro Observations

The US dollar is mostly softer against the major currencies.  Its five week high against the yen is an exception to the generalization and is coinciding with 4-week rise in US bond yields.  That move began prior to the string of better US data that now includes jobs report, retail sales, and industrial output.  Other core bond yields have risen, including Japan's, but US rate have risen more.   

Sterling got a bit of a fillip from the better than expected retail sales report (0.3% vs -0.1% consensus and the June series being revised to 0.8% from 0.1%).   Although it is continuing to flirt with the 200-day moving average (~$1.5720), the market seems reluctant, perhaps appreciating the stronger cap a bit closer to $1.5800.  The yen's weakness translated into a 1.9% rise in the Nikkei with led the MSCI-Asia Pacific Index to a 0.5% gain.  Comments by Chinese Premier Wen suggesting scope for new stimulus weren't enough to offset the dramatic weakness in direct investment in China, which fell 8.7% year-over-year, more than three times the decline the market expected.  The Shanghai Composite is approaching the multi-year low set in late July.  European shares are mixed, though Spain and Italy are continuing to out perform. 

Sterling Update: What is the BOE Thinking?

This is the big week for UK economic data. The firm CPI figures yesterday were followed by somewhat better than expected employment data today and the MPC minutes. The slew of data concludes tomorrow with the July retail sales data, which are expected to be soft (Bloomberg consensus -0.1% on headline).

The high frequency data does not change the overall picture of the UK economy. It has contracted for three consecutive quarters through Q2's 0.7% contraction, which the MPC minutes echoed BOE Governor King in playing up one-off factors for the out-sized decline. However, most of the forward looking data warns that the UK economy appears to be declining here in Q3, even if at a slower pace.

Great Graphic Europe's Commercial Empire in Retreat

This Great Graphic comes from Alea and Deutsche Bank.  Just like the end of the Great War saw the UK and France pullback from their territorial empires, with some pushing from the US (see the Suez Crisis and Indochina), the existential crisis in Europe is forcing a retreat from the commercial empire.  There are numerous examples.  This is one.  European banks have reduced their US presence by about a third.  Japanese and Canadian banks have moved into the space vacated.  This broad process of Europe's retreat may also help explain one of the forces acting to slow the euro's decline--repatriation of sorts to cover holes at home. 

Narrow Ranges on End of Bretton Woods Anniversary

The US dollar has been confined to ranges against the major foreign currencies that have largely been seen already this week.   The exchange rates may feel fixed now, but they are not and today, in fact marks the 41st anniversary of the end of the Bretton Woods agreement. They are churning as the players mark time in lieu of fresh incentives and holiday conditions prevail in parts of Europe.  There may be a bit of disappointment with the lack of follow through gains in the euro, leading to some liquidation.  Initial support for the euro is seen in the $1.2240-60 area, with $1.2320-40 serving as a cap.   US data, especially the industrial production/manufacturing reports, but also the Empire State survey, should add to the accumulating evidence that the economy has improved here in Q3. 

South Korean and Indian markets are also closed for holiday.    Equity markets are mostly lower.  The MSCI Asia Pacific Index fell 0.5%.  As hopes fade of near-term stimulus Chinese shares tumbled 1% and posted the lowest close in nearly two weeks.  In Europe, the Dow Jones Stoxx 600 is off about 0.25% near midday in London, led by a decline in basic materials and miners are particularly hard hit.  Going into this week the Dow Jones Stoxx 600 had advanced for ten consecutive weeks.  It is currently unchanged since the end of last week.  Spanish and Italian yields are lower. 

Is Rajoy Serious or is He Just Flirting?

A Spanish newspaper is reporting today that a formal request for EFSF aid for domestic banks can come as early as this week. This would be seen to clear the way for the payment of the first tranche of the 100 bln euro bank aid package that had been previously earmarked. That in turn could help meet the conditionality outlined by Draghi that would allow the ECB to buy Spanish bonds.

Rajoy himself continues to keep his card close to his vest. After meeting with the King earlier, Rajoy said that his decision still depends on knowing how the mechanism will work and the new conditions associated with ECB bond purchases.

