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Euro Zone GDP Contracts Further


The 17-nation euro zone output shrank by 0.2 percent in the first quarter 2013 creating the longest recession in the bloc’s history. Projections for the future are not promising. Analysts project slight growth in late 2013 but no significant upturn until 2015. The first quarter contraction marks the sixth consecutive quarter that euro zone GDP has contracted.

France which has been teetering on the edge of a recession finally crossed the line and suffered a 0.2 percent downturn, equaling its output in the fourth quarter 2012. Unemployment in France is at record levels.

France joined the list of euro zone economies in recessions. Finland, Cyprus, Italy, The Netherlands, Portugal, Greece and Spain are solidly entrenched in recessions. Italy and Spain, the euro zone’s third and fourth largest euro zone economies, have endured seven consecutive quarters of negative growth.

The new data pushed the euro below the 1.29USD mark. The currency fell to six-week lows and shows little hope for recovery. The trend of the euro and the anemic growth in the bloc may prompt the ECB to engage in more aggressive monetary easing initiatives.

Last week, the ECB cut interest rates to historic lows. However, Mario Draghi, ECB president, has said that he is not opposed to another rate cut.

Austerity vs. Growth

To a degree, German led calls for austerity have stabilized the euro zone treaty. But, most of the nations want to shift the focus to growth. Euro zone unemployment is estimated to include more than 19 million workers.

The consensus is that the natives of the euro zone have been pushed about as far as they can go. France has been an advocate for growth and has marked the formation of a Europe-wide banking supervisor as an important step in the region’s recovery. German finance minister Wolfgang Schaeuble and Chancellor Angela Merkel have opposed this new initiative fearing that Germany would have to bear the heavy load.

On Tuesday, Schaeuble appeared to soften his position, suggesting that the new, broader banking union could be structured by June. A second aspect of this initiative would call for identification of banks that need to be closed. Schaeuble told French finance minister Pierre Moscovici that the new banking union was a “priority object.”

Germany, always the pillar of the euro zone, is facing its own manufacturing, export and GDP problems. GDP was revised from negative 0.6 percent in the fourth quarter 2012 to 0.7 percent. Germany narrowly avoided falling into recession by posting a 0.1 percent gain in the first quarter 2013. Despite its tempered growth, Germany enjoys the lowest unemployment rate in years.

Liquidity Driving Equity Markets

The euro is off 2.3 percent in May, hitting 1.2883USD in overnight trading. The dollar rests comfortably in the 102 range against the yen. The ECB is likely to consider another rate cut before the end of the year. The dollar reached 102.63 yen overnight.

Meanwhile, the Federal Reserve and the Bank of Japan continue to pour money into easing programs. The weak yen is very liable to cause more export stress in Europe.

The UK has been damaged by the weaker euro and the stronger pound. UK exports have lowered to Europe but have increased to other markets like Southeast Asia and Africa. Outgoing Bank of England head, Mervyn King hinted that the BoE may be softening its easing program shortly. King put forth the first positive outlook for the UK since the outset of the financial crisis. Britain has been successful encouraging small business growth but still fights high unemployment and a slumping housing market.

All eyes will be on Italy’s upcoming 30-year bond auction after Spain had a successful 10 billion euro sale of its 10-year bonds on Tuesday. After Fitch Ratings upgraded the nation’s sovereign debt, a positive accomplishment, Greece’s 10-year bonds surged in Wednesday’s auction. Greece is no longer viewed as a country about to leave the euro zone, a credit to the tough love imposed by Germany.

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Troubling Data Across The Board


Politics continued to plague the euro zone and US economies and China’s rising housing crisis added fuel to the fire as currency markets trembled under the weight. European and Asian equity markets slipped on Monday as the US markets trended down by midday.

The euro slumped to 1.30USD. Britain’s pound slumped to a 2-year low against the yen and to 1.50USD on Monday.

In the euro zone, the lack of resolution to last week’s elections had markets on edge. The yield on Italian bonds rose, but the lack of a permanent government has many economists worried about how ECB Chairman Mario Draghi can help the struggling economy. Without a government, no commitment of austerity can be made to the ECB thus sealing off the infusion of more euros.

In the US, markets received the news of the sequester without blinking but by Monday a sobering tone was noted in Washington. President Obama reached out to Congressional Republicans and to Democrats in the hopes of composing middle ground legislation.

