Bernanke Returns

Tomorrow Bernanke returns
To Congress to air his concerns
‘Bout growth that’s still slow
Though rates remain low
But Congress, it just never learns

The dollar is softer this morning against most currencies as a combination of diminishing expectations for the US taper and further actions by emerging market countries to protect their weakening currencies has led to more dollar selling. I find it instructive that despite a weak global growth profile, with most emerging markets underperforming their previous expectations, we are seeing them raise rates to protect their currencies. This points to two facts: first, the Fed remains the unquestioned driver of global monetary policy; and second, the “animal spirits” that are necessary to rekindle economic growth remain trapped under a global blanket of excess debt and regulation.

As to the first point, that is why the market remains on tenterhooks ahead of tomorrow’s Bernanke testimony to the House Financial Services Committee. Given the surprising comments about tapering from last month, and the extraordinary effort to walk back those comments since then, market participants are not sure what to expect. It is clear that the FOMC is pretty well divided on the QE process, with loud voices discussing both ending it and expanding it. Given the equity market’s extreme valuations, which are based almost entirely on the fact that there is so much liquidity in the system, the consequences of Bernanke’s words can be great. But it is not just equity markets that have been impacted. Emerging market assets had outperformed for many months as the excess liquidity searched for a home with higher returns than Treasuries. It was not that long ago that Brazil’s FinMin Mantega used the term ‘currency war’ to describe the Fed’s activities as he was trying to prevent excess BRL strength. Twelve months later he is trying to prevent excess BRL weakness as the change in market sentiment has resulted in the wholesale disposal of many EM currencies. Last night it was India’s turn to raise rates, by 200bps, in order to drain liquidity and bolster the currency, which had fallen to a record low last week. This, despite Indian growth near 5%, its lowest in more than a decade and far below its target of 7.5%-8.0%. Brazil has already raised rates 3 times in the past months and of course, China has been forcing the overnight on-shore interest rates higher via liquidity draining activities.  All of this is simply a result of the discussion of the idea that the Fed may change its policy which led to a virtual stampede out of these currencies and back to more liquid instruments.

With regard to the second point, it remains evident in the overall slow growth globally, with the IMF having reduced its global GDP forecasts for 2013 and 2014 four times already this year, and global data showing no signs of a strong rebound anywhere around the world. The one constant globally has been the increase in sovereign debt as slow growth reduces national tax receipts and adds pressure to the fiscal situations in countries around the world. The G8 countries average 98% of GDP as their debt ratios! Having read the Reinhart and Rogoff book, “This Time is Different”, which pointed out that GDP growth slows once the debt/GDP ratio reaches 90%, it is hard not to accept their observation. The fact that the average level of debt amongst this group of nations is above that level bodes ill for the timing of any substantive global recovery.

So what does all this mean for the FX markets? Well, we remain in a situation where comments by Bernanke remain the market’s dominant force, followed by the words of Draghi, Kuroda and Carney (not necessarily in that order). Data plays a secondary impact and then other influences like war and global unrest are only minor players in the game of FX. For instance, UK CPI rose a less than expected to 2.9% but the pound didn’t really respond. This seems to be related to the fact that tomorrow the minutes of the last MPC meeting will be released and traders are waiting to see what transpired under Carney’s first meeting. Verbal guidance has become the final tool in central bankers’ toolkits, and it appears that all the major central bankers are using it aggressively. So with new information due tomorrow, traders won’t risk positions today. German ZEW numbers were released at a worse than expected 36.3, down from last month, and yet the euro rallied. We also saw the weakest auto sales numbers in 20 years in Europe this morning. So here it was clearly not the data driving things, but arguably a continuation of position adjustments ahead of tomorrow’s Bernanke testimony. After all, traders are still net long dollars, according to the CFTC data, in response to the first tapering talk. Fear is increasing that Bernanke will be even more aggressive in dispelling any notion of a taper any time soon, which would put the dollar back on its heels. So bad EU data will not have the same impact. However, weak US data will encourage a further USD sell-off. So keep an eye on this morning’s CPI (exp 0.3%, 0.2% core), IP (0.2%) and Capacity utilization (77.7%). If these point to less robust US growth, look for the euro to rally further and a general dollar decline. However, if the data is strong, I would not expect dollar strength, just a lack of weakness.

It is always difficult to manage risk in market situations where comments are the key drivers rather than macro data. Alas, that is where we find ourselves for now. Longer term, I don’t think there have been any significant changes, but in the immediate future, market response will be all about Bernanke (and Draghi et al.).