Great Graphic: Average Interest Rates on Debt

This Great Graphic comes from Also Sprach Analyst blog.   It depicts the yields of the periphery and Germany in an important way that is often overlooked.  It shows the average yield that the countries are paying on their debt.   Many observers  focus on some part of the curve, which helps make comparative claims and generates relative value trading ideas.   

Yet from the perspective of a country, the average yield on the outstanding government debt is what really matters in terms of debt servicing costs.  The chart also shows that although there is been some divergence in recent years, the lion's share of the convergence that took into the run-up of monetary union has been retained this far.    An important caveat, however, is that a way to achieve lower debt servicing costs is to shorten maturities, that is reduce the average maturity.   The drawback of this is that it forces countries to be more dependent on short-term financing and frequently returning to the market.  

Should ECB Sell Bunds?

The US dollar is  mostly softer as the broad position adjustment phase continues.    Whatever momentum there was though eased in the European morning after the modest upside surprise in German and French Q2 GDP estimates failed to translate into a stronger euro area GDP figure.  The 0.2% contraction was spot on consensus.  The German economy expanded 0.3% in Q2, but as today's ZEW survey and the recent PMI surveys suggest, Q3 is off to a weak start.  France was flat in Q2 rather than have contracted slightly as the market expected.  The $1.2385-$1.2400 offers resistance now for the euro, while initial support is seen near $1.2320.

The first increase in UK CPI (2.6% in July from 2.4% in June) since March saw sterling spike to record the session high near $1.5730 before pulling back. Provided the $1.5670-80 support holds, sterling can continue to edge higher.  In six of the past seven sessions sterling has risen above the previous day's high. For its part, the dollar has been confined to a 15 tick range on either side of JPY78.15.  The market's attraction to the dollar-bloc currencies we have noted appears to have eased and appear to have entered a consolidative phase.

Why Greece is Still the Word

While, the German Constitutional Court ruling on ESM and implementation of Draghi's conditional proposals for the ECB to buy Spanish and Italian bonds are awaited, Greece is looming large. A German paper reported over the weekend that the deputy parliamentary leader for the CDU threatened that if Greece does not fulfill its obligations, Germany would veto any additional EFSF payments to Greece.

Before the weekend, Greece reported that its state budget deficit, which exclude state-managed enterprises, stood at 13.2 bln euros in the Jan-July period compared with a 14.8 bln euro target. Earlier today Greece reported its economy contracted 6.2% in Q2 over Q2 '11.

Great Graphic: Housing Market Recovery in Perspective

This Great Graphic from Calculated Risk puts the US housing market recovery in the context of past recoveries.  Two points are clear.  Single family house starts is recovering and it is historically weak.  The July data is slated for release on Thursday, August 16.  

A small decline is expected after the 6.9% increase in June.   June starts of 760k was the strongest since October 2008.  Permits peaked in May at 784k, the highest since September 2008.  A small increase is anticipated in July, but not enough to offset June's 3.7% decline. 

Market Update and Three Items that Should be on Your Radar Screen

 The US dollar remains confined to its recent well worn ranges against the major currencies.   A quiet Asian session gave way to a euro bounce in the European morning, which was the main price action.  Euro gains were across the board and but with intra-day technical readings stretched, look for the $1.2335-50 area to cap it. 

The much anticipated cut in China's required reserves failed to materialize and Japan reported Q2 growth at 0.3% (quarter-over-quarter), half of the consensus expectation.  This weighed on Asian equities and the MSCI Asia Pacific Index slipped 0.2%.  The 1.5% loss in the Shanghai Composite is the largest in a month, with industrials, technology and financials the weakest sectors. 

After a soft starts, European bourses turned higher, led by utilities and financials.  The UK is under-performing, but the financials are the strongest sector.   A respectable 12-month bill auction in Italy may be helping Italian equities outperform today.  Italian and Spanish 10-year yields are a few basis points lower, while 2-year yields are a few basis points higher.  Core bond yields at both ends are a bit higher, while US yields are a touch softer.

Great Graphic: Financial Disintegration Revisited

This Great Graphic from Sober Look is taken from the ECB's latest report.  It provides more evidence of our presented here and in our recent letter to the editor at the Financial Times that the financial integration process in Europe is going in reverse. 

