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

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
Adf

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
Adf

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
Adf

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
Adf

The FOMC’s running scared
It seems they were quite unprepared
For all the bond selling
And market rebelling
Now can their mistakes be repaired?

Over the weekend, pretty much every story about markets was about the FOMC’s attempts to walk back the Bernanke comments from two weeks ago. It is remarkable how many Fed members were quoted as saying the market is wrong and has overreacted. Now I don’t doubt for a moment that the market overreacted, that is a given with markets, but I am concerned that the illustrious Fed members were completely surprised that markets have responded in this manner. After all, what we are witnessing is the beginnings of a change in the most extraordinary monetary policy stimulus in history. And throughout history, when central banks, notably the Fed, have changed their policy stance from easing to tightening, or vice versa, the market response has been both large and volatile. One would think that the response to this change will be the largest and most volatile in history given the starting point. It could make one think that the FOMC is unaware of the history of its actions. At any rate, while no one denied that at some point QE would end, to a man the entire Fed said that the timing is much later than the market is implying. I think the lesson to learn from this is that the Fed may have finally figured out it cannot directly control, or even impact, unemployment; and that the Fed can only impact inflation with a significant time lag, so it’s only timely feedback is market prices for stocks and bonds. Ipso facto, the Fed is trying to manage the stock and bond markets, which do respond in a timely manner directly to their actions. Just not always the way they want. This story is going to be with us for quite a while yet, so despite the movements we have seen in markets already, don’t expect volatility to decrease any time soon.

Looking at the FX markets this morning, the yen is notable for its ongoing weakness, making another move back toward 100 after the Tankan report was released at 4, up from 3, and indicating continuing recovery in Japan. While there is no doubt that 100 will prove to be a difficult level to once again breech, I am confident it will do so, perhaps sooner than my initial expectations which were following the Upper House election in 3 weeks.

As to the euro, the PMI data showed a modestly better picture, with German PMI slightly softer at 48.6, but EC PMI slightly stronger at 48.8. To me this is all ‘shades of grey’. After all, the readings across the continent remain below 50, and while they have been edging higher, the trend remains one of a very slow return to growth. At the current trend, it will be March 2014 before the PMI prints at 50.0 again. That’s another 3 quarters worth of weakness. All that being said, the euro did manage to rally slightly on the release, although it continues to hover just above 1.30. It appears that there is somebody who is very eager to prevent the euro from falling below 1.30 for now, but I continue to believe that its decline is inevitable.

The pound rallied first thing this morning as the PMI data there was yet another positive surprise for the economy, printing at 52.5 rather than the expected 51.4. As Mark Carney steps into the BOE Governor role today, his job seems to be getting easier. Rather than figuring out how to stop the UK economy’s decline, he merely needs to figure out how to unwind the unprecedented policy prescriptions in place in the UK. While the magnitude of the issue is not as large as the Fed’s, it is still an enormous task for the UK economy. However, you have to like the pound more than the euro here, as at least the UK’s prospects seem much brighter than Europe’s for now.

Looking at the emerging markets, the picture is mixed. The most notable change from last week is INR, which seems to have responded quite positively to the Fed’s efforts to change market views. The Rupee has rallied more than 1% in the last two sessions and is the best performer in the space. It will be interesting to see how BRL opens this morning given its ongoing weakness in the wake of the protests throughout the country. President Roussef’s approval rating has plummeted to 30% from near 60% prior to the outbursts, and it is not yet clear that she will be able to address the concerns of the population. It is always very difficult for a corrupt government to address corruption, no? On the bright side for her, Brazil won the Confederations Cup last night, so I’m sure there will be much celebrating for a little while anyway. My guess is BRL performs well today, but the pressure remains on the government to enact positive changes, and I have a feeling that will be more difficult for them to implement. I look for BRL to weaken further over time.

Finally, this week brings a great deal of data in the US, culminating in the payroll report on Friday:

We will discuss Payrolls tomorrow. Overall, I see no reason to change my views on both bonds and the dollar, lower and higher respectively, but remain amazed at the resilience of the equity markets.

Good luck
Adf

Those leaders in Brussels agreed
That bailing-in banks may proceed
But as many guessed
Dissent was repressed
More problems are still guaranteed

The yen has been the main loser in the overnight session, with many comments about it being a risk on environment. First, let me be clear in that short of a crisis event, I think recent evidence belies the idea that risk-on/risk-off is a viable paradigm any more. And second, I am trying to figure out what would have encouraged investors to take on more risk because of what we saw overnight.

Was it the fact that the Chinese liquidity crunch remains in place, albeit moderating slightly? 7-day repo rates remain at 6.74%, double their average this year and it has become pretty clear that the PBoC is not about to flood the market with liquidity. The Chinese economy is going to need to adjust to the new ideas about monetary policy and that will be a painful and volatile process, hardly a harbinger of buying risky assets.

