Key News

* China rules out option of dumping US debt  (Reuters)

* OECD warns on long-term jobless (FT)

* Treasury 10-Year Notes Fall Before Auction Announcement (Bloomberg)

* European Banks’ Hidden Losses May Threaten EU Stress Tests  (Bloomberg)

The Event Agenda

Afternoon Run-Down

Deteriorating data in the U.S. contributed to a break down in stocks and commodities and most currencies last week.  But the euro and the pound defied gravity, mechanically climbing throughout what was a potential disaster scenario for global financial market confidence. 

Technical support gave way in the U.S. stock market, projecting big downside targets, and manufacturing, housing, confidence and jobs data in the key “safe-haven” economy in the world, the U.S., showed clear signs of deterioration, increasing the probability of another economic downturn for the global economy. 

But the fear has since subsided.  Stocks are clawing back nearly 4% higher from yesterday’s lows, commodities are moving higher and nearly all currencies are rallying against the dollar. 

Why?  The euro.  The euro is where the world looks for cues on sovereign debt health.  And it has been rising. 

Why would the euro and pound rise while financial markets around the world are coming unglued last Thursday … especially given what was expected to be a gloomy employment report from the U.S. on Friday?  The answer:  China. 

A Medley Report in early June said that “well placed sources” said China would be buying euros to stabilize the euro’s decline.  The report also said that both Beijing and Washington recognize the problems associated with an unruly euro depreciation – as does the G-20 I’m sure.

With results from European bank stress tests and other event risks lurking around the corner, it’s safe to say that G-20 officials, with global stability in mind, are far more satisfied to confront these events with a euro sitting at 1.26, instead of 1.15.  With that, it’s a good bet China has been propping up the euro in the face of a deteriorating environment for risk appetite.

Meanwhile, Moody’s has placed Spain under review for a downgrade.  Spanish savings banks are said to be hiding losses.  And Spanish government bond yields are moving back toward extreme wide levels against equivalent German yields … all of this despite the relative calm communicated through a rising euro. 

But beware.  Here’s what’s coming around the corner that will likely turn tide for the euro and the focus back toward eroding global economic performance, lower global interest rates for longer, and sovereign debt problems … particularly, as it relates to European bank balance sheets.

July 8:  European Central Bank and Bank of England interest rate meetings

July 12-13:  EU-27 Finance Ministers meet in Brussels

July 14:  Fed release minutes from June 22-23 FOMC meeting.  Watch for a downward revision on GDP incorporating risks associated with Europe.

July 15:  US treasury delivers its semi-annual review on international exchange rate policies

July 23:  European bank stress tests results due

Here’s a look at the charts …

Key Charts

Euro

How high can it go?  The descending trendline from the November 2009 high of 1.5144 should contain the euro bounce in the 1.2750 area … which coincidentally appears to be nearing just as key events surrounding global growth concerns and European bank conditions will be presented.  A selling opportunity …   

U.S. Stocks

The S&P 500 broke the neckline of a head and shoulders pattern that projects a move down to 850 level.  Today its testing that neckline, now turned resistance …

Deteriorating Data

Last week U.S. consumer confidence plunged to 52.9, a negative surprise.  That’s down from a May reading of 62.7.

After a strong recovery in manufacturing in the past year, that activity is rolling over around the world…

And job creation has turned back into job losses … -125,000 last month.

With the expiration of government new home buyer incentives, pending home sales collapsed at the fastest month over month rate on record.

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Key News

* Japan sets ambitious fiscal goals, eyes tax hike  (Reuters)

* Osborne presents ‘unavoidable’ Budget (FT)

* China nudges trading band higher (FT)

* Despite U.S. Plea, European Bank Pushes Austerity  (NY Times)

The Event Agenda

Afternoon Run-Down

The change in China’s currency policy toward a more “flexible” yuan was big news yesterday.  And the interpretation of what it meant was all over the map.

In the short term, China diffuses tensions going into the G-20 this weekend by showing their willingness to start appreciating the yuan – and  keeps U.S. Congress from boiling over anytime soon.

In the end, does it prevent a rise in protectionism?  Not likely.  What it does is diversifies some of China’s risk away from a plunging euro by moving away from a dollar peg to a trading band based on a basket of currencies — of which the dollar is far less weighted.  Perhaps their biggest concern is a continued rise in the dollar – a scenario that has effectively “revalued” the yuan against many of China’s trading partners, including its biggest:  Europe.