Financial integration is the cross-border movement of capital. A key part of this integration process was that the private sector in creditor nations recycled their surplus to the deficit countries.  This process is now going in reverse, hence financial disintegration.  

The chart to the left depicts the decline in cross-border movement of overnight money market transactions.  A point the ECB underscores is that country risk is the most important consideration when banks assign counter-party credit lines.  

The chart to to right shows another dimension of the financial disintegration.  If the home bias has returned, and banks are buying primarily assets in their own countries, then the collateral they will have (which are those assets) are also going to be less international.   And that is exactly what is happening.

European economic and monetary union was predicated on convergence.  What we are talking about here is divergence.  Financial integration was an essential part of the glue that holds the  disparate region together.  Since European officials define the problem differently, such as the breakdown of the transmission mechanism of monetary policy (ECB) or fiscal recklessness (Germany), they have not deigned to address it. In this context, our concern is official attempts to deal with the monetary transmission mechanism or the fiscal crisis will make it more difficult to arrest the financial disintegration. 

Currency Positioning and Outlook

Market positioning in the week ending August 7 suggests that speculators in the futures market generally agree with our assessment that ECB President Draghi's recent proposal was not a game changer.  The recent pattern continued.  Essentially what this entails is buying the Australian and Canadian dollars and Mexican peso and some light position adjusting in the other currency futures--euro, yen, sterling and the Swiss franc.

Although many observers see the strength of the dollar-bloc currencies and peso, but also the Scandi currencies and the Polish zloty, for example, and conclude that the speculative operators are selling the euro on the crosses.  However, the Commitment of Traders report does not bear this out.

Quick Data Review

The economic reports for Canada and the US have been off consensus. We briefly discuss these and the implications.

1. Canada's jobs report looked worse than it was. The Canadian dollar dropped on the news, but the BoC will not be swayed by the optics and it will retain its hawkish rhetoric. The Bloomberg consensus has looked for a minor 6k job growth. Instead Canada reported a 30.4k decline. Yet this was due to the decline (51.6k) in part time jobs. Full time jobs actually grew 21.3k, which would be roughly the equivalent of 210k job creation in the US. The tick up in the unemployment rate is a function of a decline in the participation rate. The Canadian dollar remains among the strongest currencies this week, gaining about 0.5% against the dollar, second only the Norwegian krone (0.75%). Momentum traders have helped drive the euro to new record lows against the Canadian dollar today.

Key Crop Report Ahead of Weekend

The US dollar is trading at its best levels for the week.  Two factors seem to be behind the firmer tone.  The first is technical.  The lack of follow through dollar selling after last week's poor close is prompting some position adjusting.  Second, disappointing Chinese data (trade and bank loans) renews fears that the world's second largest economy has not yet bottomed and this fanned the risk-off.

This is also evident in the equity markets, which are finishing the week on a down note.  The MSCI Asia-Pacific Index was off about 0.5%, though foreign buying of Korea and Taiwan equities have helped those markets buck pressure and outperform today and this week.  European bourses are paring this week's gains.  The  Dow Jones Stoxx 600 is off about 0.3% near midday in London.  Although all sectors are lower, financials are among the best performers.  Spain and Italian yields are slightly higher in both the short and long ends, but largely consolidating the recent sharp decline in yields seen in anticipation of official action next month. 

Great Graphic: Central Bank Balance Sheets

This Great Graphic comes from the FT Alphaville, who picked it up from Credit Suisse.  It shows that as a percentage of GDP, the ECB and BOE's balance sheets are larger than the US. The fact that the ECB's balance sheet grew more through lending than bond buying is illustrated by the second chart.  If, as many expect, the Fed does announce another $600-$700 bln of bond (including MBS) purchases, it would boost the Fed's balance sheet by about 5% of GDP, which would still put it below the ECB and BOE.  Indeed, Draghi's proposals suggest the ECB's balance sheet may also increase.  The BOE is already expanding its balance sheet via gilt purchases, is is expected to continue its efforts, when the current program is completed. 

ECB's Greek Fudge: Nutty and Stale?