Good luck
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Who Will Be Fleeced

The latest news from the Far East
Shows China has slowly decreased
The pace that it grows
Which just might expose
Investors who’re sure to get fleeced

As we head into the dog days of summer, market activity continues to show periodic bursts of excitement. Given the constant refrain from the world’s Central Banks that they are focused on the data, it only makes sense that market participants follow suit. So the latest data we saw was Chinese GDP last night, which showed Q2 at 7.5%, in line with the (reduced) expectations and down from Q1’s 7.7%. Perhaps more importantly, we continue to see economists around the world cutting their forecasts for Chinese growth with the 2013 number approaching 7.0%, the slowest in more than 2 decades, and 2014 showing only a modest rebound. Given the recent comments from Chinese Premier Li Keqiang about numbers as low as 6.5% being acceptable, my sense is we are going to see a continued reduction in the pace of Chinese growth. Especially because the PBoC is showing no signs of loosening monetary policy in response to the cash crunch that continues to manifest itself there. And on top of this, Chinese home prices remain robust, so the housing market continues to approach bubble territory while the rest of the economy suffers. In other words, the Chinese have some difficult policy issues to address, and it seems that slowing GDP is one of their preferred solutions. This doesn’t bode well for either commodities or countries that export them; notably Australia, Brazil and South Africa; as well as for the Asian nations that export components to China like Korea and Taiwan. While Aussie is a tiny bit higher this morning, the trend remains firmly lower with a breech of 0.90 likely as soon as this week in my view. Calling all receivables hedgers in AUD, the 1yr forward is barely more than 2 cents, so all-in sales are near 0.88. That will look good in one year’s time with spot near 0.80!

Looking elsewhere, the ongoing saga in Europe continues to garner headlines as the periphery struggles to figure out how to break the cycle of despair while the Germans remain reluctant to advance any action that smacks of financing the PIGS ahead of the election in September. On that note, I couldn’t help but laugh at the following comment from the folks at the IMF: “The Greek program may still achieve its ultimate goal of keeping Greece in the euro area and of making it able to recover and grow,” the report said. The IMF and the EU “have had to commit many more resources and for a much longer period than initially envisaged and results remain deeply disappointing and the ultimate outcome uncertain.” So after 6 years and a 27% decline in economic activity, those in charge of the Greek “rescue” program are disappointed and uncertain as to how things will wind up. I can tell them, Greece will ultimately fall out of the euro because at some point, the internal politics will shift sufficiently to toss out the grand coalition led by PM Samaras, and the opposition platform of euro exit will be enacted. It is the only viable long-term solution. Freed from the shackles of German prudence, Greece will be able to revert to its former position; modestly corrupt, somewhat inflationary but sovereign in its decisions. I guess the greatest conundrum continues to be the fact that despite the ongoing problems in the Eurozone and the currency’s inherent failings, the euro remains near 1.30. While I continue to see further depreciation, it seems that we will need something much more dramatic to change the broad valuation matrix. If the Fed does begin to taper, I expect the euro to suffer somewhat, but I guess that buyers remain in place who will prevent any collapse for now. As Lord Keynes famously said, “Markets can remain wrong far longer than you or I can remain solvent.”

The data for this week could be of real interest to the FX markets, even though there is no employment data (save the weekly Initial Claims number). Here is what is coming:

Today Empire Mfg 5.0
Retail Sales 0.8%
– ex Autos 0.5%
Business Inventories 0.0%
Tuesday CPI 0.3%
-ex Food & Energy 0.2%
TIC Flows -$40.0B
IP 0.3%
Capacity Utilization 77.7%
Wednesday Housing Starts 960K
Building Permits 974K
Beige Book
Thursday Initial Claims 341K
Continuing Claims 2959K
Philly Fed 7.8
Leading Indicators 0.3%

So first thing this morning we start to get a better idea of how things are going in the US and, more importantly, whether we think that Bernanke will start to consider that taper more seriously. Keep an eye on the CPI tomorrow, for any surprise on the high side will likely see bonds suffer and the dollar rise.

Good luck
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China’s World View

Said Chinese FinMinister Lou
Our growth this year might not get to
Seven percent
While we reinvent
Our ‘conomy’s latest world view

If ever there was proof positive that the equity market rally has been based entirely on the Fed’s policy actions, yesterday was it. Wednesday afternoon, Chairman Ben essentially promised not to raise rates anytime soon, and voila, equities rally with a vengeance. Of course, this also impacted Treasuries, which have rallied 20bps by this morning from their worst levels, and the dollar, which has fallen against most currencies in the past 2 days. As I have written before, the biggest impact on markets are the comments by various officials, not the data releases that show what is actually going on in the global economy. And the number one voice remains Bernanke, with Draghi, Carney and Kuroda-san far behind in influence. With this new promise by the Fed, in conjunction with last week’s comments by Carney and Draghi regarding extended periods of monetary ease, it is time to reevaluate the current market situation.

So what do we know? Discussion at the FOMC is active with a large contingent of members believing it is time to think about moderating the QE program, but a slight majority, including BerDudLen, willing to expand the balance sheet for many months to come. As such, I expect we will hear more dissent over the coming months, but we will not see a policy adjustment unless the employment data starts to really improve dramatically. But even though there is not likely to be a change at the Fed soon, it remains clear that of the four major central banks, the Fed is closest to withdrawing its easy money. And so, the dollar should remain underpinned by this idea. The importance of the monthly payroll data has probably increased now, if that is possible, so the first Friday of every month will offer that much more excitement. We know that both the BOE and the ECB are committed to easy money for at least another year, and probably more. This is especially true for the BOE, where Governor Carney seems to be pushing very hard to expand QE there or create some other policy to imply further monetary ease. And we know that the BOJ is going to continue its QE program until the money supply in Japan has doubled from its level of 4 months ago. So the liquidity game that has been driving markets around the world is still afoot.

