Tag Archive | "Record Highs"

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USD Confidence Falls: UK Hits Highs


US equity and currency markets turned lower overnight in the face of political bickering about whether the US government should pay its bills. All three major equity markets turned down at the open on Friday and were poised to give back Thursday’s gains by 10:00 a.m. The dollar also gave ground against a number of currencies despite weakening banking news in Europe and uneasiness in Japan.

In the US, Senators Ted Cruz and Mike Lee continued their stall tactics, defying Republican leadership, and slowed the vote on the debt ceiling-Obamacare defunding bill forwarded by the House. This, in turn, will slow appropriate revisions to be returned to the House that would keep the government open. The delay tactic increased the likelihood of a government shutdown and put the debt ceiling, which will expire on October 17th, into crisis mode.

Investors are not amused. After good employment news on Thursday, The Consumer Confidence Index missed expectations on Friday coming in at 77.5, the lowest level since April 2013. Meanwhile, consumer confidence in the UK was at its highest level since 2007 and even uneasiness in the European banking sector kept consumer confidence in the euro zone higher than in the US.

In early morning trading, the Dow was off 95.05. The S&P 50  was down 9.86 and Nasdaq was 16.33 points lower.

Discord Over European Bank Stress Tests

The euro zone intends to submit its banks to controversial stress tests as a first step in solidifying the region’s banking sector. Capital infusions enabled US banks to reboot their capital reserves but in Europe there is no backstop to ensure that banks are adequately capitalized. This has caused a general tightening of credit markets in the euro zone’s more tenuous economies.

Credit markets in Greece, Italy, Portugal and Spain are frozen. As a result there is virtually no growth in these countries and unemployment remains at record highs.

The stress tests are regarded as important to stabilize international markets and currencies. However, after the stress tests are performed, there is no plan in place to remedy shortfalls. Many banks in the region have insufficient reserves. The net effect of the stress tests will be to highlight weaknesses in the banking sector with no plan to remedy the reserve shortfalls.

The tests administered by the ECB, the European Banking Authority (EBA) and the EU will reportedly be stringent. The ECB will be focused on the euro zone’s biggest banks. The model will be used by the EBA to test the remaining banks in the euro zone through a program known as the Asset Quality Review.

Europe’s top 42 banks are 70 billion euros below new international capital norms. However, analysts suspect that the problems are much bigger ion the euro zone’s smaller banks.

Euro zone purse strings are controlled by Germany who is opposed to the construction on a region-wide re-capitalization plan. Without such a plan, the stress tests will put pressure on governments in the area to boost the banks.

The prognosis is that the absence of testing gives the banks a grace period but the day of reckoning is on the horizon.

Currencies

The USD was down 0.1 percent against a basket of currencies. After gaining 0.3 percent on Thursday.

The biggest move of the day came from the UK where British sterling was up 0.4 percent at $1.6096. The UK recovery appears to be gaining momentum.

The dollar did not fare well against the euro ($1.3558) or the yen 98.280.

Yield on the 10-year Treasury continued its trend toward 2.5 percent and was at 2.62 percent early Friday.

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Employment Disappointment Shakes Markets


Disappointing numbers from the US labor Department’s non-farm payroll report unnerved investors and shook currency markets around the globe. The disappointment came along with some very positive data from June regarding consumer spending and US factory goods.

The payroll data reflects the economy’s inability to sustain growth on its own merits and will surely be viewed with concern by the Federal Reserve. Non-farm payrolls added 162,000 jobs in July, a solid number but well below projected increases of 184,000. However, the unemployment rate fell two-tenths to 7.4 percent, the lowest rate since December 2008. Over the past three months, non-farm payroll growth has averaged about 175,000 new jobs per month.

The Federal Reserve concluded two days of talks on Wednesday without announcing any policy change. Markets received this status with enthusiasm.

Markets reacted quickly to the disappointment. After closing at record highs on Thursday, equities endured modest losses on Friday. The disappointment was apparently negated by the probability that the Federal Reserve will remain committed to its $86 billion per month stimulus through the rest of the year. The S&P 500 index, which crossed the 1700 threshold on Thursday, the DOW and Nasdaq all were down by midday.

