June 8, 2011
Key News
* European Central Bank risks being ‘wiped out’ by bail-outs (Telegraph)
* China official says U.S. could pursue weak dollar policy (Reuters)
* Limited default might clear way for Greek bond swap (Reuters)
* Fitch Warns U.S. on Debt Ceiling (WSJ)
The Event Agenda
Afternoon Run-Down
The broad dollar weakness of recent days began reversing today. Yesterday, Fed Chairman Bernanke stirred global growth concerns, but most importantly didn’t hint toward of another round of QE.
He also made rare comments on the dollar, which sum up his responses to media questions over past months regarding dollar weakness …
He said:
“Some have argued that accommodative U.S. monetary policy has driven down the foreign exchange value of the dollar, thereby boosting the dollar price of commodities. Indeed, since February 2009, the trade-weighted dollar has fallen by about 15 percent.”
“However, since February 2009, oil prices have risen 160 percent and nonfuel commodity prices are up by about 80 percent, implying that the dollar’s decline can explain, at most, only a small part of the rise in oil and other commodity prices; indeed, commodity prices have risen dramatically when measured in terms of any of the world’s major currencies, not just the dollar.
“But even this calculation overstates the role of monetary policy, as many factors other than monetary policy affect the value of the dollar. For example, the decline in the dollar since February 2009 that I just noted followed a comparable increase in the dollar, which largely reflected flight-to-safety flows triggered by the financial crisis in the latter half of 2008; the dollar’s decline since then in substantial part reflects the reversal of those flows as the crisis eased.”
“Slow growth in the United States and a persistent trade deficit are additional, more fundamental sources of recent declines in the dollar’s value; in particular, as the United States is a major oil importer, any geopolitical or other shock that increases the global price of oil will worsen our trade balance and economic outlook, which tends to depress the dollar.
“The best way for the Federal Reserve to support the fundamental value of the dollar in the medium term is to pursue our dual mandate of maximum employment and price stability, and we will certainly do that.”
Beyond Bernanke’s defense of his alleged dollar killing policies, the real area markets were focusing on was QE.
Bernanke reiterated that accommodative policy is still needed but acknowledged a readiness to respond to inflation if needed. And Atlanta Fed President Lockhart said there is a “very high bar” that would have to be breached to prompt another round of QE.
As such, the much loved QE trade (long stocks) is unwinding.
The next Fed decision is June 21-22. QE2 comes to an official end at the month’s end.
As for the crisis in Europe …
The “troika” as it’s called, comprised of the European Commission, European Central Bank and the IMF, have agreed, at least amongst themselves, on pouring more money into the Greece black-hole, if its “under financing is resolved” … and only if Greece steps up sales of its public assets and, in concert with, “voluntary” maturity extensions made on Greek government debt by its creditors in the private sector (i.e. European banks).
Given the prospect for another “kick the can down the road” solution to materialize in Europe, this idea has been the key driver behind a bounce in the euro that has been nearly as dramatic as its fall that transpired throughout much of May … falling 6.5% in 14 days, and then retracting more than 70% of that decline in just 11 days.
But already the dreams of another successful campaign to put off the crisis are falling apart. Moody’s has said that the maturity extension would constitute a credit event, i.e. default. And that’s exactly what European officials had hoped to avoid when crafting the plan.
The next big focus of the week will be on the ECB Thursday morning. After running a rate hiking campaign through the first quarter of the year then following with its first rate hike since the onset of the global financial crisis, last month the ECB paused with a less ambitious message on rates. Look for the same this month.
Here’s a look at the charts …
Key Charts
Euro vs. S&P 500
As two markets that gauge the pulse of risk appetite, the euro and S&P 500 have traded in close relationship throughout much of the crisis period. With the S&P 500 now in decline, the euro catch could mean a quick return to the low 1.40s.
New Zealand dollar
New Zealand cut rates by 50 bps in March to respond to a devastating February earthquake, held the line on rates at its last meeting, and is expected to be on hold again tonight, despite an elevated inflation reading. With the hotter inflation number reported last month, the NZD charged to new all-time highs vs. the dollar. Given the inflation data was driven by higher oil prices and increased excise tax on certain products and given the massive overvaluation of NZD on a purchasing power parity basis … look for the weight of the risk-off trade to take the NZD down with it.
S&P 500
The S&P climbed 105% off of its 2009 lows. With QE coming to an end and global economic growth deteriorating, how low can it go? First big resistance comes in at the trendline from the March 2009 lows .. 1250.
Plunging velocity of money points to lower stocks
This chart from GaveKal shows the plunge in the velocity of money in red…and the corresponding effect it tends to have on global stocks (in gray)…
Key reversal signals still in play
The key risk markets all reversed their trends following the last Fed and ECB meetings, marking key reversal signals across markets … which still hold.
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