Looking to the next most important central bank, the PBoC, and the Chinese situation, we learned late yesterday that growth of 6.5% in 2013 seems to be acceptable now. As I have written before, the extraordinary growth story in China is slowly coming to an end. This is due more to the law of large numbers than any real failings in policy there. It is just very hard for a $10 trillion economy to expand 10% a year. However, there have been some policy failings there, notably the recent cash squeeze that drove interbank lending rates up 10% overnight. Also, some portion of the past growth was arguably of a synthetic variety. I am sure you have heard of the phantom cities, where the Chinese have built an entire city in the hinterlands but nobody lives there. So the building activity added to growth, but the investment has been wasted thus far. At any rate, the current Administration seems ready to make adjustments in the historic growth mix in China, with more domestic consumption focus and less export orientation. And according to FinMin Lou Jiwei, they seem prepared to grow at 6.5% this year and going forward. Well, that is a big difference than the current average forecast of 7.5%, and will weigh heavily on commodity prices. It is no surprise that despite the dollar’s relatively poor performance during the past two sessions, AUD has performed even worse. A growth rate of 6.5% implies that demand for Australia’s commodities is going to be much lower. This will have a double effect of reducing the GDP numbers in Australia and encouraging the RBA to use some of its current scope to cut interest rates further. Neither of these related outcomes is going to support the AUD and so I would look for further underperformance there. In the past 3 months, Aussie has fallen almost 15%. While it seems to have stabilized over the past weeks, I think this news will be the catalyst for the next leg lower. I see 0.85 in the Aussie’s future.

With only PPI (exp 0.5%, 0.1% core) and Michigan Confidence (84.7) to be released today, I think the market is likely to continue to focus on the Fed story and the dollar will tend lower. Emerging market currencies, which have rallied nicely during the past two sessions are likely to see a little profit taking into the weekend though, so a modest decline in most of those should be expected.

Overall, while I have not adjusted my long-term views, it seems clear that the timing of those moves may be extended somewhat as the Fed tries to deal with its unprecedented dilemma. Just how will they unwind the most massive stimulus program ever initiated, and how much market volatility will they tolerate. Remember too the law of diminishing returns. While recent verbal intervention has seemed successful, the next round will be less so, and the following even less. They will have to conjure new methods to prod markets in their preferred direction at some point. While today is not shaping up as too exciting, there remains a great deal of excitement built into the world and that excitement will play out as more volatility going forward.

Good luck and good weekend
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We’re Not Gonna Stop With QE

Bernanke said, “Listen to me
We’re not gonna stop with QE”
I don’t understand
Why traders demand
More proof than they already see

While I grant that I am paraphrasing the Chairman’s words, I think that is the message he is trying to get across. Of course, once again I ask, how is it that tapering QE is not considered tightening, when increasing QE was considered easing of policy? If anyone can answer that question for me I would be most appreciative.

At any rate, as has been the case for the past many months, markets have responded aggressively to the latest words from Bernanke, this time accepting that there is no tightening of policy coming and so QE∞ remains infinite. The predictable results were for the Treasury market to rally, equities to rally and the dollar to fall. Perhaps surprisingly, the dollar seems to have been the biggest mover of the bunch, falling more than 1% vs. most of its major counterparts. So the euro is back above 1.30, the pound above 1.51 and USDJPY back below 100.

The euro is an interesting test case because at the same time that we have Chairman Ben saying the Fed is not about to start easing, we have Signor Draghi saying that ECB policy will be accommodative for “an extended period of time” (haven’t we heard that language before from the Fed?). So, who’s easy money is more important? Yesterday it was the Fed, the day before it was the ECB. And this, my friends, is why markets are so volatile. Central bankers around the world are going through a period of one-upmanship, and each time they speak, the market reacts to the latest comments. What we do know is that economic growth in the Eurozone continues to flounder amid an ongoing recession that shows no signs of ending. We also know that the picture in the US, while uneven, is much more encouraging. This is especially true in the Housing sector and in the recent employment data. So based on the old-fashioned idea of economic fundamentals driving things over time, I maintain my view that the dollar will outperform as the Fed will be tightening policy in some form far before the ECB. Does that mean the euro will tumble soon? Clearly not. But I maintain my view of 1.20 within a year.

Looking at the pound, we have a slightly different situation. BOE Governor Carney is clearly anxious to show that he can be creative and flexible when it comes to supporting the economy, and sounds almost anxious to ease policy further. But the improvement in UK data, which has been much better than expected, is preventing him from acting without tossing away any credibility he may have coming into the role. Over the course of the past month, all the PMI data was better than expected, Retail Sales were higher than expected as was IP. The employment data is improving and home prices are rising. Perhaps the only serious negative is that wage growth has been stagnant. Inflation remains above target but Carney has already indicated he is unconcerned with that for now. All of this leads me to believe that the BOE will not be easing policy further, but what Carney did say last week was that he was not going to tighten anytime soon, similarly to Draghi. So despite a more positive fundamental outlook, we have an essential promise from the BOE that they will not be tightening policy for a long time. Again, this contrasts with the Fed, which while not seeming to tighten immediately, is clearly past the inflection point from easing to tightening. Ultimately, the pound will continue its decline, perhaps slowly, but a move toward 1.45 seems reasonable over the next months, with an outside chance of going even lower.