The ECB has made some decisions regarding Greece that clearly indicate it does not want to push Greece out of monetary union. It has gone so far as to essentially allow the Bank of Greece to fund the Greek government. 

Consider the sequence of events. There was a 31.5 bln euro aid tranche that was due in June that the Troika delayed disbursement of pending commitments from the new government. This included 25 bln euros to recapitalize Greek banks.

 

Without have the aid assured, the ECB seemed to have little choice and last month decided to no longer accept Greek bonds (or Greek government guaranteed bonds) as collateral for refi operations. Facing a 3.2 bln euro bond redemption (held incidentally by the ECB), Greece reportedly asked for a bridge loan to cover until the aid tranche is paid. The ECB refused. Greece sought to trigger a clause giving it a month grace period for its payment. The ECB refused.

Game Changers

The US dollar is narrowly mixed.  Consolidation still appears to be the main feature, though sterling and Australian dollar and Canadian dollars have marginally extended recent gains.  In contrast, the euro recorded a new low for the week.  The next level of support is seen near $1.2380.  

A further decline in Chinese CPI (1.8% July vs 2.2% in June) and a series of softer than expected data fanned hopes of new near-term easing of policy which in turn help buoy Asian equity markets and the MSCI Asia-Pacific Index rose about 0.75% to a new three-week high.  European bourses are marginally higher, with financials among the strongest sectors.  Debt markets are quiet.

Japan Update

There are three developments in Japan to note: political compromise over the retail sales tax hike, outcome of BOJ meeting and economic developments. Despite some press reports playing up the likelihood of official intervention, we continue to see the odds as slight. The dollar-yen exchange rate remains confined to a JPY78-JPY79 trading range. 

While the euro has recovered around 4% against the yen in since late July, we expect a return to the lows as the European debt crisis remains unresolved (and arguably unresolvable in the near- to intermediate term).

Great Graphic: Borrowing from the ECB

Here is a Great Graphic from Sober Look.  It shows the peripheral countries borrowings from the ECB.  It is clear from the chart why the focus is on Spain.  Its bank borrowings from the ECB continue to rise precipitously.  Italy's bank borrowings appear to be leveling off albeit at elevated levels.    Ireland and Portugal bank borrowings are largely stead.  Nevertheless, we remain concerned that Portugal may not be able to return to the capital markets in the second half of next year as currently envisioned by the Troika.  

Redenomination Genie Remains Out of the Bottle

The US dollar is trading with a firmer bias today, but largely remains confined to recent ranges.  Sentiment remains cautious.  Participants seem to lack a near-term focus, but the failure of the foreign currencies to build on last week's gains is a bit disappointing, though the pullbacks have been shallow.

Global equities are mixed.  The MSCI Asia Pacific Index rose about 0.3.  While the Nikkei rose to a four week high, following a larger than expected current account surplus for June, which helped boost exporters, the China's shares gave up most of the early gains ahead of tomorrow's inflation reports.  European bourses are lower, with the Dow Jones Stoxx 600 is off almost 0.5% near-midday in London and all the major sectors are under water.   Spain and Italy's 2-year yields are pushing higher for the second day.  The 10-year sector is more mixed, with the Spanish 10-year yield up 9-10 bp while Italy is flat to slightly lower.

Is OSI Next ?

The agreement struck earlier this year projects that Greece's debt to GDP ratio will near 120% in 2020. At the time, officials, including at the IMF, claimed this was meant the definition of sustainable. Investors were rightly skeptical. A Dow Jones report says the IMF is re-considering its position and now is interested in redefining sustainable to mean a 100% debt/GDP ratio.

Given that the private sector took a substantial haircut earlier this year, there is not much more savings that can be achieved imposing another "voluntary" haircut on them. Instead, the official sector, which holds about three quarters of Greek debt, needs to participate in some fashion IF Greece's debt profile is going to change substantially. And the IMF appears to be reaching the point that Greece's debt profile must change substantially IF it is to continue to participate in assistance programs.

Great Graphic: Subsidize This

Here is a great graphic my brilliant webmaster found over at Green Tech Media.