Earnings Strong

Another offset to the employment data is the strong performance of US corporations. Of the 375 companies that have reported second quarter earnings, 67.5 percent have surpassed expectations. On Friday, AIG, the giant insurance carrier beleaguered during the recession, announced its first capital return since the 2008 bailout. The company is offering a dividend and stock buyback. Shares jumped 3.4 percent to $48.67.

Linkedin also surpassed expectations, reporting heavier than expected sales. The stock jumped 9.8 percent to $233.88. Over the last four quarters, 55 percent of reporting companies have posted bigger gains than expected.

Other Data On Friday

The Commerce Department’s gauge of core inflation rose 1.2 percent in June. May inflation showed a 1.1 percent rise.

The average work week tuned down to 34.4 hours. Earnings slipped 0.1 percent.  5.7 percent of Americans with jobs could not log enough hours to qualify as full-time jobs. In July, 4.25 million Americans had been unemployed for six months or longer.

Politicians have rejected the President’s infrastructure worm programs and thus have forced the Federal Reserve to be more active than most Americans would like. Additionally, government layoffs continue to hurt the economy as the sequestration passed by Congress will play out during the rest of 2013. As Congress prepares for their August vacation, taxpayers should be asking what Congress will do to get Americans back to work.

Currency Changes

The euro rose 0.4 percent against the USD to $1.3265. The dollar posted gains against the yen to 99.11. The dollar index fell 0.4 percent to 81.994 against a basket of currencies.

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New Zealand Dollar: Come Back to Earth!


In March, I wondered aloud about whether the New Zealand Dollar might be the most overvalued currency in the world. Since then, it has continued its unlikely ascent, rising 10% on a correlation-weighted basis and 3% against the US Dollar, hitting a 26-year high in the process. While there are signs that the New Zealand economy might be able to withstand an expensive currency, at some point, the chickens must come back to roost.


Surely the expensive kiwi must be wreaking havoc on the New Zealand dollar? “How is New Zealand supposed to rebalance its economy away from consumption, importing, borrowing and asset selling towards investment, production, exporting and asset buying when our currency is headed for record highs?” Wonders one commentator. In fact, exporters are coping just fine, and New Zealand just recorded its highest quarterly trade surplus on record. Never mind that this is due almost entirely to soaring prices for commodities and unflagging demand. In spite of two earthquakes and other related downside factors, the New Zealand economy is nonetheless forecast to grow by 2.3% in 2011.

On the other hand, New Zealand’s current account deficit continues to rise, as foreign investors pour in to New Zealand to make acquisitions, portfolio investment, and loans to the government. New Zealand’s largest dairy conglomerate could soon be sold to Chinese investors, while China’s sovereign wealth fund (which manages a portion of the country’s sprawling forex reserves) has announced plans to purchase a big chunk of New Zealand government debt. This is just as well, since a record 2011 budget deficit will require a significant issuance of new debt.

Meanwhile, New Zealand price inflation is currently 4.5%, which means that the country’s real interest rate is -2%, certainly among the lowest in the world. Moreover, even as two-year inflation expectations tick up, rate hike expectations remain unchanged. The consensus is that the Reserve Bank of New Zealand will avoid hiking its benchmark until the first quarter of 2012. Regardless of what happens in the interim, it seems unlikely that Bank president Alan Bollard will give in, for fear of stoking further speculative interest in a currency that is already “undesirably high.”

Let’s review: record low interest rates and record low real interest rates. Record budget deficit. Large current account deficit. Declining expectations for GDP growth. Record high New Zealand Dollar. Does anyone see a contradiction here? It’s no wonder that the IMF recently speculated that the Kiwi might be overvalued by as much as 20%, echoing the sentiments of yours truly.