Finally lets look at the yen. My gut about further action last night was wrong (although I ascribed only a 25% probability) and in fact comments were indicative that they BOJ is likely to stand pat at current policy settings for a while. They seem happy with the results so far as inflation expectations are picking up and their economic assessment has improved. It can be no surprise that USDJPY fell back below 100 after the meeting since there was no immediate impetus for either a stronger USD (based on Bernanke) nor a weaker JPY (based on Kuroda). As such, long USDJPY positions were unwound. Once again, lets look into the future and see what fundamentals indicate. On the US side, as already discussed, monetary policy is heading toward tighter not looser. On the Japanese side, while economic growth has been showing signs of picking up, the inflation expectations remain below their target of 2.0%, and the question is will they be able to achieve their aims in the stated timeframe of 2 years (probably about 21 months left). If anything, I expect that the BOJ will be forced to be more aggressive than they have already been as inflation continues to lag their target. So the long-term view remains for a weaker yen. I still like the election next week as the starting point for the next leg in yen weakness, but in any case, the yen has further to decline.

What I think we can look forward to over the coming months is more volatility as every central bank, both major and minor, tries to get across a nuanced message that they are in control. The problem will remain that they are not, and that the evidence over time will prove that, be it in rising inflation or non-existent growth.

Good luck
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Continent-Wide Guarantees

In Brussels they have a new plan
Attacking their favorite straw man
The EC, they claim
Is best placed to frame
When bank wind-downs should have began

But Germany still disagrees
Just nations, bank assets, can seize
The Treaties in place
Do not allow space
For continent wide guarantees

In what has been a fairly quiet overnight session, there are two stories of note. First, the European Commission has proposed rules that say they should be in charge of bank resolutions in order to break the link between weak banks and the weak countries in which they reside. However, as Germany has claimed all along, they insist the current treaty framework does not allow for this much transfer of sovereignty and thus there must be Treaty changes before this plan can be enacted. Of course, changing EU treaties would take many years, and essentially, Germany is unwilling to be on the hook for bailing out other nations’ weak banks. It is no surprise that the two sides to this argument are the periphery + France vs. the rest of the core. This simply highlights the inherent weakness in the euro, but does not really add much new information. In fact, the euro has edged a bit higher this morning, trading up from yesterday’s 3-month lows, but this is just short term trading activity and does not represent any substantive change. The euro is still heading lower, and if I were a receivable hedger, I would be taking advantage of this modest rally to implement more hedges.

The other story is the BOJ meeting, which began last night and whose conclusion this evening is anxiously awaited by market participants. The yen rallied nearly 1% overnight as traders seem to believe the BOJ will not make any policy changes ahead of the Upper House elections in less than 2 weeks time and so unwound recent short yen positions. I have maintained for a while that the next leg of the yen weakening move would occur after the election results, but I have a sneaking suspicion that BOJ Governor Kuroda may look at the recent data and decide that goosing the process early is a good idea. In other words, despite no expectations for a policy change, I ascribe a 20%-30% chance that they add to the mix, maybe foreign bond purchases or more equity purchases, something to help boost the equity market and confidence ahead of the election. I remain confident that a weaker yen will be coming to a screen near you soon.

Beyond those two stories, we did see weaker Chinese import and export data, helping to undermine Asian equity markets and we heard from the IMF, who cut their global GDP forecast for 2013 back another 0.2% to 3.1%, and cut 2014 further to 3.8% from 4.0%. Otherwise not much else happened.

While there is no US data of note this morning, we do see the FOMC minutes this afternoon, and they should make for interesting reading. However, given the amount of Fedspeak we have received since the last meeting, I would be surprised if there is any new information that comes from their release. Chairman Bernanke speaks later this afternoon and that should be the most important activity of the session. That said, one can only expect him to continue to try to walk back the taper talk for now. Tapering is going to begin, but there is a great wariness right now in further discussions on the topic.

Good luck
Adf

Euro Injections

There once was a nation called Greece
Its creditors it loved to fleece
But German elections
Mean euro injections
Will for the time being increase

“Greece is on the right track in many ways, but there have been delays in some areas,” German Finance Minister Wolfgang Schaeuble told reporters after a meeting with euro-area counterparts in Brussels yesterday. “It is right to proceed on a cash-on-delivery basis and step by step and make the disbursements as Greece’s financing needs arise.”

Let me translate the above comments from Bloomberg for you into plain English: “Greece is failing miserably in implementing its promised programs. However, until Chancellor Merkel is re-elected with a sweeping majority in September, we are happy to spend other country’s money to prevent the crisis from exploding onto the front pages and risking the Chancellor’s victory.”