Many markets gapped on the open Sunday night, reflecting a sentiment that the China news would be global growth positive.  But the moves were sharply reversed by the day’s end.  We now have technical reversal signals (bearish outside days) in key markets like the euro, U.S. stocks and gold – perhaps an end to the short lived, but violent correction of the past two weeks.

Fiscal consolidation continues to be the theme.  Europe has rolled out its austerity plans and today we got details on UK and Japan plans.  Former Bank of England policymaker says the budget cuts will “certainly” put the UK economy back in recession.

With the U.S. still airing on the side of pro-stimulus to protect recovery, a growing division in what has been coordinated global policy should make for an interesting G-20 meeting this weekend.

Beneath the surface of all of the China and fiscal consolidation news/debates, is (still) Europe …

*EU’s Juncker Says Recovery “remains fragile … loaded with risks”

*S&P official tells Reuters Insider TV Spain needs additional measures to meet fiscal targets

*ECB Noyer:  European banks face funding problems

* Goldman Sachs reduced its crude price forecasts today because the market is “fragile” on concerns that growth in Europe and China will slow.

*Fitch downgraded French bank BNP Paribas’credit rating

*Credit Agricole warned of rising loan losses from its Greek unit

Here’s a look at the charts …

Key Charts

Euro

After retracing 5% in 10 days, the euro held trendline resistance and reversed to put in a a bearish outside day … giving the technical signal for a resumption of the downtrend in the euro.   

S&P 500

The picture looks very similar in stocks (another key risk proxy).  The reversal yesterday marked a bearish outside day, after holding trendline resisitance.  Morevover, shorter trem moving averages are near a crossing point that would signal an exit from the longer term bull trend.

Gold

After breaking-out to new all-time highs, the bearish outside day suggests a false-break scenario for gold with a correction targeting the 200-day moving average of $1125.

Chinese Yuan

When China de-pegged the yuan in 2005 it allowed a 2.1% climb the first day.  They proceeded to let the yuan rise by roughly 6% a year until returning to a peg in 2008.  Since de-pegging yesterday, the yuan has strengthened by only 21 basis points against the dollar.  The market is pricing in just a 2.5% appreciation in the yuan by this time next year.

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Key News

* Demand for U.S. Assets Increases More Than Forecast   (Bloomberg)

* Spain, Portugal Debt May ‘Snowball,’ EU Draft Says (Bloomberg)

* China regulator warns on property, local gov’t risks (Reuters)

* Brazil central bank calls auction to buy dollars  (Reuters)

The Event Agenda

Afternoon Run-Down

Global stocks, commodities and currencies are continuing a six day retracement.  The theme:  improved confidence that economies are giving attention to debt and deficit problems.  When the G-20 broke camp two weekends ago a PR campaign followed.

Fiscal consolidation was the main feature of its communiqué.  No longer was it coordinated easy money to promote recovery.  Then EU finance ministers met a few days later and spoke of aggressive budget cuts.  Then followed Bernanke’s testimony that included projections for better US growth … and then a slew of global officials that had upbeat comments on global growth and downplayed concerns on sovereign debt threats. 

Given there was no fresh negative news on the sovereign debt front last week, the above provided enough reason for some short term profit taking in the risk aversion trade (long dollars, short stocks, short commodities)—and has ultimately led to a squeeze shorts.

The euro bounced from a low of 1.1877 on Monday of last week to a high of 1.2350 today.  And the U.S. stock market (perhaps the best proxy of global risk appetite) has bounced 6.5% in six days.

Nothing fundamentally has changed.  But markets don’t go in a straight line.  We know the euro zone $1 trillion backstop threat was bold enough to buy some time. 

A Bank of International Settlements (BIS) report out this week breaks down the exposure of European banks to the shaky debt of the euro zone—in sum about $1.5 trillion.  German and French banks hold about 61% of it, hence the decision of the stronger Emu members for an “all-in” effort to stabilize the deteriorating conditions within the monetary union.

Moody’s downgraded Greece to junk bond status yesterday.  And questions continue to mount about the conditions in Spain.  Despite the risk-on retracement in global markets and the euro, Spanish yields have been climbing to new wides against German yields, indicating the market’s anticipation of growing threats.

Here’s a look at the charts …

Key Charts

 Short Squeeze in the Euro

The market has been leaning heavily against the euro—a record short position.   Expect bounces in the euro to be sharp as weak shorts all head for the exit doors.