At the same time, commentators concede that “The New Zealand dollar or any currency can deviate for a long period of time from academic measures of valuation.” And that is why making fundamental bets on currencies is so difficult. Even if all signs point to down (as is basically the case here), a currency can continue rising for many more months, before suffering a massive correction. For what it’s worth, this is the fate that the New Zealand Dollar is resigned to. Whether it will happen tomorrow or next year, alas, will depend more on global macroeconomic factors (such as the ebb and flow of risk aversion) than on what happens in New Zealand.

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Swiss Franc at Record Highs


This month, the Swiss Franc touched a record high against not one, but two currencies: the US dollar and the Euro. Having risen by more than 30% against the former and 20% against the latter, the franc might just be the world’s best performing currency over the last twelve months. Let’s look at the prospects for continued appreciation.


As I wrote on Monday, the Swiss Franc has been one of the primary beneficiaries of the safe haven trade. With each spike in volatility, the Swiss Franc has ticked upward. Due to monetary and fiscal stability as well as political conservatism, investors have flocked to the Franc in times of crisis. Of course, the Japanese Yen (and the US dollar, of late) has also received a boost from this phenomenon, but to a lesser extent than the franc, as you can see from the chart above.

Personally, I wonder if this isn’t because the Swiss economy is significantly smaller than that of Japan and the US. In other words, its capacity to absorb risk-averse capital inflows is much smaller than that of Japan and the US. For example, the impact of one million people suddenly rushing out to buy shares in IBM stock would have a much smaller impact on its share price compared to a sudden speculative flood into FXCM. The same can be said about the franc, relative to the dollar and yen.

Ironically, the franc is also rising because of regional proximity to the eurozone. I use the term ironic to denote in order to signify that the franc is not being buoyed by positive association with the euro but rather because of contradistinction. In other words, each time there is another flareup in the eurozone sovereign debt crisis, the franc typically experiences the biggest bounce because it is the easiest currency to compare with the euro. In some ways, it is basically just a more secure version of the euro. This phenomenon has intensified over the last month, as the euro faces perhaps its most uncertain test yet.

It is curious that even as investors have gradually become more inclined to take risk, that not only has the franc held its value, but it has actually surged! Perhaps this is because it is expected that the Swiss National Bank (SNB) will soon hike interest rates, making the franc both high-yielding and secure. To be sure, some analysts think that the SNB will hike as soon as June. The fact the the economy has continued to expand and exports have surged in spite of the strong franc only seems to support this notion.


On the other hand, inflation is still basically nil. And just because the Swiss economy can withstand an interest rate hike hardly provides adequate justification for implementing one. Besides, the SNB hardly wants to give the markets further cause to buy the franc. If anything, it may even need to intervene verbally to make sure that it doesn’t rise any higher. Thus, “The median forecast among economists is for a rate increase in September.”

In short, I think the franc is overbought against the dollar. In fact, you can see from the most recent Commitment of Traders data that speculators have been net long the franc for almost an entire year, and it seems inevitable that this will need to reverse itself. On the other hand, the franc probably has more room to rise against the euro. The takeaway here is that it is less important to know where you stand on the franc in general and more important to understand the cross currency.

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Risk Still Dominates Forex. The Dollar as “Safe Haven” is Back!


Well over two years have passed since the collapse of Lehman Brothers and the accompanying climax of the credit crisis. Most economies have emerged from recession, stocks have recovered, credit markets are strong, and commodities prices are well on their way to new record highs. And yet, even the most cursory scanning of headlines reveals that all is not well in forex markets. Hardly a week goes by without a report of “risk averse” investors flocking to “safe haven” currencies.

As you can see from the chart below, forex volatility has risen steadily since the Japanese earthquake/tsunami in March. Ignoring the spike of the day (clearly visible in the chart), volatility is nearing a 2011 high.What’s driving this trend? Bank of America Merrill Lynch calls it the “known unknown.” In a word: uncertainty. Fiscal pressures are mounting across the G7. The Eurozone’s woes are certainly the most pressing, but that doesn’t mean the debt situation in the US, UK, and Japan are any less serious. There is also general economic uncertainty, over whether economic recovery can be sustained, or whether it will flag in the absence of government or monetary stimulus. Speaking of which, investors are struggling to get a grip on how the end of quantitative easing will impact exchange rates, and when and to what extent central banks will have to raise interest rates. Commodity prices and too much cash in the system are driving price inflation, and it’s unclear how long the Fed, ECB, etc. will continue to play chicken with monetary policy.