Some may deem me too cynical, but as I wrote yesterday, Greece has failed on every aspect of the program and yet as I forecast, the Troika was willing to put up more money. The most likely rationale is that Merkel is buying her election with EU money. And the EU is willing to pay for it. To me it begs the question, what happens if they are successful at preventing any major blow-ups and Merkel is reelected? Will they let Greece go afterward? What about Portugal? Or Cyprus? After all, Merkel will have 4 years for the Eurozone to escape whatever nightmares arise before she next faces the electorate. That should be enough time to get things back in order, and probably on a more stable long-term footing. This is the crux of my underlying bearishness for the euro. I believe it is dawning on the European intelligentsia that despite all their best intentions, the differences between Northern and Southern European nations are too great to be bridged by a single currency. While there has been an extraordinary amount of capital, both political and monetary, invested in this project, it was doomed from the start and I continue to believe that Greece will be the poster child for its mistakes. A six-year long depression has not been sufficient to shake them loose, but bankruptcy should do the job. And so once again I say to receivables hedgers, the road ahead leads to 1.20, not to 1.30, so take advantage of the levels that remain available. Yesterday it was German IP that was weak; today the French showed a growing deficit; Italian and Portuguese governments continue to stumble and there is no rescue in sight. While Signor Draghi is doing all in his power, the diminishing returns of verbal intervention are beginning to show. And it seems pretty clear he doesn’t have the mandate to actually execute QE.

This morning the pound is weaker again, falling to its lowest level in 3 years after weaker than expected IP data was released (-2.3% Y/Y) led down by weaker than expected Manufacturing data (-2.9% Y/Y). This simply adds to the impact of BOE Governor Carney’s promise to ignore inflation and keep rates low for an extended period. Why the pound has even weakened vs. the euro in the past several sessions, and quite frankly, that is difficult. So the UK recovery is being called into question and the BOE is all-in for further monetary policy ease. The pound will have a great deal of difficulty rallying at all during the next several months in my view, and we could well approach 1.40 again before this decline is over. Now for those with a long view, buying pounds at 1.40 tends to be a very good deal. But I see no reason to jump in right now to catch the proverbial “falling knife”.

Meanwhile, the yen continues to trade around 101 as the Upper House election approaches. I continue to believe that with an LDP win in 2 weeks time, the yen will start its next leg lower. After all, I continue to look for US Treasuries to fall, and yields, both nominal and real, to increase their spread vs. JGB’s. Japanese investors are going to be increasing their purchases, especially at the 3.0% Treasury level, and in order to do so, they will be selling yen more aggressively. The yen move, which has corrected over the past two months, is getting set to accelerate again. 110 here we come!

Both Aussie and Canada have been range trading of late as they get buffeted by commodity price swings, growth estimates in their key markets of China and the US respectively, and the idea that one of the critical features in their respective rises was the fact that yield hungry investors were looking for low-risk alternatives to US Treasuries. But with Treasury yields rallying, those investors are becoming much more comfortable back in USD. While I continue to believe that Aussie will underperform the Loonie, both should decline slowly from here.

And finally, a quick peek at the emerging markets shows that over the past week, only MXN and RUB have been able to hold their own vs. the dollar. Otherwise, the weakness in this sector has been widespread and pretty robust, with many currencies declining more than 1%. The global dynamics are changing as the US and China continue to change their domestic policies. Commodity producers are suffering and will suffer further. Exporters to China will suffer, and beneficiaries of hot money flows will suffer as these policies adjust. This pretty much defines the entire emerging market space, so it should be no surprise that these currencies are under pressure and will continue to be so. There will be differences between those countries with better fiscal situations (C/A surpluses and low debt), but they are all going to fall for now. And that doesn’t even take into account the propensity for protest and revolution that we are beginning to see spread, which will only add further pressure. If you are selling into the emerging markets, hedge those revenues!

Good luck
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The Plan for the Chairman’s Succession

The markets are starting to question
The plan for the Chairman’s succession
Is Yellen the plan?
Or Summers the man?
Regardless, we’ll get indigestion

It seems that my thoughts on Friday were prescient as the payroll data was better than forecast and the dollar rallied while the bond market fell sharply. Equities performed well, but as we head into earnings season and the market starts to accept the idea that the Fed is not going to print money forever, I wonder if they can maintain their gains. In fact, I am short the market (long the SDS) as I believe recent equity performance has been entirely based on the Fed’s QE process. Once that goes, it is not clear to me that equities represent such a good value at current levels.

