Afternoon Run … May 17, 2010

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.