Consolidative Tone and Positive News from Unexpected Source

 The US dollar has been largely confined to yesterday's ranges against the major and emerging market currencies.  The Australian dollar is the notable exception, where it briefly pushed through $1.06 on the back of the stand pat central bank and no currency protest.

The general tone through the capital markets is consolidative.   Italian and Spanish are seeing yields rise across the curve today, though Greek and Portugal yields continue to fall.   Equities markets were firmer in Asia with the Nikkei rising to four week highs.    Tokyo is in the middle of earnings season and a third of the Topix is to report this week.   China's small rise was sufficient to extend its advancing streak to three days.   European bourses mostly higher, though the FTSE is being weighed by the 3.6% loss among financials and Italy and Spain also are seeing some briefly extending the ECB-induced rally to 10.1% and 14.9% respectively.

Sweden

Since mid-May the Swedish krona has been the strongest of the major currencies, appreciating roughly 4.5% against the dollar and nearly 9%  against the euro.

Sweden's interest rates are attractive, especially on a risk-adjusted basis. At 90 bp, the two-year note yield is considerably higher than attainable in the non-periphery of Europe and without taking on extra risk. In fact, all three main agencies recognize Sweden as a triple-A credit.

Four Observations to Start the Week

The US dollar begins the week consolidating last week’s losses after modest follow through selling was seen in Asia.     Soft UK house prices, anticipation of a dovish BOE quarterly inflation report midweek, and some cross rate selling has seen sterling under perform.   The other major currencies are little changed and the greenback is slightly firmer against most of actively traded emerging market currencies.   

Global equities liked the combination of ECB signals and stronger US jobs data and the MSCI Emerging Markets Index rose to near a three-month high.   Asia played a little catch-up, though Europe is managing to extend last week’s gains.   Meanwhile, European yields continue to fall.  The market is anticipating both an ECB rate cut and bond buying and this is particularly evident in the short-end of peripheral curves.

Great Graphic: Mr Market Exaggerates

At first the ECB's NATO strategy--No Action Talk Only--produced a sharp sell-off of the euro and Spanish and Italian bonds, especially the long end.  On second thought, the half glass was really half full and there was a dramatic rally of the euro and Spanish and Italian bonds.  The idea was the the ECB was preparing to support the bond markets of the "virtuous" countries.  

The reaction was nothing shy of spectacular.  Consider the effect of the one-two punch beginning with Nowotny's comment on July 25, apparently re-floating the idea of the ESM getting a banking license from ECB, through Draghi's promise do what is necessary.  Leave aside the fact the ESM does not exist and that Draghi's mandate may prevent him from doing what is necessary. The Spanish 2-year yield has fallen nearly 300 bp and the Italian 2-year yield has fallen about 200 bp. The Spanish 10-year yield has fallen 75 bp and Italian 10-year yield has fallen a little more than 50 bp. The Great Graphic above from UK's Guardian puts the recent moves in Spain's yields and curve in a larger context. 

Currency Positioning and Technical Analysis

The overall technical tone of the US dollar is suspect.  During the last few months, it has been trending lower against the dollar-bloc currencies, Canadian and Australian dollars and the Mexican peso.  The greenback has trended higher against the euro and Swiss franc and has been range bound against sterling and the yen.  

This broad pattern may be on the verge of breaking down.  The dollar is on the cusp of a break out to the down side against the euro and Swiss franc.  There is scope for additional modest gains in the dollar bloc, but cross rate adjustments, warn they may lag in the period ahead.  Sterling and the yen may remain range-bound, with sterling testing the upper side of its range and the yen testing the lower side of its.

Great Graphic: US Employment Comparison

This Great Graphic is from Business Insider who in turn takes it from Calculated Risk.  It puts the job growth during this recovery in the context of other recoveries. 

Yes this recovery is different.  Yet as we have noted before, what really stands out is that unlike previous recoveries, this one has seen the government sector shed workers.  In fact, the government sector shed another 9k jobs in July, the fifth consecutive month of job losses.  

In addition then to the well rehearsed reasons for the reluctance of business to expand their payrolls, like economic uncertainty, fiscal uncertainty, increase productivity, replace workers with machines, the shrinking government employment is an integral part of the US labor story.