Obama apparently asked for consideration of a new direction for the massive spending cuts, specifically throwing entitlement reform and tax reform on the table.  Several Republican s have said they would consider closing some tax loopholes as long as entitlement reform is art of the package.

Public consensus is that the US must deal every aspect of the entitlement scenario. A lack of progress will certainly affect every sector of the US economy.

A revealing report from China on 60-Minutes confirmed what many analysts already realize. The Chinese construction market is overdue for a slowdown. 60-Minutes showed cities of unoccupied, new housing. All apartments in the massive buildings are sold but they remain vacant, unaffordable for the majority of the population.

On Sunday, China announced that its residential construction sector had slowed to its lowest activity in five years. China added more damaging data indicating that factory output slowed to multi-month lows in February.

China is already curtailing its ever expanding residential development but the effects have yet to be felt. This could be a housing bubble that has the potential to dwarf the US housing collapse.

In the UK, the pound fell because of reaction to a decline in the construction industry. This decline could push the country into its third recession in five years.

The data has supported the Bank of England’s cries for further quantitative easing, but there is unrest throughout the economy. Ian Stannard, the Head of European FX Strategy at Morgan Stanley explained, “The construction PMI today was quite weak, but the really big one is the services PMI which comes tomorrow and if that comes in weak as well it would increase the possibility of further action at this week’s BoE meeting.”

Forecasts for a global slowing in 2013 seem more likely now that politics has entered the economic fray.

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ECB and Non-Farm Payroll Boost Euro


Momentum from Mario Draghi’s announcement regarding the ECB’s upcoming bond buying spree helped take the euro to four month highs against the dollar. A weaker than expected Non-Farm Payroll Report neutralized US equities and sent the dollar lower. The Labor Department’s report fell far short of ADP data submitted Thursday and below analyst expectations.

The economy generated 96,000 new private sector jobs in August. The projected number of new jobs was 125,000.  ADP had indicated the addition of 225,000 jobs by the private sector in August. Number of hours worked was also down. New claims for weekly benefits fell to the lowest level in a month.

The upbeat focus yesterday was dimmed on Friday but many investors feel the most recent job report gives credence to the need for QE3. The Federal Open Market Committee will hold a two-day meeting starting on Wednesday. The likelihood of new stimulus will be the featured topic. Investors believe that the program could be announced as early as Thursday.  QE3 is a highly controversial package.  The stimulus will weaken the dollar, boost equity markets and may not have enough clout to influence the overall economy.

The euro climbed to $1.2806 before settling at $1.2782 at midday. The USD fell to 80.263 against a basket of currencies. European equities continued to rise as the FTSEurofirst 300 rose to 1105.73. Yield on the 10-year US bond was up the 1.6215 percent.

In the wake of Draghi’s announcement, both the yields on Spanish and Italian debt hit 4-month lows as gold futures climbed to $1,737.30, another four-month high.

In the euro zone, a critical decision from Germany’s high court regarding the legality of the Bailout funds for euro zone members will be announced next week. Experts predict the court will vote to support the release of much needed funds but it is remain a hot topic of debate in the homeland. Germany was the lone dissenting nation in the ECB’s vote for unlimited bond buying.

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Spain Down Euro Up


With Spain on the brink of collapse and poor investor appetite for Italy’s bonds, a May Day rally moved the euro and the Swiss franc to one-month highs against the USD.  The euro climbed by 0.2 percent settling at $1.3274.  The dollar gave back 0.2 percent to the Swiss franc closing at 0.90500 francs.  Given the instability in the euro zone, the currency has not fallen below the $1.30 mark since December 20th.

The April fall of the euro by 0.8 percent seems more realistic. The currency finished April with its worst monthly performance since December 2011. The rise of the euro is based on unsettling economic developments in the US.  Data released on Monday lent to concerns about the strength and depth of the US recovery.  Poor consumer sentiment and disappointing manufacturing data from the Midwest caused a lowering of GDP projections to 2.2 percent.

Both the euro and the dollar fell against the yen.  The euro hit 2-weeks lows against the yen as the US fell to 2-month lows at 79.10.  In anticipation to Tuesday’s meeting of the Reserve Bank of Australia, the AUD fell 5 percent to $1.0418 USD.

