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Euro Slides, Dollar Rises, Italy Plays With Fire

On Friday, the euro fell to its lowest rate against the USD since January 10 and to its lowest point against the yen in three weeks. A number of factors came together to keep the euro in a steady slide and the yen on a steady rise.

In Europe, the euro zone’s 17-member nations released economic information that painted a bleak picture for the region during 2013. Only Germany seemed to discount the overwhelming evidence of another recession. The German confidence index climbed for the fourth straight month, despite a dismal finish to 2012 and data suggesting manufacturing in the country and the region was dialing down.

The euro fell to $1.3166, well below the 15-month peak of $1,3711

The euro fell to 122.23 yen, down  1.4 percent

The dollar index struck a five-month high at 81.508.

In addition to projections that euro zone unemployment would remain in the 12 percent range for 2013 and that Spain’s unemployment rate would stay at 20 percent, there were other factors that are too unsettling to overlook. The ECB had anticipated banks would  pay back 131 billion euro of borrowed funding but fell far short of the mark, repaying just 61 billion euros on Thursday.

Spain announced the country would fall far short of its debt reduction goals in 2012 and well below euro zone requirements. The events in Spain and Italy should be observed by US politicians as examples of what happens when politics and economic concerns face off against each other.

Recent production numbers from the US indicate that businesses are uneasy about how politicians will handle the sequestration due to fall off the March 1st cliff on Friday, March 1, 2013. Coupling this event with the upcoming debt ceiling expiration, the stage is set for a perfect storm that will leave the middle class crippled and the country mired in what will surely become another recession.

And, the political rhetoric in Washington marches on.

On Thursday, minutes from the Federal Reserve’s January meeting were released. The possibility that the Fed will raise interest rates earlier than expected strengthened the dollar against the declining euro.

In addition to the economic woes in Europe, the political theater is unnerving economies outside the region. The amazing but disturbing popularity of Italian bad boy and financial nightmare Silvio Berlusconi have shaken confidence in Italy’s future and thus the future of the euro zone.

Is it possible that the regions third largest economy could turn a blind eye to the unscrupulous Berlusconi? Apparently so as the former Prime Minister is locked in a three way run between himself, current prime minister Mario Monte and Luigi Bersani.

Many economists hold Berlusconi responsible for the lax financial oversight that sank the nation’s economy. However, Italians seem to prefer the wayward ways to the disciplined approach to correction that Monti has advocated.

The euro zone produces 20 percent of the global output. The European Commission said that the euro zone will not return to growth until 2014, dimming hopes of China and the US for their export markets.

Across the region, consumer inflation could deal another blow to the economy. Projection call for an inflation rate increase to 1.8 percent in 2013.

In Washington, Congress returned and seemed undisturbed by the pending negotiations that could set the country back into recession in a very short time. The inability of Congress to put their political rhetoric aside and act responsibly has been repressing the economy since the fourth quarter 2012.

On Thursday, new unemployment claims surpassed analyst expectations as signs of the political weight on the economy continue to mount.

It appears President Obama will stick to his word on reducing spending and increasing taxes. Republicans can move to the middle or cause another economic collapse. If so, it may be 2014 before Democrats regain the house and finally accomplish meaningful legislation about jobs, guns and immigration.







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Currency Manipulation Questioned At G-7

As an anxious world awaits President Obama’s State of The Union address, a bitter game of cat and mouse seems to be circulating global currency markets. At the center of the controversy is Japan’s yen causing the Group of Seven nations to call for cessation of devaluing of currencies to gain trade advantages.

Of late, currency markets have been volatile. As the USD has given ground to the euro, the euro has also soared against the yen. The euro has gained 24 percent against the yen in just three months. China has long been accused of manipulating its currency and international tensions are high.

Mario Draghi of the ECB spoke on Tuesday saying that exchange rates are equally important for growth and stability. Japan has implemented a large quantitative easing initiative that has lowered the US policy of continuing assistance from the Federal Reserve have kept the two currencies at low levels.

The US has made headway in its trade balance in the past two months with December closing the imbalance to its lowest level since the mid 1990’s. China also rode a strong export balance to its main buyers the US and Europe to a big spike in its January GDP.