Perhaps it was the fact that, as I suggested, the EU announced a compromise on the banking situation, which essentially stated that countries need to abide by the rules unless the situation is such that they don’t think they need to abide by the rules for national reasons. This was not the strong and clear rulemaking that is likely necessary for success of the banking safety net. And let’s take a moment to consider the EU meeting that starts this afternoon. Last June, they pledged “immediate action” on growth and jobs. Today, with unemployment having risen since then from 11.4% to 12.2% and GDP having fallen by 1.1% in that time, they are going to pledge “determined and immediate action” on growth and jobs. I know if I were unemployed in Europe I would feel much better now! At any rate, this does not strike as a reason to jump on the risky asset bandwagon.

I know. It was yesterday’s downward revision of US GDP to 1.8% in Q1 from the previously reported 2.4%, with the Personal Consumption piece falling to 2.6% from 3.4%. That type of news would certainly warrant jumping into risky assets, right?

Ultimately, I think all that is going on is market position adjustments ahead of the quarter end. Remember, Friday is the end of Q2 and many investors are massaging their portfolios to appear in the best possible light for reporting purposes. As such, I am not convinced that the recent gyrations are caused by changing views of the global macroeconomic situation, or changes in policy settings. The market remains quite concerned, and rightly so, that as the Fed removes policy accommodation, equity prices and bond prices will decline.

But looking across the FX markets, we have seen some strength and some weakness with no discernible pattern. Today’s US data will reveal Personal Income (exp 0.2%) and Personal Spending (0.3%) as well as Initial Claims (345K). None of these are likely to move markets greatly. Several Fed speakers are slated for today, NY’s Dudley and Atlanta’s Lockhart, and they may have a much bigger impact on things. For now, it seems that virtually all markets revolve around the Fed’s next steps, and indications that the ‘taper’ is closer will result in further selling of both bonds and equities.

Some days it’s just hard to get excited about the markets, and today is one of those. The long term trends remain in place, but the day-to-day is still subject to the next headline.

There will be no commentary tomorrow as I will be traveling and unable to observe the market.

Good luck and good weekend
Adf

In Brussels they’ll once again meet
Those ministers with the clay feet
The question at hand
The German demand
That banks fix their own balance sheet

It has been a mixed day in the FX markets as traders await further US data, but more importantly, await any further news from the Fed as to the possible timing of the next actions. Central banks have been the focus of most traders lately, between the Fed and all the talk of the ‘taper’, the PBoC and its efforts to deflate the real estate bubble without causing an economic crash, the BOE and its pending change in leadership as Mark Carney starts on Monday, and finally, the ECB, where Signor Draghi continues to assure the world that they have plenty of tools at their disposal, but seems unwilling to use very many of them. That’s quite a list and it didn’t even include the BOJ, which we all know is on a mission to double the money supply in Japan over the next two years.

Starting in Europe, more comments from Draghi indicating that the ECB will remain accommodative for now and urging individual nations to address the fiscal problems that bedevil the Eurozone were sufficient to undermine any support for the euro. It is now approaching 1.30 and I continue to believe is heading steadily toward 1.25 over the next several months. The very clear difference in tone between the Fed and the ECB will continue to weigh on the euro going forward. Perhaps just as importantly, the EU FinMins will be back in Brussels trying to iron out the banking resolution process for the future. Remember, late last week they could not agree on the measures to address bank failures and when the new banking regulator should be called in to support a particular bank. I see no reason that positions would have changed in the past 5 days, and so as I wrote Monday, the outcome is likely to be no real resolution, but some announcement that things are solved. Politically, they cannot afford to fail again, but economically, neither side will give in. As I also wrote Monday, this remains an underlying reason the euro will continue its decline.

The pound is also a bit softer this morning, following the euro and seemingly anticipating the onset of the Carney era. Remember, the entire world is expecting great things from Carney, who is on record as calling for ‘flexibility’ in inflation targets (read higher inflation) and has been willing to push the envelope with regard to innovative monetary policy measures aimed at easing policy. Certainly, if the BOE votes for more QE, one of the possibilities at next week’s meeting, the pound will suffer further.

Down Under, the political situation is heating up as PM Gillard lost the Labour Party leadership election and the Labour Party will now be lead by Kevin Rudd in the September elections to come. But the Aussie’s weakness over the past months has not been political, it has been the result of position unwinding. Aussie had been one of the favored destinations for investors seeking a combination of yield and safety with a modicum of liquidity thrown in. It is apparent that much of that positioning has been reduced. Add to that the tepid economic growth and the apparent weakening in China, and Aussie suddenly doesn’t look so attractive. Remember, the 10 year average price of AUDUSD is 0.8575, with recent time spent above 1.00 as the historic outlier. Aussie has further to decline.