Every time doubt is cast into the system – whether from a natural disaster, monetary press release, surprise economic indicator, ratings downgrade – investors have been quick to flock back into so-called safe haven currencies, showing that appearances aside, they are still relatively on edge. Even the flipside of this phenomenon – risk appetite – is really just another manifestation of risk aversion. In other words, if traders weren’t still so nervous about the prospect of another crisis, they would have no reasons to constantly tweak their risk exposure and reevaluate their appetite for risk.

Over the last few weeks, the US dollar has been reborn as a preeminent safe haven currency, having previously surrendered that role to the Swiss Franc and Japanese Yen. Both of these currencies have already touched record highs against the dollar in 2011. For all of the concern over quantitative easing and runaway inflation and low interest rates and surging national debt and economic stagnation and high unemployment (and the list certainly goes on…), the dollar is still the go-to currency in times of serious risk aversion. Its capital markets are still the deepest and broadest, and the indestructible Treasury security is still the world’s most secure and liquid investment asset. When the Fed ceases its purchases of Treasuries (in June), US long-term rates should rise, further entrenching the dollar’s safe haven status. In fact, the size of US capital markets is a double-edge sword; since the US is able to absorb many times as much risk-averse capital as Japan (and especially Switzerland, sudden jumps in the dollar due to risk aversion will always be understated compared to the franc and yen.

On the other side of this equation stands virtually every other currency: commodity currencies, emerging market currencies, and the British pound and euro. When safe haven currencies go up (because of risk aversion), other currencies will typically fall, though some currencies will certainly be impacted more than others. The highest-yielding currencies, for example, are typically bought on that basis, and not necessarily for fundamental reasons. (The Australian Dollar and Brazilian Real are somewhere in between, featuring good fundamentals and high short-term interest rates). As volatility is the sworn enemy of the carry trade, these currencies are usually the first to fall when the markets are gripped by a bout of risk aversion.

Of course, it’s nearly impossible to anticipate ebbs and flows in risk appetite. Still, just being aware how these fluctuations will manifest themselves in forex markets means that you will be a step ahead when they take place.

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What’s Next for the Yen?


After the G7 intervened in forex markets last month, the Yen fell dramatically and bearishness spiked in line with my prediction. Over the last week, however, the Yen appears to have bottomed out and is now starting to claw back some its losses. One has to wonder: is the Yen heading back towards record highs or will it peak soon and resume its decline?


Some analysts have ascribed tremendous influence to the G7, since the Yen fell by a whopping 5% following its intervention. From a mathematical standpoint, however, it would be virtually impossible or the G7 to single-handedly depress the Yen. That’s because the Yen holdings of G7 Central Banks are decidedly small. For example, the Fed holds only $14 Billion in Yen-denominated assets (compared to the Bank of Japan’s $800+ Billion in Dollar assets), of which it deployed only $600 million towards the Yen intervention effort. Even if the Bank of Japan is covertly intervened (by printing money and advancing it to other Central Banks), its efforts would still pale in comparison to overall Yen exchanges. Trading in the USD/JPY pair alone accounts for an estimated $570 Billion per day. Thus, given the minuscule amounts in question, it would be unfeasible for the Central Banks alone to move the Yen.

Instead, I think that speculators – which were responsible for the Yen’s spike to begin with – purposefully decided to stack their chips on the side of the G7. Given the unprecedented nature of the intervention, and the resolute way in which it was carried out, it would certainly seem foolish to bet against it in the short-term.  In fact, the consensus is that, “Investors are confident that the G7 won’t let the yen go below 80 versus the dollar again.” Still, this notion implies that if speculators change their minds and are determined to bet on the Yen, the G7 will be virtually powerless to block their efforts.