Draghi said that he believes Spain is “on the right track” towards economic recovery. Meanwhile, Italy captured a significant windfall from its 2012 property tax enforcement. Italy collected 23.7 billion euros in property taxes, surpassing Treasury’s estimate by 1.2 billion euros.

It is expected that the windfall will be used to reduce the nation’s budget deficit below 3 percent of 2012 GDP. The target was 2.6 percent but analysts think that bar will not be achieved even with the windfall. The 2012 annual review will be published on march 1, 2013.

The US, Britain, France, Germany, Japan, Canada and Italy, the member nations of the G-7, was called to consider Tokyo’s expansive monetary policy. Reuters quoted a spokesperson for the G-7 as saying; “The G7 statement signaled concern about excess moves in the yen. The G7 is concerned about unilateral guidance on the yen. Japan will be in the spotlight at the G20 in Moscow this weekend.”

The G20 finance ministers are scheduled to convene in Moscow this weekend. It is a full plate this time around and currency valuations will be at the fore.

Britain heads the G-8 which includes the G-7 nations and Russia and released a statement saying that as far as Britain’s easing and restructuring: “We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates.” This is the intent of easing to assist national economies meet oppressive challenges.

Japan’s Finance Minister, Taro Aso, insists that the country’s policy is aimed at reviving the stagnant economy. It is unclear what leverage the G-20 has to stabilize the disparities.

Japan gained support for the US when Treasury official Lael Brainard told the media that the US recognized Tokyo as easing efforts as a remedy for the lackluster economy with massive unemployment.

Regarding the euro, France has been most vocal about setting a large for the currency that does not yield a competitive edge. Many euro members have concerns about the exchange rate but Germany lowered the anchor on such speculation. Finance minister Wolfgang Schaeuble said, “There’s no foreign exchange problem in Europe. There are concerns that there could be something like this in other parts of the world.”

Since December 2012, the euro has climbed 10 cents against the USD. This is the effect of the ECB tightening its balance sheet while Japan and the US continue to expand their easing programs.

Analysts hope that the President’s State of the Union will pave the way for a political compromise to reduce the deficit in reasonable terms and engage the public sector in a powerful growth initiative.

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Euro Zone Offers Spain 100 Billion Euros

After receiving calls from leaders of most of the global community, the euro zone nations agreed to lend Spain up to 100 billion euros to be used to capitalize the country’s struggling banking sector and build adequate reserves. A 2.5 hour conference call between the 17 euro zone member nations was reported to be heated at times. However, Spain’s application for assistance was met with strong support and euro zone members were quick to state their intentions to help Spain.

A statement from the euro group said, “The loan amount must cover estimated capital requirements with an additional safety margin, estimated as summing up to 100 billion euros in total.” This is the type rescue plan the global economy needed to see.  A banking failure in Spain would lead to euro zone contagion on a much wider scale.  With most countries on the continent in recession, one failure could devastate the euro economy.

In the tense and fragile global economic environment all nations are now feeling the economic pain.  The world’s largest economy, the US, is struggling with political dysfunction and a thread bare recovery so delicate that Fed Chairman Ben Bernanke appealed to Congress to reserve severe austerity trimming until the economy has an upward trend. Bernanke would like to see additional investments in growth and employment, a message echoed by the President on Friday.  The President called upon Europe to take swift and decisive action to remedy the regions multiple debt crises.

Spain has been hesitant to request assistance because of a sense of national pride and because the austerity programs required by the euro zone were too stringent. With its back to the wall, Spain opted to request the aid.  The amount will be determined by an audit that was scheduled to be released Monday but will now be released June 21, 4 days after Greece votes for a new government.

Spain insisted that the IMF not provide any assistance. Spain’s Economy Minister Luis de Guindos announced that “The Spanish government declares its intention to request European financing for its recapitalization of the Spanish banks that need it.”