Now, back to FX. This morning the dollar is modestly weaker against the major currencies, but that is merely a reaction to Friday’s sharp gains. The euro has found support at the 1.2800-1.2850 level for now, but I expect that to give way this week. While the weekend press was not terribly exciting, the information at hand was how difficult things were in Portugal and how Greece is back at the end of its financing abilities. As I type, the Troika is meeting in Brussels to determine if the next tranche of Greek aid should be released despite the fact that the Greeks have not met their deficit cutting goals; not reduced the government payroll by the requisite amount; nor been able to generate anywhere near the expected value in asset sales. In other words, the Greeks have failed to show the ability to remain on the bailout program. But I am sure that within hours, the Troika will release the funds while saying something like, ‘Greece has shown it is on track to pass the programs necessary to continue the economic corrections within the nation’ or some such nonsense as that. It has become abundantly clear that until the German elections in September, Chancellor Merkel has instructed everyone to prevent any problems from becoming visible. So the question really is, will the ECB and Troika be able to prevent the next flare-up of economic tragedy for almost 3 months? I am not so sure, and if I am right, then the euro will be much lower sometime soon. I think the risks are highly asymmetric here, with only a potential modest rally if things work out well and a significant decline if things go pear-shaped. I bring this up for the benefit of euro receivables hedgers, as my concern remains that the euro has much further to go during the rest of 2013. A move toward 1.20 or below is not out of the question at this point. Remember, ECB President Draghi promised no tightening for a very long time, which will be quite the contrast to the FOMC. And real US 10 year yields are up near 1.7%, the highest in the G4 nations, which adds to the attractiveness of the dollar as an investment.

In Japan, campaigning for the Upper House election is in full swing and the polls are showing that PM Abe and the LDP are leading handily. While in May his announcement of the third arrow was a disappointment, if he captures the Upper House and the LDP controls the entire legislative branch of government, I expect that we will see more aggressive actions on his part resulting in the next wave of yen weakness. Spot is little changed today and USDJPY remains about 2% below the highs we saw in May, but as I have written several times, once the election is past, I expect the next leg of yen weakness to manifest itself. This should take us through 105 and it is not unreasonable to see 110 by autumn. Certainly my call for 110 in December remains right on track.

The story in China is one of analysts and economists trying to determine if the PBoC’s recent liquidity actions are going to be beneficial in the long run, and perhaps even more importantly, if Premier Li’s plans to rebalance the economy toward more consumption are going to work while maintaining the 7.5% pace of GDP growth currently forecast. Personally I doubt he will be able to do both. My sense is that Li believes the rebalancing of the economy is a critical long term goal, and that if growth suffers for a period in the interim, he will accept that. I read of one economist calling for 6.0% GDP growth in China in 2014. That would be a significant adjustment for China as well as for global markets, notably commodities. While I do not believe they would report such a low number, simply the fact that analysts are thinking that way indicates a sea change in the underlying views of the market. It was always impossible to believe that an economy as large as China’s could grow at an 8%-10% pace for any extended period of time. It appears to me that China is going to start behaving more like a developed nation than an emerging one in terms of growth rate. Keep that in mind when looking for global engines of growth.

Today there is no US data of note and this week brings very little of consequence on the data front. So, earnings and foreign stories will be the key drivers, as well as the ongoing discussion as to who will replace Bernanke in January. While Yellen remains the odds on favorite, apparently, Larry Summers is making a push. Either way, an uber dove is likely to be in the chair.

Good luck
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Draghi and Carney’s Reflections

Both Draghi and Carney reflected
Their policies weren’t connected
To Ben’s latest caper
The infamous ‘taper’
Instead low rates should be expected

It seems to me that the market may be moving to a new level of concern about Europe and its ability to address the myriad problems that exist within the Eurozone’s weaker members. Last week, the Greek governing coalition lost its junior member, as they could no longer support the government’s austerity measures. Two days ago it was Portugal that saw turmoil as two ministers, including FinMin Gaspar, resigned from the government calling into question the viability of the governing coalition in Lisbon. Again, the reason was they could no longer support the government’s austerity measures. Notice a pattern here? It took two months for Italy to form a coalition, which ultimately based its electoral legitimacy on its plans to unwind some of the previously implemented austerity measures. Spanish unemployment continues to climb, currently above 27%, and the pressure to find a solution there is intensifying. Through all this, Chancellor Merkel looks on and cares only about her re-election prospects in September, which means she cannot countenance any further German aid for the periphery.

It was back on June 14 when I commented that the euro would trade 1.25 before 1.35 as I felt the underlying structural problems in Europe combined with the idea that the Fed was seeing the light at the end of the free money tunnel would force market participants to reevaluate the euro’s future. Today, I am looking a lot better on that call as the euro is firmly below 1.30, ahead of the Payroll releases this morning, and quite frankly looking like it has nowhere to go but down. As the pressure intensifies on the peripheral nations’ governments to end austerity, the Troika is going to find itself with a real problem. If it condones any changes in policy, it will lose all legitimacy with respect to insisting on conditions for any future bailouts. If it holds the line on its austerity policies, the possibility of Greece or Portugal or Ireland or Cyprus exiting the euro grows dramatically. At some point, these countries are going to start to look more closely at the potential long-term benefits of getting out from under the ECB’s (and Germany’s) thumb.

All of this is the backdrop to yesterday’s unprecedented comments from both the ECB and the BOE. It started with new BOE Governor Carney releasing a statement after the MPC meeting despite not changing policy. The statement was basically, we don’t care what the Fed is doing, we see no reason to raise rates anytime soon. Shortly thereafter, it was Mario Draghi’s turn to step outside the traditional ECB framework and promise that rates would remain low for an extended period of time with a downward bias to boot. It certainly makes sense that the ECB will keep rates low as the recession there continues unabated. So it will be difficult for the euro to find support for a while, especially if US data points to better times ahead. The UK story is a bit tougher as the data there has shown modest growth and the forward looking surveys are actually looking up. My concern for the pound is that inflation starts to increase and the BOE finds itself unable to address the issue effectively.

