We’ve been dogging on the pound for a series of months now. And for the most part, we expect to be dogging on it for months to come. Basically, weak economic data points are going to weigh on Bank of England and their interest rate policies. That, in turn, should undermine the pound. But ...

We could be on the brink of a major (or somewhat major) turn in the euro. Fresh off highs versus the dollar, pound, and yen, the euro is in need of a major cool down. If the cards fall right, this euro swing could come very soon.

So if you’re looking for a way to get in against the euro, but you’re too skeptical of a dollar recovery, then maybe you look to the British pound.

 

We’ve got one word to describe the above chart of the euro versus the pound: nosebleed. If investors become legitimately concerned with the outlook for the euro, the British pound could easily make good on the shockwaves.

This pair has run awfully high in the last nine or ten months. It looks as though there’s plenty of room remaining for a reasonable correction. The 7600-level appears to mark the spot.

Sorry for the lack of posts today -- been pretty busy. One thing that I couldn't help comment on, however: Have you noticed that mortgage rates have been ticking higher lately? And that this has had an impact on purchase applications?

The Mortgage Bankers Association's weekly purchase application index dropped 6.4% to 357.30 in the week of April 18. This index has only been lower once this year -- 356 in the week of March 28. The MBA also said its measure of 30-year fixed-rate loan rates popped back above 6% (6.04%) for the first time since the beginning of March.

Now I don't want to make too big a deal out of this. But if we were to break down out of the recent range in purchases (let's say, below 350) and/or break out to the upside in interest rates (let's call it above 4% in the 10-year Treasury note yield, or 6.4% on 30-year mortgages), it'll be something to pay attention to.

The culprit for this recent upside move appears to be inflation fears, spurred by record-high commodity prices, and the flight of money out of bonds and into stocks, spurred by greater risk-taking behavior on the part of investors.

Fed Takes Broad Action to Avert Financial Crisis
The Federal Reserve took dramatic action on multiple fronts last night to avert a crisis of the global financial system, backing the acquisition of wounded investment firm Bear Stearns and increasing the flow of money to other banks squeezed for credit.

XX This Washington Post story reads like a freaking financial horror story -- the kind of thing Wall Street bankers tell their children to give them goosebumps. And it's happening now! Check out some of these lines ...

1. The Fed's moves were meant to reverse a rising tide of panic...
2. The extraordinary measures were made necessary, in the view of the policymakers, by the most dire threat facing world financial markets in years....
3. It took 85 years to build Bear Stearns and four days for it to dissolve....
4. Starting today, and lasting for at least six months, this new operation will allow "primary dealers," which are 20 major Wall Street firms, access to cash in exchange for assets in which the market is not currently functioning.

XX P.S. The Fed also approved a cut in its benchmark interest rate to 3.25 percent from 3.50 percent. The Washington Post now calls this the Fed's "emergency lending rate".

Today is Central Bank Day! And tomorrow is Jobs Day! Wa-hoo. Can you sense my sarcasm?

Basically, over the next two days we can expect FX traders to be jumping in and out of the market like a bunch of six-year-olds hanging around a swimming pool. The Bank of England, the European Central Bank, U.S. jobless claims, and U.S. pending homes sales should provide for volatile markets today; and the U.S. Non-farm Payrolls will be more than enough to make investors go crazy tomorrow.

Those of you with well-reasoned positions should be prepared to get splashed.

The Bank of England already announced their decision to stay put on interest rates. Apparently inflation is a concern again. Unlike the Federal Reserve, the Bank of England is taking a bilateral approach with monetary policy – acknowledging both growth and inflation. The pound is making good immediately following the announcement.

As we work the rest of the way through this gauntlet of monetary and economic reports, the euro is trading at record-highs versus the buck. And there aren’t a whole lot of reasons for it not to. A story on Bloomberg.com this morning highlighted the expectations for the Euro area economy to expand at a faster pace than the U.S. economy this year.

To that I say okay, but everyone knows just how badly the U.S. economy is faring these days. How impressive is it for a major industrialized economy to outpace the U.S. at a time like this? The actual figures cited in the article sure weren’t that impressive. U.S. GDP is set to decline to 1.5% from 2.2% last year. Euro area GDP is set to decline to 1.6% from 2.6% last year.

Do expectations like that warrant and exchange rate of 1.53 euro per dollar? I’d have to lean towards no. But hey, it’s the market that makes the call.

I just wonder if things in the euro area could get any worse. After all, the U.S. doesn’t have a whole lot of room still to tumble. The euro area still could. And more importantly, traders and investors could be caught off guard if the Euro area starts on a more noticeable slide, no matter how orderly the decline.

One structural dynamic that has the potential to shift – demand from foreign countries for European capital goods (Carlos Caceres and Eric Chaney over at Morgan Stanley Global Economic Forum highlighted this point last month.) Thus far demand of this sort, from emerging economies in particular, remains solid. But you have to wonder when the exchange rate will come into play.

My guess is fairly soon. And the faster the market bids up the value of the euro, the sooner we’ll see an overvalued exchange rate negatively impact the European economic backdrop. And then maybe the market thinks twice about 1.60 euro per dollar. Maybe.

 

The ECB will most likely stay put on interest rates as well. But there’s no telling where these currencies might finish when the day ends. Good luck navigating these markets today and tomorrow.