While the IMF funding will not occur, the IMF and EU institutions will participate in monitoring Spain’s economic and banking activity. While euro zone embers preferred that a specific amount be requested, Spain chose to wait until the completed audits were presented. The region would like to have finances in place before the Greek elections which could lead to a withdrawal of Greece from the euro zone and a fiscal collapse.

In an interesting report provided by the BBC, the youths of Spain and the youths of Greece have a common pursuit. Disillusioned by city life and high unemployment, youths are migrating to the country to attempt to make use of farming land.

While the promise of funds for Spain’s banks is encouraging, markets will be only moderately settled until specifics of where the funds will come from are described. Funds could come from the EFSF or the more permanent ESM which goes live next month.

To satisfactorily capitalize itself with acceptable reserves, Bankia will need 23.5 billion euros.  Bankia was nationalized last year and now consists of the original entity plus seven community banks. Moody’s had pared Spain’s credit rating by three notches to BBB.  The reason for the downgrade is the banking sector’s exposure to bad real estate loans and a slumping marketplace. Last week, Spain was extended another year to get its sovereign debt down to 3 percent of GDP.

The next two fire alarms in the euro zone will be the Greek elections and the fate of Italy’s banks. It will be interesting to see what the credit agencies think of this plan and what its effect on stronger euro zone nations will be.

Germany’s normally conservative Finance Minister, Wolfgang Schaeuble, threw his support behind Spain’s request. “Spain has taken big steps to get its economic and financial problems under control. It has launched profound structural reforms and that is what all international institutions are saying.”

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Euro Tumbles, S&P Strikes

 Last month when S&P posted a warning that the credit ratings of the 17-member nations of the euro zone were under review, global markets quivered.  As of mid-afternoon Friday, the downgrade rumors were rampant and world markets showed the stress.  After hours confirmation by S&P confirmed the market’s fears.

According to S&P, Ireland avoided a downgrade.  Likewise, Finland and the Netherlands survived the rating’s scrutiny and will retain their AAA ratings. The news was not so good for France, which fell one notch from AAA to AA+.  Not to be lost in the rubble, Austria lost its AAA rating and fell one notch.  Portugal and Spain fell two notches. Italy collapsed from A to BBB.  There was no news from several other Euro Zone members who are awaiting the axe. 

This week, Spain’s three-year bond auction was fully subscribed giving cause for optimism.  But, one day later, Italy’s 3-year bonds fell short of expectations and highlighted the stress Italy will have to overcome in bond sales over the next three month.  Even at near record yields, private investors cannot warm to the Italy. 

Germany has dodged the bullet this time around but the government is pouring money into the system at unprecedented levels.  Another disappointing bond sale in Italy and the ongoing hedge fund battle with Greece weigh heavily on the euro zone.  Greece has a 14 billion euro call in March.  Without help, Greece cannot meet this obligation. 

Highlighting investor’s aversion to long-term euro zone bonds, investors are desperately seeking more relief from Greece.  One cannot imagine that any deal with Greece is simply kicking the inevitable doomsday down the road. 

This aversion has put the ECB in dangerous waters.  The central bank left interest rates unchanged at 1 percent.  The ECB has made low cost, three-year loans to member banks.

On Friday, the euro fell to a 17-month low at $1.2623.  Against the yen, the euro fell to an 11-week low at 97.28. The collapse of the euro bond market has increased demand for U.S. Treasuries, JGB’s and Swiss bonds.

After trading hours, several analysts reported to CNBC that if the euro can hold the $1.26 level, they would play the currency to climb to $1.30.  However, the $126 mark is key.  If the euro falls below this threshold, investors expect a steep downward slide.  Conditions do not merit the $1.30 value.

What is sustaining the market now is the ECB’s aggressive lending which has created a risk play of borrowing at 1 percent and purchasing high-yield Italian (6.73), French and Spanish bonds.  In spite of these favorable yields, euro member bond auctions show a troubling trend as consistently under subscribed.

The elephant in the room is China.  Thus far, the elephant has been passive but looming in the brush.  These downgrades are likely to have a ripple effect.  Previously, China had stayed with the euro zone bond markets but how they will react to the downgrades is likely to quiet their appetite.