When the Greek crisis began back in 2010, I had written that the best (only?) solution for the euro was for it to decline dramatically, to parity or below, as only then would the peripheral nations start to have their labor priced competitively in global markets. But that has not happened and that repricing of labor has come via direct cuts in wages and reduction in those nations’ workforces. This has been the recipe for disaster which is currently playing out. The euro has further to fall my friends, of that I am sure.

Today we are awaiting the US payroll story, with the market pretty bulled up on things. Expectations are for NFP at 165K, Private payrolls at 175K and the Unemployment Rate to fall to 7.5%. Equity futures are pointing higher after yesterday’s holiday though equity markets in Europe are generally lower. As I wrote Monday, I expect a good number today, something near 200K, which will simply confirm the differences between the US and the rest of the developed world in terms of economic prospects. This should help the dollar and hurt Treasuries, with the initial move being positive in equities. But the equity conundrum remains; stronger US growth will lead to a quicker taper in QE by the Fed, which means higher interest rates and equity market support will waver. Ultimately, I continue to believe that the US equity market is priced incorrectly and is very expensive. So alongside a strengthening dollar, look for weaker stocks.

Good luck
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Austerity Fatigue

To add to the euro’s intrigue
Now there’s austerity fatigue
Two Portuguese Mins
Much to their chagrins
Said this is becoming bush league

Austerity fatigue is the term of the day. It is being blamed for the Portuguese government’s problems as coalition members are finding it difficult to continue to support the government’s efforts to shrink itself, thus leading to the resignation of two Ministers, including FinMin Vitor Gaspar. The key concern is that if Portugal seeks a renegotiation of its bailout terms, what kind of effect will that have for the other recipients of Troika ‘love’. In the meantime, Chancellor Merkel continues to campaign to be re-elected and is trying to show her compassion for the suffering periphery while burnishing her financial bona fides. Of course there is a solution to these problems, and that is for the weak links in the euro to exit. Once again I ask, do you think that Greece would be worse off now (it being in the 6th year of its Depression) than if it had just jumped ship at the beginning and gone back to the Drachma? The peripheral countries do not have the ability to adjust their economies sufficiently to be able to live with monetary policy and a currency based on German requirements. They never will, and will suffer for a very long time unless they accept that reality. As such, while the periphery remains part of the euro, the euro will always have a fundamental weakness.

While it’s not universal, the dollar is generally stronger this morning after a series of events have called into question the rosy picture trying to be painted by global financial authorities. In no particular order we have had:
1) The two Portuguese ministers resign from the government as they can no longer support the austerity measures required thus calling into question Portugal’s willingness to stay the Troika course.
2) WTI trading above $100/bbl for the first time since May of 2012 on the back of a significant drawdown in US inventories and the ongoing crisis in Egypt opening possibilities of a closure of the Suez Canal.
3) Further decline in the Eurozone economy as highlighted by the Services PMI data printing at a worse than expected 48.3 with almost universal individual national weakness.
4) Ongoing concerns in China on the PBoC’s ability to walk the line between preventing another housing bubble and supporting economic growth sufficiently to achieve 7.5% in 2013.
5) Comments from RBA Governor Stevens that leaving rates on hold was a close call indicating concern for further weakness in Australian GDP going forward.

It should be no surprise that this combination of events has led to weaker equity prices in both Asia and Europe with US futures also lower; modestly higher Treasury prices and a growing sense of anxiety around the world. The exception to this story is the UK, where the Services PMI was a much better than expected 56.9 helping the pound to rally nicely.

As I was posting my poems from 2010 on my website (www.fxpoetry.com) last night, I was reading some of the commentary I had written back then. Much of it sounded remarkably similar to current comments, except I marveled at Greek unemployment at 14% and Spanish at 10% wondering if the governments could withstand such clear failure. Obviously they couldn’t, as both those nations have elected new leadership since then, but also obviously, the new governments have not been able to stem the tide of woe. The real concern is that while the European periphery is the weakest link in the global chain, the problems they have are nearly universal amongst the developed nations around the world. Government has grown incessantly and its cost is starting to outweigh each nation’s ability to pay for it. The corresponding increase in national debt to unprecedented levels on a global basis is undermining any opportunity for a soft landing. The G3 central banks are printing money as fast as they can trying to support things, but no politician (or at least only a very few) are willing to discuss the fact that government promises made in the past were based on assumptions that did not pan out. This miscalculation has made those promises (Social Security and Medicare in the US, similar elsewhere) untenable, and private investors are searching for places other than government debt to park their funds. Today’s reaction was a 100bp rise in Portuguese 10yr yields, and spikes higher throughout the rest of Europe, Germany excepted. I still have a very hard time creating a long-term positive euro scenario.

