Highlights
Euro weakness intensifies as we start the week, risk-off trades dominate and the US dollar and the yen are the winners in the current context, still. There was no fresh ‘bad news’ from the EZ, but sentiment is extremely poor, with continued concern over the various austerity measures economic consequences and contagion (see below). The EZ finance ministers are holding a meeting today (see below). The euro has fallen to a new four year low overnight and $1.20 within reach even if a rebound is seen in early US session (a good selling opportunity). Cable has also become highly vulnerable (down 1%), breaking through $1.45 support and to a low $1.4252 in Asia as debt jitters resurface (see below). Commodity prices are soft and so the AUD (-0.9%) and the kiwi (-0.8%) had a very poor session too. Japan’s March machinery orders came out softer than exp. on a m/m basis but Feb’s tumble was offset (at +5.4% m/m in March vs -3.8% previously and vs +6.3% exp). EMEA currencies had a poor start to the week as it is all about risk off trades, with the RON (-0.45%), the CZK (-0.4%) and the PLN (-0.3%) the weakest links. Violence in Thailand continued at the w-e. Just the US May Empire mnfg index and March TICS figures due for release today. CFTC data shows that for the week ended May 11, speculative accounts mostly increased their strong US dollar bets.
European jitters have returned to haunt the Asia equity market which recorded its largest decline in three months. The MSCI Asia Pacific index tumbled 3%, with all regional indices ending the session sharply lower. This included the Nikkei (-2.2%), the Hang Seng (-2.14%), the Shanghai SE (-5%), the Shenzen SE (-5.97%), the Kospi (-2.6%) and the S&P/ASX 200 (-3.1%). However, European bourses have recovered from Friday’s lows, with the FTSE 100 and the Dax-30 both up 1.1% by mid-day. The S&P future points at a marginally higher open on WS later. WTI Crude oil prices have recovered somewhat from the $70 brl mark.
The recovery in equities is providing a good opportunity to take profit on the bond market. 10 yr UST yields were trading 1bp higher by midday in Europe with core EZ bond mkt also trading lower (10 year bond yields were up 3bp in France and Germany). Periphery looks very shaky again. 10 year Greek bond yields were already up 36bp in mid session. Note that the ECB is expected to detail how it will sterilize its bond purchases this week.
Currency Markets
Sentiment on the euro remains very shaky as the market’s faith over last weekend EU/IMF Eur750bn bailout package and ECB QE relief is fading away quick while concerns over the various austerity measures economic consequences have become dominant. There was no new euro bearish development over the weekend, but it seems that at this stage, the market does not need any new bearish euro news to shorten the currency. The lack of supportive news is enough for euro bears at this point, no news is good news. In this context, today’s EU Finance ministers meeting will be of interest. Yet, after last week’s announcement, we feel that there is little that the EU can/will do. In turn, this implies that there is little in the way of further euro weakness at this point. A new four year low (at 1.2235) was tested overnight, with strong downward momentum still in place in early European session. It is only a matter of time before the fair value $1.20 level is tested. Meanwhile, despite rumors heard on Friday, there was no bombshell weekend announcement about the euro by German Chancellor Merkel. Instead, we got a bit of honesty when she admitted that the stabilization plan merely buys Europe time to implement the needed fiscal reforms. In that regard, two senior German banking officials both candidly said that it was very unlikely that Greece could avoid a debt restructuring. Greek PM Papandreou said that the country was considering legal action against US banks for their role in creating its debt crisis. This will win him no fans. Blaming speculators and foreigners just looks desperate, and we note that recent polls show that over 95% of Greeks blame their own politicians for the crisis. Lastly, contagion risks remain high. Why else would Italian officials say it may make extraordinary spending cuts and raise the retirement age to narrow the budget deficit? Italy has not been in market cross-hairs yet, but officials are clearly nervous. Lastly, German press reporting that Fin Min Schaeuble is working on an action plan to stabilize the euro, and will be unveiled May 21.
In the UK, the debt predicament is hardly news and partly explains the 13% sterling depreciation versus the US dollar since the beginning of the year. However, in the current euro zone debt crisis hysteria context and ahead of the June 22nd new government emergency budget, sterling is vulnerable. Amongst his first new policy measures, Chancellor Osborne has announced the creation of a new Office for Budget Responsibility (OBR) entity which will be chaired by Sir Budd as an interim head and which will basically review the Treasury’s books and prepare a ‘proper set of national accounts’. In practice, Osborne is handing over the responsibility for growth and public finance forecasting to a new body. We would expect the OBR to paint a worse fiscal position than currently assumed for the UK. Indeed, it is well known that the previous government’s economic forecasts have had a tendency of being overoptimistic over the past few years (for instance, next year’s budget relies on a 3%/3.5% GDP growth rate, well below the 2% guide used by most private forecasters and highly unrealistic), implying that the UK public finances outlook is most likely worse than currently assumed. Note that this year’s budget deficit is officially expected at £163bn – the risk is that this figure is revised to the upside too when the government unveils its emergency budget on June 22nd. In turn, this means that this year’s budget deficit to GDP ratio could be even higher than currently assumed and above the 12% mark. For 2011, private forecasters expect UK borrowing to be £15bn worse than the March Budget estimates. Again, this is a finding likely to come through from the OBR. All this means that the likely findings of the OBR will be bearish for sterling: a growth outlook worse than expected, a worse than expected fiscal position and this means a need for even more drastic action on the spending cut/tax hike front for the new government. Note that Osborne has hinted at the weekend that the deficit reduction measures will be roughly 80% in the form of spending cuts and 20% in the form of tax hikes. There is also a risk that this will be accompanied by concerns over credit downgrades, giving fresh ammunition to sterling bears in the near-term. Over the longer-term, we believe that the creation of the OBR will give a boost to the Treasury’s credibility and be supportive for sterling, but this is clearly not today’s story. For now, the sterling bear trade has returned and the euro situation is not helping. Cable has broken through $1.45 support overnight, with fresh support identified at $1.4245, $1.4170 and then $1.4110.
Upcoming Economic Releases
America: US April retail sales, industrial production, May Michigan index, March business inventories, Canadian March manufacturing sales. Events: Fed’s Lockhart, Evans to give a speech, Greece to submit deficit-cutting progress report on EU.
———–
This was the BBH CurrencyView by Marc Chandler. Marc is the Global Head of Currency Strategy at Brown Brother Harriman. For more of BBH’s currency views, visit the BBH FX website here.
This material has been prepared by Brown Brothers Harriman & Co. (“BBH”) and is intended for information purposes only. This communication should not be relied upon as financial, investment, tax or legal advice. This communication should not be construed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency. This information may not be suitable for all investors depending on their financial sophistication and investment objectives. The services of an appropriate professional should be sought in connection with such matters. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete in its accuracy and cannot be guaranteed. Sources used are available upon request. Any opinions expressed are subject to change without notice. Please contact your BBH representative for additional information. BBH’s partners and employees may own currencies in the subject of this communication and/or may make purchases or sales while this communication is in circulation.