Greece continues to suggest that they will strike a deal with investors and insurance companies who have been cool to taking a 50 percent hit on their investments.  Rumors from hedge fund investors suggest that private equity will not be invested in Greece unless substantial concessions are made by Greece.

One unnamed source, privy to the negotiations, reported to Reuters, “Yesterday, we were optimistic and confident. Today, we are less optimistic.”  Private investors have been less receptive to Greece because of the ongoing bad news for an economy that is not marketable and will not grow for at least three years.  Rumors persist that if Greece is unable to strike a deal with its private/public investors, the country will return to its own currency and be expelled from the euro zone.  Unfortunately, the outcome will send ripples through the entire global currency and equity markets.  The Euro Zone members will be especially hard hit.

In after hours, S&P confirmed the downgrades but made it clear that the German “austerity” programs were not enough to ease pressure from the ratings agency.  Some CNBC contributors warned listeners to expect that massive quantitative easing is probably the failsafe.  Not only will the euro plunge, but other currencies will also take hits.

In terms of quantitative easing, analysts acknowledge this is the only way to save Europe, but it will come at a steep price.  In Friday, there were reports that the U.S. Federal Reserve was preparing for another round of quantitative easing.  Next week has the look of a point in time that will be in every history book.  Unfortunately, it seems unlikely that the news will be bullish.

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Euro Looks To Monday Teleconference

Get ready for an evolving Euro term that you will hear much about in upcoming days, months and years.  Media releases now refer to the Eurogroup, which is composed of the 17 Euro Zone nations and the European Union’s 27 nations minus the UK.  In efforts to enact a feasible bailout plan for the Eurogroup, member nations will engage in a teleconference on Monday.

Eurogroup President Jean-Claude Juncker’s office announced the critical teleconference will include discussions about the 550 billion euro European Stability Mechanism (ESM), which was formerly called the European Financial Stability Fund (EFSF). 

One of the proposals that seems to have traction is a measure changing the firing mechanism for relief funds through a revised voting plan that would only require a majority vote. This change would prohibit one or two smaller countries from blocking the release of funds.

Finland objects to this change because approval of the revision would require a two-thirds majority in the Finnish Parliament.  This approval is not achievable. 

The Eurogroup will discuss with the IMF increasing the IMF crisis financing by 150 billion euros.  The Eurogroup will contribute 100 billion euros and IMF contributors will kick in another 50 billion euros.  This plan must be complete by December 19th.

Fitch Doubtful

 The Eurogroup has acknowledged that a solution to the crisis must be a multi-faceted bunch of remedies.  This will include austerity cuts for all nations, increased revenue and GDP growth. The formula looks good on paper but at least one of the big-three credit rating services has registered serious doubts.

Fitch’s concerns have foundation.  The concerns might have best been described by Italy’s Deputy Finance Minister, Vittorio Grilli, who said, “We all know that Europe has not been able to convince markets that its governance set-up and its measures against the crisis were enough.  More integration and more effective instruments are needed. We are not there.”

On December 9, Eurogroup nations agreed to add legislation that every required each member nation have a balanced or surplus budget.  Failure to do so would invoke immediate corrective measures.  The hole is too deep now and cannot get deeper.

This provision is designed to would limit government borrowing and reduce Eurogroup debt. This legislation could not occur until at least a year.  The Eurogroup is busily trying to ease investor concerns.

Fitch points out that the Eurogroup does not have funding to bailout Italy and/or Spain.  Investors are already nervous with Greek debt headed to a settlement of 50%. Investors are advised that Greece is a stand-alone situation.

To calm investors, Euro Zone members have proposed that the funds in the ESM be ready for activation by July, 2012.  On Monday, the Eurogroup will discuss language to be included in the final draft of their mission statement. 

Germany’s approval is contingent on contributions from other EU members.

Like all other summits, the Brussels summit appeared to have a unified game plan.  As has happened after virtually every other summit, when the nations returned home, things began to unravel.  This scenario was repeated after the Brussels summit two weeks ago.  Markets responded on news a viable plan was in play.  As the details were revealed, the markets have all suffered substantial hits.     