In the US, equity markets look for relief from the Federal Reserve, but several of the Fed Governor’s have been vocal in dissent of a possible QE3 stimulus package. The demand for US exports has been diminished by the crisis in Europe, the USA’s largest importer.

Spain Fighting The Inevitable

Last week, S&P lowered Spain’s credit rating to BBB+, regarded as generous by many investors.  On Monday, the axe fell for 9 of the country’s 10 largest banks that were lowered to junk rating.  Spain has pushed for consolidation of the country’s banks.  The result of this has put undue pressure on the 10 banks.

The country’s banks have taken on large pools of distressed and defaulted assets and are finding dwindling deposits and skeptical investors.  The country’s banks are the largest holder’s of sovereign debt. 

Greece was spared because the region’s two largest economies, France and Germany, were heavily vested in the struggling economy.  Spain does not have that luxury.  The only elements that can help Spain are the continuation of the ECB to purchase Spain’s debt.  Technically, Spain does not meet the IMF’s stringent requirements.  Spain’s Prime Minister and his cabinet remain steadfast that Spain does not need outside support.

Without a rescue plan, the question is no longer will Spain default but rather when will Spain default. The populace wants change and a loosening of the austerity programs that are shrinking GDP.

A Monday report regarding Spain’s 24.4 percent unemployment rate eerily resembles US unemployment during the Great Depression in the 1930’s.  A study of the US unemployment rate in the 30’s suggests that Spain has not seen the worst.   Since July 2007, Spain’s unemployment rate has been a vertical climb without any plateaus of relief.

There appears no relief for Spain.  Unlike Greece, Spain’s default could easily be unstructured. This event may trigger a domino effect for nations like Portugal, Ireland and Italy. The European Stability Mechanism (ESM) is underfunded to meet these cumulative needs.

Spain’s ten-year bonds are yielding 6 percent, an unsustainable rate. While the country has implemented austerity cuts, they appear too little, too late.

France And Greece

Two key elections this week may shape the trajectory of the euro zone.  Incumbent French President Nicolas Sarkozy is a distinct underdog to keep his job.  Socialist Francois Hollande is the favorite and has run on a platform calling for reform in the euro zone treaty.

In Greece, the outcome to the elections is not clear.  However, there are undertones that Greece will not comply with its bailout agreement deemed unacceptable by the citizenry.

Austerity Programs

What has been increasingly apparent is that austerity cuts alone do not work.  The better formula for growth involves well-considered cuts and support by the ECB and IMF.  These loans are not quantitative easing, which would be the best way to proceed.  However, the ECB funds are low interest and fairly loose terms.

Austerity cuts only address one side of the problem.  Economists advocate a balanced approach that can lead to growth, the most important component in a recovery. The euro zone’s paymaster does not see it that way.  Germans have difficulty funding poorly administered economies.

No matter how you slice the pie, euro zone’s recovery must have a path for growth.  If Spain, or any other euro zone nation, were as focused on growth as they are on austerity, the economy would have broader appeal to investors.  There is no way standalone austerity cuts can accomplish the job.

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Has the US Dollar Hit Bottom?


In April, I declared that the dollar would rally when QE2 ended. That date – June 30 – is now only a few weeks away, which means it won’t be long before we know whether I was right. Meanwhile, the dollar is close to pre-credit crisis levels on a composite basis, and has already fallen to record lows against a handful of specific currencies. In other words, it’s now do-or-die for the dollar.


Since my last update, a number of things have happened. Commodity prices have continued to rise, and inflation has ticked up slightly. Meanwhile, GDP growth has moderated, the unemployment rate has stagnated at 9%, and the S&P has fallen slightly as investors brace for the possibility of an economic downturn. Finally, long-term interest rates have fallen, despite concerns that the US will be forced to breach the debt ceiling imposed by Congress.

From the standpoint of fundamentals, there is very little to get excited about when it comes to the dollar. While the US is likely to avoid a double-dip recession (the case for this was most convincingly made by TIME Magazine, of all sources), GDP growth is unlikely to rebound strongly. Exports are growing, but slowly. Businesses are investing (in machines, not people), but they are still holding record amounts of cash. Consumption is strong, but unsustainable. The government will do what it can to keep spending, but given that the deficit is projected at 10% of GDP in 2011 and that Congress is playing hardball with the debt ceiling, it can’t be expected to provide the engine of growth.