Euro correction

How far can the euro retrace?  The long term trend line from the November highs (white line) suggests the 1.27 area is major resistance.  More importantly, watch the European risk proxies (govt’ bonds, CDS, financial system liquidity) for cues.

S&P 500

The 200-day moving average (yellow line) should offer resistance for stocks—especially given the fragile risk environment.  But a break would present a scenario where stocks could build a right shoulder over the coming months topping out around 1150, before breaking down again.

Crude Oil

Crude is also testing the 200-day moving average (yellow line).  A technical point that has historically contained price trends.

European Bank Exposure to the PIGS

BIS report shows European banking system on the hook for $1.6 trillion worth of PIGS debt …

Spain Gov’t Bond Yields

Despite the bounce in the euro, Spanish 10-year government bond yields continue to new “wides” against German yields …

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Key News

* UK Cameron: Govt To Lay Out Plans For Spending Review   (WSJ)

* G20 communique after meeting in South Korea (Reuters)

* ECB’s Trichet: Euro is a ‘Credible,’ ‘Solid’ Currency (Market News Int’l)

* Hungary Aims to Calm Fear on Debt  (WSJ)

Afternoon Run-Down

The euro’s breach of the 1.21 area on Friday has set the tone for currencies and global financial markets.  With a little help from the publicly exposed problems in Hungary and weaker U.S. employment data on Friday, the euro, on its fifth attempt, finally sliced through 1.21. 

Last week I noted the recent stability of the euro under the 1.22 area.  As suspected it was “official” interest.  China and Bank of International Settlements were among the buyers in that area acting to slow the pace of decline in the euro.

The breach of that significant zone in the euro was a signal for more risk aversion … i.e. across the board selling of global stocks, commodities and currencies – and more strength in the dollar and U.S. treasuries safe havens.

Expect coordinated efforts at levels along the way to keep the decline in the euro orderly.

Also, overnight, the euro slid further on reports that German courts were weighing imposing interim order against Germany’s participation in the 750 euro package.  The move of “solidarity” as a desperate attempt to stabilize the ugly state of the monetary union is a recipe for political fireworks—expect more to come. 

Another market moving issue last week for currencies was the resignation of the Japanese Prime Minister.  That’s four Prime Minister’s in four years.  And given the recent Japanese Finance Minister is the replacement … that makes eight Finance Ministers in four years.  As with the public trashing of economic prospects from Hungarian officials last week, this is not the market environment to talk openly about the calamitous state of your economy, nor is it the environment for introducing more political uncertainty – read Europe, the UK and Japan.

Financial markets are roiled as a result.

We have three central bank meetings this week: Reserve Bank of New Zealand (RBNZ), the Bank of England (BOE) and the European Central Bank (ECB).  The market is pricing in a high probability of a first tightening out of New Zealand. 

As a result, the kiwi has enjoyed some relative strength in the past week.  Expect a hike to be met with subdued interest, but a surprise “no change” on rates to fuel big selling in the NZD.  This afternoon’s sell-off in the kiwi suggests the market is pricing out expectations of a rate hike.   

The ECB, which has been in exit mode from its “emergency policies” will likely show bias toward more extraordinary stimulus (loan provisions) on Thursday.  As for the BOE, while hotter inflation data has prompted speculation of some tightening steps to come, tighter fiscal policy in the pipeline and the deteriorating global environment will keep the BOE standing pat.

Here’s a look at the charts …

Key Charts

 Euro

On Friday the stability protection team finally backed away from the $1.21 zone and the euro broke to new four year lows.  The next support is the November 2005 low of 1.1640. 

Aussie Dollar

A long term chart of the Aussie dollar shows a potential C wave, which projects a move down to the low .70s – another 14% lower.

New Zealand Dollar

…the New Zealand dollar has a similar corrective ABC Elliott Wave structure developing on the daily chart.  A surprise “no change” on rates out of New Zealand on Wednesday night could take the kiwi down to the 60 cent level.

Global Risk Gauges

Credit default swap markets and sovereign debt spreads have are back on the rise. 

S&P 500

The Monday close in U.S. stocks was the lowest close since November of 2009.  Fibonacci support of the retracement from the November highs to the March 2009 Lows come in at:  1008 (38.2% retracement),943 (50% retracement) and then 878 (61.8% retracement).