Were it not for encouraging news from the U.S., the global markets may well have been in freefall.  Demand for Eurogroup nation bonds has slowed dramatically.  Many of the world’s biggest investors have stopped investing this year.

The one possible agency that could stem the tide is the ECB. However, the ECB feels it is constitutionally limited in its ability to provide necessary bailout funds.

Fitch consistently has said that six Eurogroup nations are in serious jeopardy of further downgrades.  Italy and Spain are the most vulnerable.

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Merkel, Sarkozy And Body Language

The world listened carefully to the joint statement made by French President Nicolas Sarkozy and German Chancellor Angela Merkel on Monday.  Transcribed, the announcement had legs but if body language means anything, it was noticeably absent and in fact reflects the strain that has existed between the euro zone’s largest economies.

On Friday, the news was positive and equity markets responded in kind.  On Monday, reality once again spoiled the warm and cozy feeling.  A strong US equity bounce was tampered when Merkel and Sarkozy took to the stage.  On the surface, everything sounded encouraging.  In reality, there is little reason to feel cozy in the euro zone.

With the European Union, which consists of 27 member nations, meeting this weekend, the world is hoping for positive strategies and commitments to come from the members.  However, the UK does not use the euro as its currency and has already voiced pessimistic support.

Merkel and Sarkozy will present their plan on Wednesday.  Merkel stated that if the UK is not on board, the German – French plan will be submitted to the 17-member euro zone. The appearance of France and Germany working toward a positive result that would include any euro zone members or EU members who wanted to participate boosted lowered the yields on Italian and Spanish bonds significantly.

But, there is much negotiating to accomplish.  Merkel and Sarkozy seem to have fashioned a plan to free the European Central Bank from its mandate so that the central bank can expand its purchase of sovereign debt.

However, the ECB cannot fund the rescue of the euro zone or even Italy alone.  To set common standards for euro zone members, France and Germany will require all members to meet preset austerity cuts.  

Coincidentally, Italy’s new Prime Minister Mario Monti announced acceptance of his 30-billion euro austerity plan.  The market reacted enthusiastically to his balanced budget.  Monti has increased taxes and trimmed government spending.  Naturally, Italians are not happy and a labor strike is readying.

Italian 2-year bonds shed 85 basis points and fell to 5.78 percent.  Ireland also released details of its 60 percent spending reduction in next year’s 3 billion euro budget.  Lenders were briefly encouraged.

Merkel has won on one front because France’s proposal to issue Eurobonds has been tabled.  Germany was insistent that euro bonds issued after 2013 must have language to investors that “the bondholder may have to share the burden of future bailouts.”

The Merkel-Sarkozy proposal may well include participation of the IMF and request that the IMF take action.  However, the US has declined to participate in funding this rescue either directly or indirectly.  All one has to do to understand the Administration’s position is to see the malfunctioning body that is Congress.

S&P Serves Notice

On Monday, the S&P served notice to France, Germany and 13 other euro zone members that their credit ratings were under review.  If the zone’s talks do not lead to changes, the credit rating fro each member will suffer. 

Greece is already sporting a CCC credit rating.  Basically, Greek bonds are junk bonds.  Cyprus has already had a credit rating fall.

One of the strict covenants of the new plan will require that members cannot carry a debt level of more than 3 percent of GDP.  Sarkozy and Merkel agreed that for the time being, Greece would be the only exception.  This would also be true if Greece had to default on its debt, which is almost a sure thing. 

When one considers the euro zone media events, everything seems laughable.  Are Germany and France leading the euro zone or is the euro zone leading its two biggest economies?  Either way, the US should be on the sidelines in this one.

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Euro Zone The Great Divide

On Monday, German Chancellor Angela Merkel warned fellow Euro Zone members and the European Union Members that the continent faces its greatest threat since WWII.  The ominous analyses of the Euro Zone has paralyzed world credit markets and put immense pressure on the euro. 

As new “technocrat” led governments take over in Italy and Greece, there still remains lingering doubts about the real-time ability of Portugal, Italy, Ireland, Greece and Spain, affectionately called the PIIGS, to navigate the domestic waters and the economic turmoil on the continent.