Meanwhile, Ben Bernanke, Chairman of the Fed, has implied that QE2 will not be followed by QE3. Still, he warned that “economic conditions are likely to warrant exceptionally low levels for the federal-funds rate for an extended period.” With low growth, high unemployment, and low inflation, there isn’t any impetus to even think about raising interest rates. In fact, Bernanke and his cohorts will continue to do everything in their power to hold down the dollar, if only to provide a boost to exports. Bill Dudley, head of the New York Fed, intimated in a recent speech that the Fed’s current monetary policy is basically a response to emerging market economies’ failure to allow their currencies to rise.

In short, if I was arguing that fundamentals would provide the basis for renewed dollar strength, I would have a pretty weak case. As I wrote a few weeks ago, however, there is a wrinkle to this story, in the form of risk. You see- the dollar continues to derive some significant support from risk-averse investors, as evidenced by the fact that Treasury yields have fallen to record lows.


Ironically, demand for the US dollar is inversely proportional to the strength of US fundamentals. As the US economy has rebounded, investors have become more comfortable about risk, and have responded by unloading safe haven positions in the dollar. With the US recovery faltering, investors are slowly moving back into the dollar, re-establishing safe haven positions. While the dollar faces some competition in this regard from the Franc and the Yen, it still compares favorably with the euro and pound.

In fact, some traders are betting that the dollar’s fortunes may be about to reverse. It has fallen 15% over the last year, en route to a 3-year low. With short positions so high, it would only take a minor crisis to trigger a short squeeze. Said the CEO of the world’s largest forex hedge fund (John Taylor of FX Concepts): “We see a big upside USD catalyst in the next ’3 or 4 days’ on the grounds that…’Our analysis of the markets has shown that they are very, very dangerous.’ ”

For what it’s worth, I also think the dollar is oversold and expect a correction to take hold at some point over the next month.

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Economic Theory Implies Canadian Dollar will Fall


Sometimes I wonder if I’m living in the clouds. All of my recent reports on the Canadian dollar were twinged with pessimism, and I argued that it would only be a matter of time before reality caught up with theory. While the continued surge in commodities prices has confounded everyone’s expectations, but other economic trends continue to work against Canada. In other words, I think that there is still a strong argument to be made for shorting the loonie.

To be sure, the rally in commodities prices has been incredible- nearly 50% in less than a year! Oil prices are surging, gold prices just touched a record high, and a string of natural disasters have driven prices for agricultural staples to stratospheric levels. Given the perception of the Canadian dollar as a commodity currency, then, it’s no wonder that rising commodity prices have translated into a stronger currency.

As I’ve argued previously, rising commodities prices are basically an irrelevant – or even distracting – factor when it comes to analyzing the loonie. That’s because, contrary to popular belief, commodities represent an almost negligible component of Canada’s economy. Canadian exports, of which commodities probably account for half, have recovered from the recession lows of 2009. On the other hand, the value of Canadian exports are basically the same as they were 10 years ago, when one US dollar could be exchanged for 1.5 Canadian dollars.

Consider also that Canada now imports more than it exports, and that the Canadian balance of trade recently dipped into deficit for the first time since records started being kept 40 years ago. Its current account has similarly plunged, as Canadians have had to finance this through loans and investment capital from abroad. Based on the expenditure approach to GDP, trade actually detracts from Canadian GDP. Any way you perform the calculations, commodities are hardly the backbone of its economy, account for about 15% at most.

As if that weren’t enough, the press is full of stories of Canadians that think their own currency is overvalued. Businesses complain that they can’t compete, and that banks won’t lend them the money they need to upgrade their facilities and become more efficient. Meanwhile consumers whine about higher prices in Canada, compared to the US. I think it’s very telling that their is now a 2-hour wait to cross the border from Vancouver, and shopping malls on the American side have reported a huge jump in business. Even the famous Big Mac Index shows that the price of a hamburger was already 12% higher in Canada back when the loonie was still hovering around parity with the US Dollar.

One area that higher commodities prices will be felt is inflation, which is nearing a two-year high and rising. At 3.3%, Canada’s CPI rate is now higher than in the EU. Given that the European Central Bank hiked rates earlier this month, it probably won’t be long before the Bank of Canada follows suit. In fact, forecasters expect the benchmark rate to rise by 50-75 basis points by the end of the year, from the current 1%.