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Key News

* Eurozone banks face 195 bln euro writedowns to end 2011-ECB  (Reuters)

* Prudential deal near collapse as AIG snubs lower offer (Reuters)

* RBA Leaves Rates Unchanged (RBA.gov)

* Europe blocks U.S. emergency exit door  (Reuters)

The Event Agenda

Afternoon Run-Down

Global stocks, yields and currencies started the week on soft footing.  But as we’ve seen many times in recent weeks, when the New York session starts, it becomes short squeeze time.  This morning was no different.  The euro traded to new four year lows this morning, only to bounce aggressively … again.

With global market stability tied to the orderly trade of the euro, it’s reasonable to think the ECB, or someone of their behalf, is acting as a speed bump for the euro decline.

Take a look at this 20-day chart of the euro …

As of this morning, we’ve seen four tests of the sub 1.22 area, and four sharp rebounds.  The price action suggests some “official interest” … i.e. central bank activity.   Today was the fourth challenge.  Notice the slope of the rebounds … very similar. 

The fundamental evidence continues to weigh against the euro.  The ECB’s Financial Stability Report was released yesterday and revealed that European banks would likely see another 195 billion euros in write-downs through 2011.  That only pertains to the bad assets associated with the 2008 financial crisis.  As we know, the European banking system also holds a big stake in questionable sovereign debt.

The ECB also said there was a risk of asset price bubbles in emerging market economies from a sharp increase in net investment inflows, forecast to rise by 66 percent in 2010, the biggest annual rise in more than 15 years.

That dovetails with some other “risk negative” news that has weighed on markets this morning …

Fitch downgraded Spain late Friday afternoon, which reversed the warm and fuzzies associated with the big stock market rally of last Thursday.  Further adding to the risk aversion mood, China’s manufacturing activity is rolling over.

The pound is the relative winner today driven by a massive M&A deal that is falling apart. UK based Prudential’s is balking on its $35 billion bid for an AIG unit, a theoretically pound negative/dollar positive deal.  Given the deal may be dead, the currency market influence is being unwound – putting upward pressure on the pound. 

The G-20 meets this Friday and Saturday in South Korea.  While China’s currency had been expected to be a hot topic, the problems in Europe and global deficits will likely dominate.

Finally, we’ve had two central bank meetings this week.  The Reserve Bank of Australia held-the-line on rates overnight.  After its 25 bps hike to 4.5% last month, the RBA suggested that rates had reached “average levels.”  Today’s hold on rates and the reiteration of their view that rates were now average suggest this rate hiking cycle is on pause for the foreseeable future. 

The Bank of Canada raised rates this morning from 25 basis points to 50 basis points as expected – the first g-7 country to start raising rates post financial crisis.  But the BOC’s statement was one of caution—recognizing the threats in the global economy and the need for continued monetary stimulus.

Key Charts

 Euro

In the past thirty days the euro has fallen from 1.3361 to today’s low of 1.2111.  With a number of signficant technical levels already broken, look for any bounce to continue to be sold …

Euro vs British Pound

With the outlook for the Prudential/AIG deal looking grim, euro/gbp has broken down … trading to new 18-month lows.

S&P 500

Last Thursday’s rally in the U.S. stock market was one of the strongest days for stocks dating back to the middle of the financial crisis — when volatility was more than twice current levels.  A short squeeze or something of signficance for the bulls to hang their hats on?  Given the lack of strength since, it looks like a selling opportunity.

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Key News

* Osborne sets June 22 Budget date  (FT.com)

* Europe needs quantum leap in budget oversight: Trichet (Reuters)

* China stocks slide 5 pct as retail investors flee (Reuters)

* Europe blocks U.S. emergency exit door  (Reuters)

The Event Agenda

Afternoon Run-Down

The euro broke through its 2008 lows overnight, the pound was down 2% before Europe came in, and Chinese stocks unraveled 5%. 

The activity of the past week, following the desperate actions taken by Europe in attempt to stabilize the European monetary union (Emu) are just further steps in a deteriorating global sovereign debt situation.  Now we’re seeing countries compete to weaken their currencies.  It’s starting in Europe, moving to the UK and Japan’s yen will likely be next.

Overnight, comments from European officials give more confirmation that Emu members are quite comfortable with the euro slide.  They don’t want it trading at parity with the dollar tomorrow, but an orderly decline is on their wish list, to be sure.  If the fall in the euro were to grow disorderly, we should expect some intervention (likely coordinated with other central banks), but it would likely only come at much lower levels than the euro is currently trading … perhaps 1.10 or closer to parity as a reasonable guess.

