G-20 Offers Little To Support The Euro

By Marc Chandler of Brown Brothers Harriman.



US dollar was mostly firmer vs. majors, with EUR/USD making new multi-year lows after breaking 1.20.  More jitters about Hungary didn’t help the euro.  Yen was stronger across the board and outperformed the buck and so dollar/yen fell back below 92.  EM FX was mostly softer, with EMEA the biggest losers.  Only gainer on the day vs. USD was JPY, while biggest losers vs. USD were HUF, PLN, AUD, SEK, and BRL.  US jobs data was worse than expected (see below).  Weekend G-20 Fin Mins meeting yielded little on FX or bank tax, but acknowledged recent debt jitters and called for countries to run credible policies aimed at fiscal sustainability.  Iran denied press reports that it was dumping euro assets, but press reported Egyptian central bank lowered euro share of reserves over last 6 months.  Hungary pledged to meet -3.8% of GDP deficit target in 2010 and said it will release fiscal plan early this week.

US equity markets were lower, as DJIA, S&P, and NASDAQ ended down 3.2%, 3.4%, and 3.6%, respectively.  European markets were lower too, with Euro Stoxx 50 falling 3.1%.  Asian equities are likely to open down today as Asian ADRs were lower during N. American trading Friday.  Nikkei futures point to a down open for Japan, and the firmer yen should hurt Japan exporters.

US bond market was higher, as 2- and 10-year yields were down 10 bp and 17 bp, respectively.  European bond markets were mixed, as 10-year yields in UK, France, and Germany were down 7 bp, 2 bp, and 9 bp, respectively.  But Greek 10-year yields rose 8 bp, Portugal rose 10 bp, Ireland rose 10 bp, Italy fell 4 bp, and Spain rose 2 bp.   

Currency Markets
The US employment data was disappointing.  The key measure of private sector job creation was only 41k compared with expectations for 180k and a 3 month moving average of 155.6k.  The fact that the unemployment rate ticked down is not really good news as the decline in unemployment was not a function of more jobs but a reflection of people leaving the work force.  There were two bright spots though that should not be discounted.  The first is the hourly earnings rose 0.3%.  This bodes well for income and therefore consumption.  Also the work week increased by 0.1 which is roughly the equivalent in terms of output of a bit more than 300k workers.

The euro collapsed through the CHF1.40 level where the SNB had thought to be defending, and this helped drag the euro below 1.21. A combination of ill-thought out comments by the new Hungarian government coupled with a surge in the Swiss franc is seeing the forint drop like a rock and is seeing CDS on Hungary explode.  Many Hungarian mortgages are denominated in Swiss francs and the sharp appreciation of the Swiss franc would likely have weighed on the forint in any event.  However comments by Hungarian officials that Hungary is not far from Greece fate simply adds to the market anxiety and talk of default are not helpful.  On one hand it might be posturing as it re-negotiates its IMF package.  On the other hand, the heightened state of anxiety in the capital markets would seem to caution against such inflammatory comments.  The market fears another Greece situation.  The new government is claiming that the prior government manipulated the data and lied about the state of the economy.  Fear is taking a toll.

Here are some facts about Hungary to put things into perspective.  While the outlook for that country remains poor, it does not quite have the potential to roil markets as much as Greece or the other peripheral euro zone members.  We looked at BIS on cross-border banking exposure to Hungary as of Q3 09, and total was $158.1 bln vs. $302.6 bln for Greece, $286.7 bln for Portugal, and $1.15 trln for Spain.  Still, it’s worth noting that 92% of that exposure is held by European banks, with Austria (24% share of total), Germany (21%), Italy (17%), Belgium (12%), and France (8%) accounting for the lion’s share.  Despite having many loans denominated in Swiss francs, Swiss banks themselves hold only 1% of the total cross-border banking exposure to Hungary.  UK and US exposure is negligible.  Next quarterly BIS report is due out in June, and will cover end-Q4 09.  IMF official Boutros-Ghali earlier warned that the agency needs more funds after committing aid to Greece.  He expressed concerns about Europe, noting that "If we are going to start including funds made available to Europe, then the IMF is not properly resourced.”  It’s not Greece or Hungary he’s worried about, but rather the potential contagion and domino effect that could prevail in Europe.

EM in general remains on the defensive as a result of falling US stock market and ongoing troubles in Europe.  It’s not a surprise that EMEA currencies are the worst performers on the day, but we will stress again our view that EM FX will not be able to stage a sustainable rally until the European crisis is somehow resolved.  We would expect Asian markets to go with the negative trend when they reopen Sunday evening.  Which Asian currencies are most vulnerable?  In emerging Asian currencies, correlation with EUR/USD over the past six months has been strongest for USD/SGD (-.555), USD/KRW (-.319), and USD/INR (-.237), so these remain most at risk if the negative sentiment continues into today’s North American close.  By way of comparison, Latin American currencies are much more correlated with EUR/USD over the past six months, led by USD/BRL (-.607) and USD/MXN (-.492).  In EMEA, USD/TRY (-.632), USD/ZAR (-.555) and USD/ILS (-.422) are highly correlated with EUR/USD over the past six months, as are USD/CZK (-.868), USD/HUF (-.853), and USD/PLN (-.832).  Looking at Asian equity markets, Singapore has had the highest correlation with the S&P 500 over the past year at .286.  This is followed by India (.279), Hong Kong (.240), Thailand (.231), and Korea (.225), so these remain most at risk if the negative sentiment continues into today’s North American close.  By way of comparison, however, Latin America equity markets are much more correlated with the S&P 500 over the past six months, led by Brazil (.782) and followed by Mexico and Argentina (both .777), Peru (.681), and Chile (.564).  In EMEA, South Africa has the highest correlation with the S&P 500 over the past six months at .582, followed by Hungary (.518), Russia (.530), and Poland (.513).  Overall, these correlation studies support our view that while all of EM is vulnerable to the risk off trades emanating from Europe, Asian currencies and equities are best-positioned to outperform in this environment.  No surprise, but EMEA is the worst-positioned and so the currencies and equity markets there are likely to continue underperforming.  We reiterate that as a whole, Asia fundamentals remain the strongest in EM while EMEA remain the weakest, and so cross-EM FX plays favoring Asia over EMEA are likely to remain profitable.  Best Asian performers in Q2 so far are MYR (down 0.3% QTD), THB and SGD (both down 0.9%), and IDR (down 1%).  By way of comparison, HUF and PLN both lost 18% vs. USD so far in Q2.

CFTC data shows that for the week ended June 1, speculative accounts US dollar bets were overall mixed.  Net short euro positions fell to -93,325 from -106,736 previously, Swiss franc net shorts increased to -14,724 from -12,619, and sterling net shorts eased to -70,454 from -75,079 previously.  Dollar bloc saw their net long positions fall again (AUD at 15,045 vs. 19,523 previously, CAD at 22,154 vs. 23,872 previously), while MXN saw net longs decrease again to 19,773 from 28,857 previously.  Speculators cut net short yen positions to -6,484 from -10,238 previously.  With the yen soft at start of last week, net yen shorts should increase a bit in the next weekly report. 

Upcoming Releases

Asia: Philippine, Singapore, HK, Malaysia reserves; Taiwan trade, CPI Europe/EMEA:  Czech trade, IP, retail sales; South Africa, Russia reserves; Norway IP; Germany factory orders Americas: No US data; Chile IP.  Fed’s Potter, Yellen, Bernanke speak.

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