This might excite carry traders, but probably few others. Besides, given that other central banks will probably raise rates concurrently, it can’t be assumed that carry traders will automatically gravitate towards the Canadian dollar. Not to mention that as I pointed out in my previous post, the carry trade is hardly a risk-free proposition. In this case, an interest rate differential of only 1-2% probably isn’t enough to compensate for the risk of a correction in the USD/CAD.

And that is exactly what I expect will happen. The fact that the loonie has shattered even the most optimistic forecasts is not cause for bullishness, but rather for concern. According to the most recent Commitment of Traders report, net long positions are reaching extreme levels, and it’s probably only a matter of time before the loonie returns to earth.

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Gold Hits Record High


Historically, demand for gold increases as political unrest sets in and causes the value of the dollar to drop.  In other words, the environment for a gold rush is perfect.  Investors drove gold to an all-time high on Thursday at $1,508 per ounce.  At the same time, silver reached a 31-year high at $41.64 per ounce.

As confidence in the United States, the euro zone and the Japanese yen diminished, gold has fared very well.  In 2010 gold rose 30% after gaining 25% in 2009.  The price of gold has doubled since hitting low points in 2008.

The uncertainty in the Middle East and North Africa, the tragedy in Japan and the rising inflation in China and India are all compounding the weakness in the dollar, the euro and the yen.

Reuters recently polled 12 analysts.  Predictions for the future of gold covered a wide range from $1,000 to $2500.  The average projects that gold will hit $1,500 by 2015. The consensus revealed that the value of gold could change if positive political action begins and if economic recoveries gain solid ground.

Investors in India and China appear to be driving the price of gold.  As individual wealth increases in these vibrant economies, investors are selecting gold over other markets.  Based on the trends of these investors, an analyst from FastMarkets, James Moore, said that the demand from China and India will raise the price of gold to at least the $1,750 mark by 2015.

China and India purchased 1.54 tons of gold jewelry, bars and coins in 2010.  The World Gold Council reports that there are only 4,108 tons of gold in the market.

Wang Tao, a Reuters analyst, suggested that gold follows and eight year cycle.  Tao’s theory is that gold will hit $2,000 in 2012 and then will have a sharp slide.  The ability and will of the United States to reduce their deficit and strengthen the dollar are major factors in this scenario.

This week, the dollar has hit three-year lows.  The warning from Standard and Poors and the endless bickering in Washington have caused the dollar’s decline.  It is not just U.S. taxpayers that have lost confidence in Congress but it is also international investors.

The lack of confidence in the dollar has also spurred a strong rise in the price of oil.  At the rate oil is rising, Americans have a chance to hit $6.00 per gallon this summer.

Ronald Simpson of Action Economics  in Tampa Florida, “ There’s no reason to buy dollars right now.” Unfortunately, Simpson has it right.  Washington needs to get together and restore the U.S. image from its current third world imitation to the strongest economy in the world.

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Forex Volatility Rises from Multi-Year Lows


In the last month, volatility in the forex markets touched both a two-year low and a one-year high. In the beginning of March, volatility essentially returned to pre-credit crisis levels. One week later, when the earthquake and inception of the nuclear crisis in Japan, volatility surged 40%. While it has since resumed its downward path, investors are still bracing themselves for continued uncertainty.


The carry trade has perhaps born the brunt of the volatility spike. The carry trade depends on interest rate differentials – as opposed to currency appreciation – to drive profits, and  thus demands stability. When the markets become choppy and exchange rates spike wildly in one direction or another, it makes the carry trade significantly more risky. Hence the paradoxical rise of the Japanese Yen to a record high following a series of crushing disasters, as highly leveraged traders moved to unwind their Yen-short carry trades.

Likewise, high volatility should spur demand for so-called safe haven currencies. If only it were clear what constitutes a safe haven currency. Traditionally, that would send the US Dollar, Swiss Franc, and Japanese Yen upwards. In this case, the Franc has benefited most, followed closely by the Yen. The Dollar spiked against emerging market and high-risk currencies, but hardly budged against its G4 counterparts. Could it be that the Dollar’s multi-year positive correlation with volatility has (temporarily?) abated.