And let’s talk about China now, where the PBoC continues to moderate the liquidity problems that have arisen in the banking system. While they are working hard to prevent a melt-down, and certainly do not want to see any bank failures, it has become clear that the Xi Administration is keen to make major adjustments in the Chinese economy. The effort to diversify away from an export led economy to one that is more reliant on domestic consumption has been fraught with periodic problems, like this liquidity situation. This is the conundrum in which the Chinese find themselves. It is easy to add liquidity and reduce the short term lending rates, but in so doing, they would continue to encourage the property speculation they are trying to defeat. So they are trying to find a middle ground, and the short term gyrations are the result. This highlights just how difficult it is for a country to make monetary policy adjustments and have markets behave as desired. And this is in China, where the government has much greater control over everything. Remember that when thinking about the Fed and its ability to control its message, policy and market responses, or rather its inability to do so.

Finally, a quick word on India, where the Rupee traded to a new historic low vs. the USD at 60.765, falling a full 1.75% on the day. The problem has been a steady outflow from the Indian stock markets by international investors combined with the domestic problems of slowing growth and rising inflation. The RBI has not yet focused on either growth or inflation, trying to manage both simultaneously. This has reduced international confidence in the currency, and quite frankly, I expect it will continue to slide. There is nothing that says it cannot reach 65 at some point on this move, regardless of the RBI’s modest intervention efforts.

Good luck
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I have begun the process of archiving my old verse on my blog.  As of now, everything I have from 2009 is on www.fxpoetry.com so if you are interested, click the link and peruse them.  While you are there, you can sign up to follow the blog, which will automatically send you each morning’s report.  I expect to have 2010 and 2011 done over the next several days.

Much to the Fed’s consternation
The market’s most recent translation
Of Chairman Ben’s speech
Was QE would screech
To a halt, causing Ben much frustration

In response we got speeches from two
Presidents of the regional crew
The word ‘exit’s not right
Nor will money get tight
When QE’s days are finally through

Markets are funny things.  Understanding what drives prices and anticipating how they will respond to particular signals is a game fraught with difficulty.  As I wrote last Thursday, historically Central Bankers (and truly government officials on the whole) typically don’t do this very well.  At least based on the remarkably stupid things that they regularly seem to say.  Anyway, it is clear that the Fed was unhappy with the market’s interpretation of Bernanke’s recent press conference and so he sent two of his minions, Fisher and Kocherlakota, out to try to explain further the Fed’s thought processes.  What we learned was that “the word exit is not appropriate” for what the Fed is doing, according to Fisher, and that even if it is, policy would still remain accommodative “for a considerable time” afterwards according to Kocherlakota.  On the surface, these seem somewhat contradictory statements.  It is almost as if they want their eventual reduction in purchases to be ignored as a market signal.  Rather, they would prefer that the economy continue to merrily roll along without the Fed having to do anything special.  Alas for them, that is never going to be the case, and so the process of messaging will remain highly uncertain and extremely difficult.

All that said, the message from the two non-voters seemed to be accepted by the markets as we have seen equity markets bounce modestly, Treasuries rally slightly and the dollar soften a bit.  I don’t think it was the overnight data, which was extremely light, but the other possible catalyst for this bounce could have been comments released from the PBoC, where they indicated that they will keep money market rates at a “reasonable” level going forward.  Those comments were sufficient to reverse a 6% decline in the Shanghai Composite, and perhaps settle market players’ nerves a bit further.

One of the other things I have learned over my extended time in markets is that high volatility tends to come in short bursts.  It is very difficult for traders to continue trading in high volatility environments for extended periods, they literally just get too tired and step away, so given what we have seen over the past several weeks, it would be reasonable to expect a bit more quiet until next week when we get the payroll data.

For the rest of this week, we do have some interesting data being released, notably Durable Goods this morning and the PCE Deflator on Thursday.  The latter is the Fed’s preferred measure of inflation (clearly not one that has anything to do with our everyday lives), but they will respond to that signal rather than CPI.

So for today, I expect that we will continue the consolidation of the bulk of the recent moves without significant volatility.  Of course, this is subject to any comments from other Fed officials, and things remain on edge regardless.  I didn’t mention the yields on peripheral European bonds, with Spain above 5%, Portugal near 7% and asking about the ECB’s willingness to actually use the OMT.  Remember, too, we have the EU meeting in Brussels on Thursday to try to hammer out the details of who is going to be on the hook for any necessary capital infusions into European banks if they should arise under the mooted bank regulator.  In other words, there are plenty of things around which can cause a market dislocation, I just have a feeling that today will be without much drama.  Take advantage of the quiet to establish hedges here.  It is much easier on a quiet day than on one where the s*it hits the fan.

Good luck
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