These fresh multi-year lows made overnight in the euro open up much deeper downside potential, with technical points of support growing fewer and farther between.

As for the pound, despite the bullish forecasts many bank strategists have made in recent months, the pound is proving to be the next in-line for a deficit induced devaluation.   Overnight the pound traded as low as 1.4252, 5% lower than its highs just three trading days ago.  The post-election coalition government leaves the UK with a bunch of question marks, not a position of envy when the market is looking for tough decisions to be made on the country’s budget.  An article in the FT overnight put the pound in a deep decline.  The article noted the new chancellor said budget forecasts had been “fiddled in order to help the government to present the sort of Budget it wanted to present”.

None of these problems will end overnight.  Look for the confluence of sovereign debt problems, austerity plans, currency and debt devaluations and slower global growth outlooks to continue to build. 

This week we have the minutes from four central bank meetings to sort through, as well as a slate of inflation data.  But the activities in the currency markets, sovereign debt markets and liquidity proxies (like Libor) will be the areas to watch.  For now, central bank exit plans will likely be moved to the back burner.  Markets are now pricing in less than a coin flip chance of the Fed moving this year.  Last month that number was as high as 90%.  

Key Charts

Euro

The euro broke an eight year trendline two weeks ago, retested that line last week following the Emu stabilization plan, and it promptly failed.  Overnight the euro breached 2008 lows.  We now have the following Fibonacci support levels that plot retracement points from the move off of the all-time highs of 2009 (1.60) from the all-time lows of 2000 (82 cents).

British pound

The pound broke a 15-month trendline, retested that line last week and failed.  The 2009 lows of 1.3503 look like the next test – about 6% lower from current levels.

Libor

When the financial crisis was at its peak in 2008 Libor, the rate at which banks make short term loans to each other, spiked to 4.81%.  Meanwhile, equivalent U.S. Treasury bills were yielding zero.  While moving off of a very low base, the Libor rate has continued to creep higher, nearly doubling in the past two months … signs of balance sheet concerns in the financial system. 

Commodity Currencies

With stocks showing some persistence to the downside, commodity currencies are rolling over. 

Purchasing Price Parity

The following is the OECD’s over/under valuations on currencies based on Purchasing Price Parity.  This analysis would put euro fair value around 1.16. 

Chinese stocks

A development to keep an eye on … China’s moves to tighten the reins on liquidity, coupled with elevated global risk from sovereign debt problems sank have put Chinese stocks well into bear market territory.

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Key News

* EU announces 750-bln euro crisis shield with IMF  (Reuters)

* ECB to Intervene in Bond Market to Fight Euro Crisis  (Bloomberg)

* USD funding costs drop as Fed swap lines revived (Reuters)

* BOE Leaves QE Unchanged Stg200bn; Bank Rate Unch At 0.5%  (Market News)

 The Event Agenda

Afternoon Run-Down

The scariest development last week in global financial markets was the sign that credit was tightening … banks were starting to become more concerned with counterparty risk, hesitating to make short term loans to other banks … i.e. global credit (especially dollar based funding) was starting to look like another 2008 credit freeze was underway.

It all boils down to the deterioration in Europe.  Europe’s crisis started with market concerns over shaky sovereign debt scenarios within the euro zone, which quickly exposed the structural flaws of the monetary union.  Both of these problems escalated the crisis last week into a potential second round of a global financial crisis.

With disaster looking like a serious possibility, Europe rolled out threats of massive intervention over the weekend in a desperate effort to calm the government debt markets and the growing fear in the European banking system.  This is like firing tear gas into the crowd of bond market speculators.  They also gave financial markets a clear sign that they will not let a country fail—at least any time soon.

This takes a default scenario or an exit of a member country from the monetary union off the table—for a while, at least.  It shows all of the sixteen members are stuck in this battle to save the monetary union because of the systemic nature of the sovereign debt crisis.  The European banks are too exposed and would death-spiral if a member country were to default or exit the euro.

So on Friday evening, the Emu leaders announced an “all-in” approach.  With it, they outlined a road of austerity for all euro members.  And yesterday they followed with the big guns including a 750 billion euro fund to show the extremes they will go to stabilize the weak euro zone countries.  They also announced that they will be intervening in government bond markets – a clear warning to bond market speculators to back-off. 