For now, speculators lack any reason to bet on the Yen. Aside from the persistent financial uncertainty that has buttressed the Yen since the the 2008 credit crisis, almost all other forces are Yen-negative. First, the crisis in Japan has yet to abate, with this week bringing a fresh aftershock and an upgrading of the seriousness of the nuclear situation. The hit to GDP will be significant, and a chunk of stock market equity has been permanently destroyed.


Thus, foreign institutional interest in Yen assets – which initially surged as investors swooped in following the 20% drop in the Nikkei 225 average – has probably peaked. The Bank of Japan will probably continue to flood the markets with Yen, and the government of Japan will need to issue a large amount of debt in order to pay for the rebuilding effort. Given Japan’s already weak fiscal situation, it seems unlikely that it can count on foreign sources of funding.

Even worse for the Yen is that Japanese retail traders (which account for 30% of Yen trading) seem to have shifted to betting against it. They are now driving a revival in the carry trade, prompting the Yen to fall to a one-year low against the Euro (helped by the recent ECB rate hike) and a multi-year low against the Australian Dollar. “Data from the Commodity and Futures Trading Commission (CFTC) showed speculators went net short on the yen for the first time in six weeks and by the biggest margin since May 2010 at a net 43,231 contracts in the week to April 5.”

It’s certainly possible that investors will take profits from the the Yen’s fall, and in fact, the recent correction suggests that this is already taking place. However, the markets will almost certainly remain wary of pushing things too far, lest they trigger another G7 intervention. In this way, Yen weakness should become self-fulfilling, since speculators can short with the confidence that another squeeze is unlikely, and simply sit back and collect interest.

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Japanese Yen Down on Risk Aversion


It seems the gods of the forex market read my previous post on the Japanese Yen, in which I puzzled over the currency’s appreciation in the face of contradictory economic and financial factors. Since then, the Yen’s 6-month, 15% appreciation (against the US Dollar) has arrested. It has retreated from the brink of record highs, and undergone the most significant correction since March of this year. Have investors come to their senses, or what?!

USD JPY Chart
You certainly can’t give the Bank of Japan (BOJ) any credit. Aside from its single-day $25 Billion intervention in September, it hasn’t entered the forex markets. In fact, it has already repaid the funds lent to it by the Ministry of Finance, which suggests that it doesn’t have any intention to replicate its earlier intervention in the immediate future, regardless of where the Yen moves.

Perhaps the BOJ foresaw the current correction in the Yen, which was probably inevitable in some ways. After all, Japanese interest rates – while gradually rising – still remain at levels that are unattractive to investors. While US short-term rates are low, long-term rates are more than 1.5% higher than their Japanese counterparts. When you factor in that Japan’s fiscal condition is worse than the US, there is really very little reason, in this aspect, to prefer Japan. As one analyst summarized, “The whole interest-rate differential argument is turning out to be dollar supportive, at least in the near term.”

The same is true for risk-averse capital. For reasons of liquidity and psychology, the Japanese Yen will continue to be a safe-haven destination in times of distress. Still, it’s hardly superior to the Dollar, in this sense. Inflation is slowly emerging (or at least, the risk of deflation is slowly abating) in Japan, and it could conceivably reach 1% this year if the Bank of Japan has its way. Its proposed 35 trillion yen ($419 billion) of asset purchases dwarfs the comparable Federal Reserve Bank’s QE2 program (in relative terms) and contradicts the notion that the Yen is the best store of value.

Japan Economic Structure - Dependence on Exports
Finally, the Japanese economy remains weak, and vulnerable to a double-dip recession. On the one hand, “Japan’s economy expanded at an annual 4.5 percent rate in the three months ended Sept. 30.” On the other hand, its economy remains heavily reliant on exports (see chart above, courtesy of Bloomberg News) to drive growth, which is complicated by the expensive Yen and concerns over a drop-off in demand from China and the rest of the world. In fact, “Exports rose 7.8 percent in October, the slowest pace this year, while industrial production fell for a fifth month and the unemployment rate climbed to 5.1 percent.” In addition, the closely watched Tankan survey registered a drop in September, “the first fall in seven quarters.” While Japanese companies are still net optimistic, analysts expect that this to change in the beginning of 2011.