With France facing a downgrade of its AAA credit rating and Germany gingerly holding the rudder, the Euro Zone is now openly showing the tense internal and external challenges that are on the forefront.  Recent growth of the Euro Zone shows a treacherous downward spiral of the continent’s GDP.  The GDP for Europe is now projected to be closing in on no or negative growth in 2011.

France and Germany, the two largest economies in the Euro Zone, are holding billions of euro bonds from member nations.  With Greece and Italy considering the harsh reality of structured defaults, the bondholders can not expect more less than a 50 percent haircut and it could very well be worse by the time a plan is enacted.

On Tuesday, the euro slid to the $1.35 mark.  Many analysts feel the currency is filled with risk.  The Euro Zone does not have the ability to move swiftly.  By the time the politicians have raked each possible remedy over the coals, the plan is old news. 

Amidst the Euro Zone, there seems to be a growing tension between the Northern, more stable, economies and the troubled southern tier.  The bottom line is that the European Financial Stability Facility (EFSF) must be leveraged but probably needs another euro infusion. While the economies are considering leveraging the account to create a 1 trillion euro fund, there is disagreement on how the funds should be utilized.

Two months ago, the Euro Zone appeared settled on this course of action.  Things changed in a hurry when Italy suffered a deep downgrade and raised their debt service to an all-time high over 7 percent.  Italy is the region’s third largest economy and the eighth largest economy in the world.

Financial ministers have worked to perfect the leveraging. Under on plan, the investor will be issued a guarantee by the EFSF that a defined percentage of the investment will be assured.  If there is a default, the investor can control their loss and thus their exposure.  Under this plan, there remain questions as to whether the bond or certificate can be traded independently.

An option that is not creating much noise is the Co-Investment Fund (CIF).  This investment vehicle is geared for the individual investor.  The CIF would acquire sovereign bonds in primary or secondary markets. The Euro Zone is rushing to detail a third option.

China has been approached by several financial ministers.  To date, China is awaiting the EFSF options before deciding their strategy.

In other developments, a new book released by a reporter from the BBC indicates that Goldman Sachs invested heavily in Greece and manipulated the currency and the economy with full knowledge of former Prime Minister George Papandreou.  When Goldman had to reveal their strategy, they halted investments in the country and suddenly appeared to have a deep debt problem.  In reality, the debt existed all along.  When Goldman halted, Papandreou was forced to reveal the depths of the country real economy.

In Monday’s address, Merkel called for the 17-member Euro Zone to come together and save the euro.  However, the German populace is critical of Merkel who holds the slimmest of margins in her Parliament.

As Italy and Greece build new cabinets, the citizens have become unruly and are holding violent, destructive protests.  Merkel had it right that the continent faced grave challenges.  However, the northern tier members are losing their appetite for the exposure their economies face. 

Look for the Euro to tailspin.  Even if Greece and Italy approve the austerity plans set by the Euro Zone, Europe seems to be facing more severe contagion than previously predicted.  The risk looks like a bottomless pit and it is unlikely that Merkel can receive support to any additional exposure from her Parliament.  Stay tuned for market-claiming media reports that carry little substance.  Without Germany, the Euro Zone is dead in the water.

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Euro Cuts Raise Concerns

At the June G-20 summit in Toronto, it was decided that countries would pursue necessary budget cuts to reduce sovereign debt.  The U.S. insisted that the member nations continue to pursue growth as part of a successful formula to end the recession.  The growth-trim controversy was the key discussion at the Toronto summit.

While the participants agreed to the concept, they returned home to unleash austerity cuts with little concern for growth.  The avoidance of a strategy to grow alongside the debt reduction has spread beyond the euro zone as Britain, Brazil and India have joined the parade.

On Tuesday, China expressed concern that the euro zone cuts would greatly affect the country’s export balance.  The U.S. has expressed the same concern ever since Greece needed assistance to meet its obligations.

In Monday’s after trade quarterly reports, IBM and Texas Instruments announced lower than expected results.  The surprise announcements sent tremors thought European markers and sent the Nikkei to a 1.2 percent loss as European equities fell for a fifth straight day.