The European Central Bank is in too.  They’ve already relaxed rules to accept junk bonds as collateral and now they are buying up government bonds … i.e. printing money. 

An important development for currencies, the Fed reinstated its currency swap lines for global central banks.  This was key in releasing the pressure valve on the credit freeze in 2008.  Global banks can now part with dollar loans more freely, supplied by the Fed.  This ultimately had a negative effect on the dollar after the 2008 crisis moderated.  But the problems now are different.  It’s about sovereign debt.  And the austerity measures taken in Europe will likely be played out in other spots around the world, putting a global double dip recession back in focus.

Key Charts

Euro

This is the weekly chart I showed last week.  This eight year trendline gave way.  This week’s data doesn’t show up on this chart until the Friday’s close, but today the euro has tested this red line (now resistance) and fallen back 276 points.

With euro-wide austerity, money printing and a re-write of the euro’s founding principles in the plans, look for euro to go much lower. 

Risk Premium for Greek Debt Collapsing

Greek yields were driven up to a nearly 10 percentage points higher (the white line) compared to yields of its fellow monetary union member, Germany (the orange line).  With the announcement of the massive Emu backstop of Greece, that spread has collapsed …

British Pound

With Europe going all out to defend against a default in the euro zone, the next candidate for sovereign debt scrutiny is England.  The UK is on the clock to produce a credible plan for curtailing deficits, which should prove difficult given the political uncertainty.   

Fed Swap Lines

The Fed agreed to give foreign central banks U.S. dollars at a determined exchange rate for the currency of the respective foreign counterpart. And when the swap ends, the two central banks simply repay the same quantity of currency back. There’s no exchange rate risk and no impact on the demand for currency in the open market.

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Key News

* Euro Seen As Vulnerable As ECB Bends Collateral Rules   (WSJ)

* Greek Rescue Doubts Spur Sovereign Debt Risk on Contagion Bets  (Bloomberg)

* Spain Seen as Moving Slowly on Financial Reforms (Bloomberg)

* UK: Bank rate ‘will stay low for four years’  (Timesonline)

 The Event Agenda

Afternoon Run-Down

Uncertainty surrounding sovereign debt and the stability of the euro is finally dealing a heavy blow to financial markets today.  Markets are begrudgingly beginning to accept the idea that growth may be slower than expected and that the probability for more systemic shocks may be higher than what’s been priced in.  On the search for safety, the dollar and gold are moving higher this morning … a dynamic we can expect to see as debt and deficits dominate a rising global risk scenario (i.e. gold and the dollar moving together, as opposed to inversely).

With risk being trimmed, stocks and commodities are moving aggressively lower.  Crude oil is down 2.6%.   Stocks are down 6% in Greece, 3.7% in Portugal, and 4.3% in Spain.  Government bond yields in the fragile Emu countries are shooting higher again, after a short three day reprieve from the bond market attack of last week.  And U.S stocks are sharply lower.

Australia raised rates again last night, for the sixth time in eight months.  But the RBA said that lending costs are back to “average”… i.e. rates are back to normal.  That has the Aussie dollar in a sharp decent.  Adding to the pressure on the Aussie, the Australian government levied a 40% tax on mining companies over the weekend.

The Greek drama continues to unfold.  The ECB has relaxed the collateral standards for Emu members to access short term funding from the central bank – they now accept junk.  A total package of 130 billion euros has been announced by EU/IMF and now we wait to see if the Greek parliament will agree to the tough austerity measures.  That could be difficult given parliament employees are said to be planning a strike to prevent the introduction of the package. 

By the end of the week, we should see if all sixteen members of the European monetary union approve the massive bailout.  An approval likely extends to timeline of pain in the euro zone.  A veto means Greek goes into default and a chain reaction sovereign debt despair likely follows.  As a result, the euro is challenging the 1.30 level vs. the dollar.

It’s not just the euro and Aussie getting hit, currencies across the board are being sold against the dollar (emerging and developed market currencies). 

In Canada, the data for much of April built the case for Canada moving earlier and more aggressive on interest rates.  But the weaker showing in core consumer price data and retail sales has cooled that speculation.  In fact, central bank follower the Medley Report, delivered a dovish statement on Canada this morning.  That combined with lower global stocks (especially lower U.S. stocks) has USD/CAD moving higher, away from parity with the dollar. 