I don't worry (too much) about the subprime credit crisis at Merrill Lynch, Goldman Sachs and others. Sure, it could total $600 billion, but these are smart people who will figure a way out of the the problem they created. If they don't, these companies will go bankrupt. Life will go on.

But the crisis in the municipal bond market is scaring the bejeezus out of me. Let's look at this mess.

As Forbes explains ...

Municipal bond insurance got its start as a way to protect investors if their bond issuer defaulted. After starting in 1971 ... The invention of municipal bond insurance revolutionized the public debt markets over the next 36 years.

The U.S. municipal bond market grew steadily over several decades to about $2.6 trillion in value as of year-end 2007, according to the Securities Industry and Financial Markets Association (SIFMA).

$2.6 trillion is about as much as the US will spend on the Iraq War. It's a heck of a lot of money. But this is basically how states and cities function now. They issue debt for projects at very low interest rates because the bonds are insured. But that insurance may turn out to be a mirage, or at least, it may no longer be available.

Bloomberg explains ...

Yields on top-rated 30-year bonds rose to 4.99 percent today, the highest in almost four years, as U.S. state and local governments plan to sell $20 billion of new bonds in the next 30 days, the most since December.

The biggest buyers of variable-rate notes, tax-exempt money-market mutual funds, are avoiding issues backed by insurers and local governments whose own rating is less than AA, said Joe Lynagh, who manages about $2 billion of tax-exempt money funds.

New York state paid rates ranging from 2.80 percent to 10.94 percent on seven-day variable-rate demand notes sold Feb. 27, the most recent data available. Bankers set interest rates of 5 percent or higher on six of the 18 issues sold that day.

Now, the market is actually seizing up.

Reuters explains ...

Two of these markets, auction rate and variable demand note obligations, have frozen because investors fear some bond insurers that backed this debt are no longer credit-worthy as a result of their bad bets on subprime mortgage investments.

This couldn't come at a worse time for municipalities. Their tax revenues are drying up due to the implosion of the housing market. Suddenly, it turns out that many municipalities may not be able to make good on their debt payments.

And that brings us to the next logical step -- municipal bankruptcy.

As the LA Times blog explains ...

The city council of Vallejo, Calif., had planned to vote late Thursday on whether to file for bankruptcy protection because its employee-benefit costs are soaring even as tax revenue declines. The vote was put off after officials said they had reached a tentative deal with their major unions.

Is the problem snowballing? In a word, "yes."

Even high-quality muni issuers that have no credit problems may pay more if they borrow soon, simply because of the heavy supply of bonds expected to hit the market.

This is absolutely the worst time to bring debt to market. Naturally, states and cities aren't changing their plans at all ...

In Sacramento, state Treasurer Bill Lockyer intends to proceed with next week's planned sale of general obligation debt, said Paul Rosenstiel, head of public finance.

Although the state may have to pay higher yields on the bonds than it would like, "we have a need to get into the market because we have a lot of projects to build," Rosenstiel said, noting the numerous infrastructure programs approved by voters in recent years.

"We have a schedule, and we're probably going to stick with it," he said.

And now Bloomberg explores the crisis of cities forced into loans with "predatory yields" ...

U.S. municipal borrowers from Camden, New Jersey, to Sacramento, California, might face a third week of higher interest costs as failures in the auction- rate bond market persist.

How bad will the crisis get? On Minyanville, Professor Bennet Sedacca takes a guess ...

Net asset values of all sorts of municipal mutual funds, both closed end and open end will likely get smashed. How badly? It depends on the quality but I am guessing anywhere from 5-20%.

Forbes says the municipal bond market is worth$2.6 trillion, but Sedacca's estimate is closer to $3.5 trillion. 20% of $3.5 trillion would be $700 billion. And as with all of these credit crisis estimates, they usually go much higher.

Let’s go Down Under to start this fine Tuesday. The Reserve Bank of Australia stepped up and hiked interest rates another 25 basis points overnight. The benchmark rate now sits at a whopping 7.25% -- towering over the 3% Fed Funds rate here in the U.S. Most other major central bank lending rates fall short as well.

So you might expect the Aussie dollar to rally on news like this. And it did, just not after the announcement was made. AUDUSD actually tumbled when the word got out this morning. Right now it’s working to fight its way back.

The fact is, much of this interest rate decision had already been priced into the Australian dollar. That’s why the rally came well before last night’s announcement. Prospects of an RBA rate hike weeks ago have already flowed into the Aussie, and now there’s not enough buying power to give it that extra oomph.

Additionally, a lackluster report on Australian retail sales and trade deficit could have raised a few warnings signs. Expectations called for retail sales to move higher; they remained flat in January from the month prior. Plus, a wider-than-expected increase in the trade deficit isn’t a comforting feeling. Failing to make hay off strong Chinese demand, for whatever reason, raises some questions.

Needless to say the health of Australia’s economy stands well above the health of the U.S. And that should eventually allow the Australian to appreciate even further. It just may need a few days to gather itself.

Make sure you get a good seat for the rest of this week – there’s the potential for some major fireworks. The Bank of Canada, Reserve Bank of New Zealand, Bank of England, European Central Bank, and Bank of Japan are up this week. Most are expected to keep benchmark rates unchanged, but as always, it will be interesting to see how the market dissects the rhetoric.

And as we wind down the week we’ll eventually get to the U.S. Non-farm payrolls report on Friday. This big monthly jobs report always has the potential to excite. So stay tuned.