Earlier in the day, the euro had crossed the $1.30 mark and was holding at $1.3029.  Nervous investors seemed to doubt the currency’s ability to handle the results of the stress tests to be revealed on Friday.  The euro was trading at $1.2851 when U.S. markets opened but the slide looked to be continuing.

Director of research at Forex.com, Jane Foley, explained, “We’ve seen risk appetite claw back a fair amount and the market is questioning whether that move is valid.

China Speaks

On Tuesday, China’s Ministry of Commerce spokesperson, Yao Jian, said that the country’s export business would fall as a result of the cuts in he euro zone.  China has enjoyed stellar gains in the first half of 2010.  

In June, exports increased 43.9 percent in year-over-year comparisons and 48.5 percent in May comparisons.  However, imports also rose dramatically and nearly nullified any growth in GDP.

 Yao said that second half export growth would fall to about 16.3 percent yielding a 24.5 percent rise in GDP.  That rise is modest by 2009 comparisons, but wages have been increased in certain areas and the Ministry of Commerce mentioned these changes are detrimental to the export-import ratio.

 According to the International Energy Agency, China has replaced the U.S. as the world’s energy consumer.  China challenged the report saying that Beijing was aggressively pursing replacement of outdated manufacturing plants.

Yao said China is expecting to begin new construction projects to meet the country’s rising consumption expenditures.  With newly increased wages, demand for products has also increased and China will see a significant rise in internal sales.

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China Jumpstarts G-20

China’s decision to allow its currency to trade more openly looks good at first glance but there may be more to the move than meets the eye.  The immediate effect is that certain G–20 economic leaders may be caught off balance in advance of this weekend’s G-20 summit in Canada.  Monday’s announcement appears designed to give China a more balanced import-export level and to answer public criticism of the nation’s currency policy.

The timing of the announcement, just days before this weekend’s G-20 summit in Canada, may thwart some tough resistance from member nations but conservatives warn it is too early to fully assess the impact.  China’s trade policy has been the focus of many disgruntled G-20 nations heading into the weekend meetings.

The net effect appears to be that companies like GE and Caterpillar with big investments in China will not see much change but companies like Walmart, Liz Claiborne and Target that rely on low cost manufacturing from China may be pinched to keep their prices down.

The Beijing announcement ends a 23-month peg against the dollar and will clear the way for the appreciation of the currency, which many analysts feel is undervalued by 20-40 percent.  Internally, China has been pressured by the labor force to increase wages.  A recent strike at a Honda Plant and 11 suicides at manufacturing giant Foxconn have pressured the government to act and thus spur internal consumer spending.

G-20 Divided Over Austerity Cuts

The move by China may divert some of the criticism that was planned by G-20 members.  Now, the rift may well be centered on the austerity trimming policies of euro zone countries and specifically Germany.  Chancellor Angela Merkel feels political pressure to maintain a somewhat defiant posture about austerity cuts.  The Chancellor has openly rejected advice from President Obama about the depth of euro zone cuts and the timing of trimming measures.

The U.S. feels that the depth of the cuts and the rapid implementation of the austerity plans will send Europe spiraling back into another recession.  Merkel has said that Europe will push for a fast exit from loose fiscal stimulation policies and will state its case at the G-20 with a strong budget consolidation plan.

The United States sees a relatively loose approach as a deterrent to a double dip recession.  China is expected to criticize the U.S. policy at the G-20.  Obama has said that nations, like China, with large export surpluses should change their focus to developing internal consumer spending. The idea that the U.S. consumer can be relied upon to lead the way out of the recession is outdated.  U.S. unemployment stands at close to 10 percent and surveys reveal continued uneasiness on Main Street.

Increased Consumer Spending In China

China’s shift in the yuan policy should help ease trade imbalances among G-20 member nations.  On Monday, global equity markets responded favorably to the move.  The change in policy will raise the cost of goods in China and may make goods manufactured in the west more appealing.