Let’s look quickly at the emerging markets. Yesterday I reiterated my concern over BRL, which promptly fell more than 1% and seems poised for further decline. Two weeks ago USDBRL was a bit higher, but it seems to me that as long as Roussef cannot quell the protests, a move back toward the 2008 peak of 2.62 is quite possible. How about USDINR, which jumped back above 60 overnight to within 1% of its recent historic high. The news there is simply weak growth fomenting weak equities and no obvious way for either the government or the RBI to address the problems quickly. If we continue to see the overall global situation suffer, I think we could test 65.00 before the year is over. MXN has had a very nice retracement from its recent extended weakness to 13.46, but seems to be heading back in that direction. Again, it is hard to believe that with multiple concerns growing around the world over both economic growth and political stability that emerging market currencies will do anything but decline further.

Today we get a bunch of US data, starting with ADP Employment (exp 160K), and followed by the Trade Balance (-$40.1B), Initial Claims (345K) and ISM Non-Mfg (54.0). There is plenty to move things in this grouping, and quite frankly, I sense that further dollar strength is in the offing. Tomorrow both the MPC and the ECB meet, but no movement is expected by either, and of course, it is the July 4th holiday here in the US. Friday’s payroll data should be quite interesting, especially because US staffing will be light due to the holiday, resulting in less liquidity and more possible movement. Funnily enough, I think that the US data will print better than expected, and the dollar will benefit further as talk of the taper will resume.

Good luck
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The Leaders’ Desires

In China, Brazil and some others
The market has proved it still smothers
The leaders’ desires
To cause what transpires
No longer do they get their druthers

The dollar is generally stronger this morning as the market continues to react to comments from Central Bankers around the world as well as the ongoing stream of data. The thing is, there is no longer a consensus as to what is going to happen with monetary policy almost anywhere on the globe, Japan excepted. I have discussed the Fed issues at length, and am sure I will continue over time, but suffice it to say that there is a great deal of uncertainty over the timing of any reduction in monetary ease at the moment. The ECB has been somewhat less mysterious, but remains behind the eight ball because the Eurozone economy remains mired in recession and is showing no signs of a quick recovery. So while there is no expectation of tightening any time soon, the real question seems to be will there be further ease?

The BOJ is easy, printing presses are running at full speed with no end in sight. Will it solve their problems? That is far less clear, but after 20 years of economic purgatory, the Japanese seem willing to try anything. The Old Lady of Threadneedle Street is in a quandary similar to the Fed. While they have a new governor, Mark Carney, ready to add to the easy money party, the data from the UK continues to show improvement, like this morning’s Construction PMI print of 51.0, (the highest level in 12 months), and so evidence of a recovery is building. Easing into that situation will be a difficult call for Governor Carney.

We also heard from the RBA last night, which left rates on hold, as expected, and claimed that despite a recent 10% decline in the AUD, it still remains high. It can be no surprise that the new Treasurer, Chris Bowen, came out looking for more rate cuts as every politician is a fan of easy money, but for now, it seems that the RBA will keep further rate cuts in their pocket as the economy continues its adjustment to a less mining intensive one. As long as the AUD continues to soften, and I think it will, the RBA will be reluctant to act further without a sharp decline in output there.

Let’s look at some of the emerging markets though, where the leadership is finding out that one of the downsides of becoming a more open economy is that government control over things is diminished. In China, for example, they have been struggling with how to effectively prevent another housing bubble while simultaneously maintaining sufficient stimulus for the economy to grow elsewhere. There is also a macro program to rebalance the economy to more domestic consumption and less export dependence. Well, that is a tricky set of objectives for any nation, but perhaps even more so for a nation that has a history of intense secrecy in its financial dealings with the market. The results have been a sharp spike in short term financing rates during the past month, rumors of a bank default, weaker economic data and no solution in sight. While the Renmimbi is not likely to collapse any time soon, what has become clear is that its steady appreciation has halted. The current level between 6.12-6.15 seems to be all there is and it would be no surprise to see a gradual move back toward 6.25. This problem for the Chinese is there is no simple solution, and I would look for more market gyrations there, expressed as equity market moves, over the rest of the year and beyond. But remember, no market lives in isolation, so if the Shanghai Composite is tumbling, you can expect a knock-on effect in other markets.

And in Brazil, the problems are manifesting themselves via the massive protests in the streets. Already we have seen the government there back off the bus fare hikes that started things, and now they have offered more direct democracy. But it strikes that what the people want is not direct democracy, they simply want competent and uncorrupted leadership by the elected officials. Of course, that is a rare outcome in any country, let alone one that has as short a history of democracy as Brazil’s. The Central Bank is having a problem because inflation has jumped above the top of its target range at 6.5%, but growth remains weak at 1.9% annually. The term stagflation springs to mind, but in a nation where the government’s legitimacy seems to be being questioned by the people. If you remember, when we first saw the weakness of EMG currencies several weeks ago, I mentioned that I thought there was a chance of a very significant decline in the BRL. I think that probability continues to grow seeking only the next surprise. I fear a move toward 2.50 is a realistic event this summer.

Today’s US data is dull, with only Factory Orders of note. All eyes are on tomorrow’s start to the employment story as that is intimately tied to the FOMC decisions. I sense a modest day today, with limited overall activity in FX, especially as the July 4th holiday approaches.

Good luck
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