With regard to strategy, currency traders have a handful of choices. If you believe that volatility will continue declining or remain stable, you’re probably going to go long emerging market and high-yielding currencies, and short one of the safe-haven currencies, all of which are quite cheap to borrow. The main risk of such a strategy, of course, is that volatility will once again spike, in which these safe have currencies will rally.


If you think that the ebb and volatility isn’t sustainable, then you’re probably going to bet on the Franc, Dollar, or Yen. As I wrote in an earlier post, I think the Yen could theoretically appreciate in the short-term, but actually remains quite risky over the long-term. Despite the best efforts of the Swiss National Bank, the Franc will probably continue appreciation. Economically and monetarily, it is in an excellent shape. Besides, the fact that the supply of Francs is intrinsically small means that even modest capital inflow often translates into a big jump in its its value. As for the Dollar, it is now the most popular currency to short. It remains a safe choice and a good store of value, but probably won’t deliver the returns that safe-haven strategists have come to expect.

From a practical standpoint, you may also want to consider reducing your leverage. As everyone knows, high leverage increases profits but also magnifies losses. In the current environment of heightened volatility, leverage also magnifies risk. Either way, you may also want to consider hedging your exposure, by trading a basket of currencies and/or through the use of options.

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Emerging Market Currencies Flat in 2010


The recovery that emerging markets (their economies and financial markets) have staged since the lows of 2008 is impressive. In most corners of the financial markets, all of the losses have been erased, and securities/currencies are trading only slightly below there pre-credit crisis levels. Even compared to twelve months ago, in 2009, the performance of emerging market currencies holds up well. In the year-to-date, however, most of these currencies have appreciated only slightly, thanks to a particularly weak month of August.

Emerging Market Currencies

The MSCI emerging market stock index is currently down 2.5% since the start of the year. You can see from the chart above that most emerging market currencies tend to track this index pretty closely, rising and falling on the same days as the index. Interestingly, emerging market stocks appear to be much more volatile than emerging market currencies. You can also see that while the Malaysian RInggit has started to separate itself from the pack, the others have moved in lockstep with each other and are all about even for the year.

On the other hand, emerging market debt – as proxied by the JP Morgan Emerging Market Bond Index (EMBI+) has been unbelievably strong. Prior to the slight correction in the last couple weeks, the index has risen a whopping 20% over the last twelve months. On the surface, this disconnect between stocks and bonds would seem to be an anomaly, or even a contradiction. After all, if investors are only lukewarm about emerging market currencies and stocks, what reason would there be for them to get so excited about bonds.

jp morgan embi+ 2010

If you drill a little deeper, however, it all starts to make sense. Due to a weak appetite for risk, 2010 has been a favorable year for bonds, at the expense of stocks. I would have assumed that poor risk appetite would also have helped G7 financial markets, at the expense of the emerging markets, but you can see from the chart below (which shows the MSCI emerging markets stock index closely tracking the S&P 500) that this simply isn’t the case. On the contrary, this same dynamic is playing out simultaneously in emerging markets. “Today, we are favoring emerging-market debt over emerging-market equities because the debt provides us with a better risk-adjusted return,” summarized one portfolio manager.

S&P 500 versus MSCI emerging markets 2010

When it comes to debt, emerging markets have actually outperformed G7 debt, in spite of the current risk-averse climate. “Funds investing in emerging-market local-currency debt have attracted $16.9 billion of net inflows so far, more than triple the record annual intake of $5 billion recorded in 2007.” The logical basis for this shift is surprisingly straightforward: “When we look at government debt, we’re always comparing and contrasting the yields versus the fundamentals. I just don’t know why you would want those low yields from a Treasury bond in the developed world when you can get much higher yields — and in our estimation, an improving economic story — in Indonesia, Malaysia or Brazil.”

In other words, why would you want to earn 2.65% from a country (US) whose national debt is close to 100% of GDP, when you could earn double or triple that rate from investing in the sovereign debt of countries whose Debt-to-GDP ratios are sustainable?!  In addition, when it comes to investing in debt, the lack of volatility in emerging market currencies can bee seen as a plus, since it prevents the interest rates from becoming diluted. To be fair, fundamentals don’t represent the whole story: “After 2008, you really have to take liquidity into consideration. Emerging markets are going to be some of the first to freeze up in a crisis.”
Government Bond Yields Inflation 2010
In fact, some analysts are already starting to question whether the markets haven’t gotten ahead of themselves in this regard, and that perhaps we are due for a big correction: “Come September, when trading resumes in earnest, we’ll find out if the cozy emerging markets world we have experienced over the past few months was summer laziness or strong conviction.” With vacations ending and traders set to return to their desks, we won’t have to wait long to find out.