The cost of Chinese manufacturing has already increased 8 percent in the past 12 months.  In early Tuesday trading, the yuan fell slightly as China’s banks moved to purchase dollars instead of the national currency.  On Monday, the currency posted its biggest gain in four years.

In April, China posted its first monthly trade deficit in six years.  In May, the export-import balance returned to positive, but the labor force continues to apply pressure.  The increased labor costs are seen to be subtly impacting export levels, a welcome trend for the west. 

Most likely, this weekend’s G-20 summit will only result in the release of each country’s conceptual policies regarding economic reforms.  At the November summit, specific policies are expected to e stated by each country.

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Euro Falls Further

Fear of further weakness in Greece, Spain and Italy drove the euro to levels close to parity against the dollar as many investors moved to the sidelines while gold pressed the 1200 mark as a safety net.  European equity markets closed at the lowest levels in nine months as U.S. equities underwent across- the-board meltdowns.

The euro downtrend hit $1.2142 before a small rally just after European markets closed.  Currently, the euro has lost 17% since January and is well below 2008 highs of $1.60.   

With Greece resisting certain provisions of the EU’s austerity plans and Spain applying for assistance to hedge banking sector weakness and Germany announcing the possibility of broader short selling bans, turmoil reined in global currency and equity markets.

Jane Foley, Research Director at Forex.com said the euro’s weekly average of $1.18  marked “fair value” for the troubled currency.  “Historically, currencies don’t stay around fair value for long.  In the medium term, I think there is a risk of overshoot which could take us down to $1.15/1.10 area,” said Foley.  The Research Director did not rule out the possibility that the euro could fall as low as $1.00.

BNP Paribas Forex strategists suggested that Purchasing Power Parity (PPP) euro/dollar stands at $1.1370 and that the euro would fall further in the first quarter of 2011.  Ian Stannard of BNP Paribas reported that, “Assuming an adjustment to one standard deviation below PPP, this provides a target of $1.03, which is consistent with our forecast of parity.”

Greece and Italy Raise Fears

Greece’s Labor Minister said on Monday that the EU and the IMF were tightening the country’s controversial pension reform as part of the “aid for pain” agreement.  The EU fell short of saying that Greece was non-compliant but said their role was to assure member nations of Greece’s compliance with all austerity plans.

The current pension draft allows pensioners to begin drawing funds after 37 years of contributions.  The new plan would add another three years of contributions before payouts could commence.  The current plan would commence on 2018 but the EU-IMF expects a 2015 deadline.

In essence the EU’s plan addresses more comprehensive changes such as raising the retirement age for women and discouragement of early retirement among public employees.  These provisions are included in the EU’s plan but have not been approved by Greece’s parliament.

In Spain, fear of more bank bailouts has weighed on the euro.  Over the weekend, the Bank of Spain seized control of Cajasur, a small savings bank, whose merger efforts with Unicaja failed.  Other Spanish banks fear takeovers by the Central Bank if their planned mergers do not succeed.

The takeovers come in the wake of a 15 billion euro austerity package announced by the government just last week.  Investors fear that bank balance sheets in the euro zone exceed the government’s ability to bail them out.

“We believe the intervention is quite negative news for the financial system, for the sovereign risk profile and for the economy in general,” offered Credit Suisse analyst Santiago Lopez.  The bailout comes on the heels of the S&P’s sovereign debt downgrade last week.

Spain’s bank shares fell sharply during trading on Tuesday.  Approximately one third of the country’s savings banks have already completed mergers while an additional one third are in merge talks.

Expanded German Short-Selling Bans

A paper created by the German Finance Minister and leaked on Tuesday indicated the country planned further bans on naked short selling that would include derivative trading.  Markets fell sharply upon the release.

As Italy prepared to announce a two-year austerity trimming plan, fears escalated that the European Union was in the midst of a banking crisis.  The pan-European stock index fell by 3.4 percent to a nine month low.

Meanwhile U.S. Treasury Secretary Timothy Geithner will be moving from China to Europe.  It is believed the Secretary will be calling for stress tests used by the U.S. to stabilize financial markets.  It is believed Geithner will encourage the stress tests as a mean to restore transparency to the euro zone.

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