For the rest of the year, how the Yen performs will depend largely on investor risk-appetite. If risk aversion predominates, then the Yen should hold its value. In addition, it’s worth pointing out that even as the Yen has fallen against the Dollar, it has appreciated against the Euro, and remained flat against a handful of other currencies. Against the US Dollar, however, I still don’t see any reason for why the Yen should trade below 85, and I expect the correction will continue to unfold.

JPY comparison chart 2010

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Reaction To Fed Mixed


Tuesday’s Federal Open Market Committee (FOMC) announcement went under the investor microscope on Wednesday and the result was a flight to gold and other commodities. The dollar dropped sharply against major currencies while equity markets declined in light trading.

Many analysts were mystified by the language and tenor of the Federal Reserve announcement. Scott Anderson, a senior economist at Wells Fargo summed up the Wall Street sentiment, “They have to do a better job of communicating. The markets abhor the vacuum of uncertainty around QE2.”

The intentionally vague aspects of the Fed’s guidelines for the acronym QE2 for Quantitative Easing 2, had analysts reading between the lines as to what events would spark the second round of printing money. The consensus is that the Fed will do whatever easing it takes to prevent double digit unemployment and advance the slow moving recovery and places these priorities ahead of inflation concerns.

Precious Metals and Commodities Up

Gold closed in on the 1300 mark and hit record highs for the fifth consecutive session. Gold is up nearly 17% in 2010. As the Dow Jones continues to flirt with the 11000 level, investors were cautious despite strong quarterly reports.

Investors looking for safety flocked to precious metals. Silver closed in on a 30 year high at $21.00 an ounce and is up 9% in September. Spot palladium rose 3.6% to $545.50 an ounce and platinum closed at $1631.50 up 0.7%.

The euro rose to five month highs against the dollar as the inverse relationship between gold and the dollar returned to form.

Gold has benefited from basic concerns about the health of financials and the impact of reform legislation on those institutions as well as from stale currency markets. When there are concerns about currencies, equities and the financials, gold has become a stable asset.

What The Fed Is Saying

The Fed seems to be shifting away from its stance that growth is acceptable. While companies are performing profitably, those profits are not translating to jobs and there is no indication of a change in corporate strategy.

The Fed seems to be saying that if employment does not improve by the mid-term elections, they are prepared to print and ease credit to get companies to move forward.

The cheap dollar may help with exports and will certainly continue to lift prices for most commodities that are traded in dollars.

 

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FOMC To Print Or Not To Print


The Federal Open Market Committee (FOMC) is a key component of the Federal Reserve that is responsible for overseeing the country’s open market operations. Since 1981, FOMC has met eight times per year at intervals of five to eight weeks. At today’s meeting, the principal item on the table is the Federal Reserve’s decision relative to quantitative easing; the magical process by which the government turns on the presses and prints more money.

FOMC is the committee that makes decisions about interest rates and the growth of the United States money supply. How the committee votes today will set the monetary policy until the next meeting. Many of the members with voting rights have opposing views about quantitative easing, the state of the USD, the slowing growth of the economy and inflation.

Most analysts believe the Fed will stand firm on interest rates and hold off on quantitative easing. Yesterday’s announcement that the recession officially ended in June 2009 may have played well on Wall Street but drew skepticism on Main Street where the recession is better measured by the employment crises.

Quantitative Easing Round Two

Immediate quantitative easing has support among some of the FOMC voters. It is expected that whether quantitative easing is approved or not, guidelines for activation will be set.

The sharp rise in commodities is driving consumer prices up while there is high unemployment and a weak dollar, a formula that fuels fears of inflation. Gold hit a fifteen year high early Tuesday. Commodities like sugar and cotton are also approaching record highs.

The Fed and FOMC have also been criticized over the effectiveness of the first round of printing, which may have saved the financial sector but did little for the taxpayer. A second round of quantitative easing could only be justified to significantly bolster employment and growth.