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China Speaks About Euro, The World Listens


A report published by The Financial Times on Wednesday indicated that China’s State Administration of Foreign Exchange (SAFE) was disturbed about the instability in the euro zone and that the government was re-thinking its investment position in the zone.  The report indicated that China would pullback from its hefty investments in euro zone and especially in its bond holdings in the zone’s peripheral economies, Portugal, Italy, Ireland, Greece and Spain, commonly called the PIIGS.  The report sent world equity, commodity and currency markets into a tailspin as investor’s sought safe havens.

SAFE manages China’s reserves controlled by the central bank.  Those reserves include approximately 630 billion euro zone bonds.  In the past 18 months, China has increased its euro zone bonds while decreasing its large investments in the U.S.  The move toward diversification has worked well for the euro and more recently for other Asian economies and emerging commodity economies.  Currently, China has more than $2.4 trillion invested in foreign reserves.

China’s reserves have increased rapidly in recent years as exports continue to outweigh imports, which are tightly controlled by the government.  The trade surplus is critical to the nation’s stability.  The diminishing euro could be viewed as a threat to China’s trade surplus.  On Wednesday, the euro fell below the $1.22 mark and settled at four-year lows.

SAFE has been holding meetings with many international bankers over the past few days.  These meetings have raised speculative tensions about SAFE’s future plans.  As a matter of policy, the investment actions and strategies of SAFE are not revealed, but the uneasiness surrounding the euro does not appeal to the agency.

Geithner Tries to Unify Euro Zone

The news from China came as U.S. Treasury Secretary barnstormed from the U.K. to Germany in efforts to calm nerves and unify finance ministers in the sixteen member European Union and the U.K.  Rumors persisted that Greece would default on its sovereign debt and the euro members were revisiting the prudence of the 110 billion euro pledge to bailout the country.

Against the dollar, the euro has fallen 8 percent this month alone.  What was perceived to be a sovereign debt crisis is now considered to be a banking crisis.  Geithner pushed for a series of stress tests designed to increase transparency for the zone’s banks.

Geithner’s meetings included talks with the U.K. a dinner meeting with European Central Bank President Jean-Claude Trichet and another meeting with Axel Weber, the head of Germany’s powerful Bundesbank, who is adamantly opposed to the one trillion dollar bailout plan. 

Earlier in the day, Geithner’s had a tense meeting with German Finance Minister Wolfgang Schauble, a strong critic of U.S. investment policy.  Conservative Germany is critical of the U.S. financial regulation but is the zone’s biggest economy and most important member of the bailout contributors.  German independence is marked by their recent ban on certain short selling, a policy that is unlikely to change.

After his meeting with Schauble, Geithner commented that, “I think we all agree we want more conservative restraints on capital and leverage.”  Schauble acknowledged that the U.S. and its European partners were opposed to the country’s ban on naked short sales of euro sovereign bonds, credit default swaps and protected financial shares.  Germany insists outside speculators worsened the euro zone crisis by betting against the euro.

Italy and Spain Join the Frey

Just as China announced it was not reviewing its euro position, Spain reported that its announced austerity cuts had passed its legislature by the slimmest of margins, one vote.  The country’s cuts will save 15 billion euros over two years.  Opposition to the austerity plan has been especially vocal among the country’s labor unions.

Meanwhile, Italian Prime Minister, Silvio Berlusconi, obtained approval from his cabinet for a 25 billion euro budget cut.  Publicly criticized, Berlusconi defended his package saying, “The sacrifices required are indispensable to save the euro.  For years, Italy, like many countries in Europe, lived above their means.  We are all in the same boat.”

Portugal and Greece have already gained approval for their plans.  Some cuts have already been implemented by Greece but the public debate rages on. 

China’s announcement that The Financial Times report was inaccurate and Geithner’s statement that Europe and the U.S. agreed financial regulation was necessary but should not limit recovery quelled global marketplaces.  The European equity markets gained 2 percent but the euro still hovered in the $1.23 range.

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