Free Trial
Sign up for a 2-week free trial subscription to Rockfeller Treasury Services Daily Strategic Currency Briefings
We have sovereign debt crises in three of the top three economies—US, Japan and Europe. Japan is out of the spotlight because nearly all its debt is held domestically, but the amount of indebtedness is still too high. As for both Europe and the US, we see default of some sort in both places. In the US, we say the bond market is wrong to imagine the Gang of Six proposal has “credibility” and will be accepted. When Aug 2 rolls around with no deal, Obama may have the chops to take the Constitutional back-door and issue an Executive Order lifting the debt ceiling, but such an action is not a solution. While the bond market may be willing to buy into it, the ratings agencies have already said they will lower the US rating from triple A to double A in the absence of a credible and sustained cut in debt. How can longer-term yields not rise on such news?
We also expect default of some sort in Greece. Greek debt is already 160% of GDP and inching toward 172% next year. As the FT says, this is so large it may never get paid. “Officials cannot acknowledge this, however, for fear of spooking bondholders into believing default is at hand. Similarly, private investors face political pressure to bear the burden of a new bail-out – but among the largest investors in Greek bonds are Greek banks, which would take huge losses (and need more international aid) if their holdings were cut in value.”
Well, tough cookies. It is the job of bond buyers to assess the riskiness of the paper they buy and to take losses if they are wrong. Politicians everywhere want the taxpayer to take the losses and not the investors, which is the triumph of Wall Street over Main Street (again) no matter what language. (Nobody seems to remember the New York City “bankruptcy” and “flower bonds,” which is the closest we can recall to the current situation.) Both Germany and the Netherlands, and presumably Helsinki, say that bondholders must be involved and must be forced to eat their spinach, or a Greek Bailout II will lack credibility as well as sustainability. They are, of course, correct.
To an economist, the interesting phenomena are what comes after default. Textbooks say first it’s contraction, and then (after sufficient deleveraging and a fresh build-up of capital), a boom. Goldman Sachs, among others, is going to watch the PMI’s carefully in upcoming months for just how much contraction appears. We get the first EMU batch tomorrow, as the summit is taking place. Market News estimates the July flash manufacturing PMI to dip to 51.5 from 52 in June and the services PMI to slide to 53 from 53.7 in June. This is not much and still over 50. Will the US show more or less economic response to default?
The Soros Quantum Fund was reported yesterday as baffled by the market’s response to the debt crises, and to be 75% in cash. Soros said “I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis. The markets are inherently unstable. There is no immediate collapse, nor no immediate solution.” Moore Capital (Louis Bacon) has also cut risk. Remember that Soros had said Greek default is inevitable but didn’t need to be disorderly.
Bloomberg reports that “Funds such as Moore’s and Soros’s, which chase macroeconomic trends by buying stocks, bonds, currencies and commodities, have been the worst performing hedge-fund strategy this year. They fell 2.25 percent through June 30, according to Chicago-based Hedge Fund Research Inc., as managers made losing bets that the euro would fall against the dollar and that the yield on U.S. Treasuries would rise. Some managers also got caught when prices for oil and other commodities dropped in May. The biggest macroeconomic managers aren’t the only ones hesitant to make large wagers. The proportion of asset allocators, including hedge funds, with lower-than-average risk across their portfolios jumped to a net 26 percent in June from a net 15 percent in May, according to the survey by…Bank of America.”
On the whole, the FX market has been more willing to sell euros on rallies than it has been interested in shorting the dollar on either the same-old general principals or the “new” debt-default problem. This is a reasonable judgment, since the EMU lacks the political institutions to get a fix, even though historically the market has been in love with the euro experiment and given it more latitude than it deserves. Even after the US gets downgraded, panic is not the likely response, since all it takes is a few elections to get a budget deficit fix—clearly not the case in Europe. So, with the caveat that the best macro analyst of all time doesn’t see the end-game, we think the euro should fare less well than the dollar at the end of all this. The problem is that we don’t know where the “end” is. Greece can probably defer default until Sept or Oct.
But to be embracing risk now is insane. Things are blowing up all over the place. Greek yields at nearly 40%–how can anyone want risk? The implication is that risk aversion will swing back hard and bite the optimists on the rear end. This is dollar-favorable. So, the less-ugly girl is the US.
SPOTCURRENT POSITIONSIGNAL STRENGHTOPEN DATEOPEN RATEPOSITION GAIN/LOSS USD/JPY78.94SHORT USDWEAK06/29/1179.040.13% GBP/USD1.6124SHORT GBPWEAK06/17/111.61330.06% EURO/USD1.4210SHORT EUROWEAK06/17/111.42200.07% EURO/JPY112.08SHORT EUROWEAK07/05/11111.23-0.85% EUR/GBP0.8813SHORT EUROWEAK07/12/110.8800-0.15% GBP/JPY127.27SHORT GBPSTRONG06/13/11130.742.65% USD/CHF0.8218SHORT USDSTRONG05/27/110.85754.34% USD/CAD0.9472SHORT USDWEAK06/29/110.96601.98% AUD/USD1.0735LONG AUDWEAK07/08/111.0788-0.49% AUD/JPY84.76SHORT AUDSTRONG07/13/1184.65-0.13% USD/MXN11.6543SHORT USDWEAK06/29/1111.74270.76%
Similar Posts:
- Now is the time to ask “So What?”
- The euro “should” be on the rocks for real reasons
- Take the holiday: summer is not a time for longer-term positions
- The FX market is bewitched and besotted by the euro
- Canadian Dollar Approaches Two-Month High Against Euro