The slowing of the growth of the GDP is another major concern. Fed chairman Bernanke has bet heavily on growth, which has been slower than expected.

Opponents of quantitative easing fear the creation of market imbalances and horrific inflation rates. These opponents maintain that there is no evidence that QE will solve the employment crises and may in fact lessen the credibility of the Federal Reserve.

At The End Of The Day

By a vote of 8-1, FOMC made no changes in its monetary policy. However, the committee expressed great concern over the unemployment rate and the sluggishly slow pace of the recovery.

The official statement issued by FOMC said, “The committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.”

The Fed purchased $1.7 trillion in long-term U.S. government debt and mortgage bonds. The easing policy implemented by the Fed has weakened the dollar and raised the value of other currencies.

Statements by Bernanke suggest that the Fed stands ready to boost the economy if growth does not show signs of improvement. In other words, FOMC is on hold until November, but if unemployment does not decline and growth is stagnant, the presses will most likely get to work.

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Could Greece’s Fiscal Problems Really Sink the Euro?


Currency markets operate in funny ways. Greece’s fiscal problems are hardly a new development. During years of boom and bust alike, it ran unsustainable budget deficits. Why investors have decided to fret now – as opposed to last year or next year, for example – on the distant possibility of default, is somewhat mysterious.

After all, the credit crisis exploded in 2008, and conditions now are inarguably more stable than they were at this time last year, when volatility and credit default spreads (insurance against bond default) – two of the best measures of investor risk sensitivity – were still hovering around record highs. On the other hand, the unveiling of Dubai’s hidden debt problems, has certainly provided impetus to investors to re-evaluate the fiscal situations in other highly leveraged economies. In addition, Greece just estimated that its budget deficit for 2010 at 12.7%, 4% higher than earlier estimates, which were also shockingly high. Regardless of 1, the markets are now focused firmly on Greece – and by extension, the Euro.

euro
How serious are Greece’s fiscal problems? Serious, but not insurmountable. Its sovereign debt recently surpassed 125% of GDP, higher than the US, but lower than Japan, for the sake of comparison. Of course, the Greek economy is hardly a picture of robustness. Neither is the US, these days, for that matter, but its size means that it is pretty much immune from speculative attacks on its credit and capital markets. Greece, on the other hand, remains extremely vulnerable to the whims of international investors.

On the whole, these investors still remain willing to finance Greece’s budget deficits; the last bond issue was five times oversubscribed, which means that demand exceeded supply by a healthy margin. Still, interest rates are rising quickly, and spreads on credit default spreads have risen above 400 basis points, suggesting that nervousness is growing and Greece cannot take for granted that future bond issues will be met with such healthy demand.

In this context, in stepped the European Union. In fact, it isn’t even clear if Greece asked for help. As I pointed out above, the Greek debt “crisis” is largely playing out in capital markets, and doesn’t necessarily reflect a change in the fiscal reality of Greece. Still, leaders of the EU were alarmed enough to convene a meeting between the finance ministers of member states, to discuss their options.

After weeks of denial that any kind of aid to Greece was being considered, EU political leaders announced that they were prepared to step in to help after all, but they were vague on the details. There were no ledges of specifc dollar amounts, only hazy promises of support should conditions warrant it. In the end, what was clearly intended to comfort the markets achieved the opposite effect, as investors took no comfort in the “moral support” and worried about the new uncertainty.

It’s premature to say whether this whole episode will threaten the viability of the Euro. Much depends on whether Greece (Portugal and Spain, too, for that matter) can get its fiscal house in order (Among other things, it has promised to reduce its 2010 budget deficit by 4%). More importantly, it depends how, and to what extent, the EU responds to this crisis as a community. The Euro is already 10 years old, and you would think that it would have been accepted already within the EU, as it has by the rest of the world. On the contrary, it remains deeply divisive and fraught with politics. Many of its critics have seized on this opportunity to challenge to raise fresh calls for its abolishment. If the problems of Greece deteriorate to the point that other EU members are actually required to intervene, you can expect these calls to crescendo.

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