Key Charts

Euro

The euro broke below this eight year trendline this yesterday (not shown on this chart).  Look for a move toward 2008 lows of 1.2330.

Aussie dollar

The Australian dollar after putting in a double top and bearish outside range in past weeks has now broken long term trend line support.

Canadian dollar

After a brush with U.S. dollar parity, USD/CAD is now breaking long term trend line resistance of the downtrend from 1.30 last year.  A break down in U.S. stocks should fuel more momentum.  Look for the 1.0515 200-day moving average (in yellow) to test soon.

S&P 500

Stocks broke down last week driven by fears of a global sovereign debt contagion.  The trendline support that gave way turned into resistance, which tested and held nicely.  Look for stocks to challenge the rising ten month trendline (in red) and the 200 day moving average (in yellow).

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Key News

* Greek, Portuguese Bonds Drop as Downgrades Escalate Debt Crisis   (Bloomberg)

* Portugal Suffering Greek Contagion Pressures EU Bonds (Bloomberg)

* Greece Bond Losses to Be ‘Significant,’ Buiter Says (Bloomberg)

* UBS: threat to pound from hung Parliament is ‘overblown’  (Telegraph)

 The Event Agenda

Afternoon Run-Down

The euro crisis is accelerating.  This morning S&P downgraded Portugal by two notches, and Greece to junk status.

The euro-zone bond market is a firework show.  The yields on Greek 2-yr debt rose to 15% this morning.  The next in line, Portugal, has seen its borrowing costs on 2-year debt double since the beginning of April (see chart/table below).    

And on the radar, Spain … JP Morgan says Spain will have to sell EU150B in debt this year but has done only 26% of that number, the smallest percent of a euro zone country. 

The euro-zone debt contagion is well underway.  And the euro has falling sharply this morning toward 2010 lows. 

After a formal request of financial aid from Greece on Friday, currencies bounced into late yesterday afternoon.  The idea of Greece “activating” the EU/IMF funding was enough to get short term traders to cover shorts going into the weekend on Friday.  But the next step in the Greek drama has only emboldened the bond market speculators—and that is the cue for the path of the euro. 

The Greek “activation” now raises the questions of what the conditions will be … the necessary size … and most importantly, will the funding actually get passed by all sixteen members.  Monday morning, Angela Merkel, the primary Emu political figure to watch in the Greece bailout venture, made a speech to address the proposed Greek aid, and confirmed that the lifeline for Greece is far from a done-deal.

Here are some of the Bloomberg headlines on the Merkel speech yesterday (more fuel for selling euros) …

*Merkel says Greece must show it’s on path to sustainable budget

*Merkel says Germany will help Greece if preconditions met

*Merkel says Greece must accept ‘tough’ conditions for years

*Merkel says no decision on aid until IMF agreement

Given the negative revision to the 2009 Greek Budget Deficit, Merkel wants to see a plan for more budget cuts, for longer.  That raises the probability that aid will be vetoed. 

On default probability, this is from Bloomberg this morning …

“With the financial terms currently on offer — from the euro area member states and from the markets — a significant haircut for creditors or even a formal default become more likely,”   Willem Buiter, a former external member of the Bank of England’s policy making Monetary Policy Committee.

What happens if Greece defaults?

• Expect a run on deposits at Greek banks,
• Greek banks no longer have collateral to access ECB liquidity,
• Greek banks become insolvent,
• European banks start to tremor, holding about 80% of Greek government debt.
• And Portugal, Spain, Ireland and Italy and the dominos in line.

We get another look at a Fed statement tomorrow.  Expect to see the same three drivers of current ultra-low rates keep the Fed’s statement uneventful … “low rates of resource utilization, subdued inflation trends and stable inflation expectations.”

Key Charts

Euro-Zone Default Risk Proxies

Greek-German Yield Spreads– updated

Skyrocketing Yields on the rest of the PIIGS

In the third column in the table below, you can see the rising 2-yr yields on government debt for the weak euro zone periphery countries.  Since April 1, the borrowing costs on 2-year debt for both Greece and Portugal have jumped 3x.

PIIGS Credit Default Swaps– updated

Euro

The euro bounced on Friday’s news that Greece was requesting rescue funds.  Now a break of 2010 lows looks imminent.

More perspective on the euro …

A break of last week lows of 1.3202 is also a break of a 9-year ascending trendline in the euro.  Look for that break to fuel momentum and a move toward 2008 lows of 1.2330.

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