No Closure

The US debt ceiling debate continues.  The House vote, initially slated for today, has been postponed.  President Obama's advisers and the the executive branch's Office of Management and Budget were urging a veto of it in any event as it provided for a six month fix only.  Such a short term fix would not have been sufficient to prevent a downgrade of US triple A rating.  A Reuters poll found 30 of 53 respondents expect at least one of the three major rating agencies to downgrade the US and the policy market, www.intrade.com shows 82.5% expect S&P to cut the US rating by the end of 2013.

Yet the dollar is mixed today as some of the downside pressure has eased.  Problems with the new European initiative are becoming clearer.  For taking grave risks, including the first default by developed country in 60 years, which as Moody's noted, will serve as a template for Ireland and Portugal, there is little substantive reduction of Greek's debt burden.  The optimists assume about a 24 percentage point reduction, leaving it with more than twice the Maastricht and Stability Pact target of 60% of GDP.  Hence the ink is hardly dried, the agreement yet to be ratified and already one must be cognizant of the need for Greek 3.0.

And even those figures assume a 90% participation rate by the private sector holders of Greek bonds, which seems high.  The projected 21% haircut seems small--less than half of what may ultimately be needed.   German Finance Minister Schaeuble threw another spanner in the works by warning that the plan for the EFSF to buy sovereign bonds in the secondary market may not be ratified by the Bundestag.  This is more important than the rejection by Slovakia's SAS party.  After all, Slovakia did not support the first Greek support package either.  

Schaeuble's warning suggests that the Berlin-Paris axis is not all that, contrary to some of the euphoria of last week.  Recall that the size of the EFSF was not increased (victory for Merkel) and that its decision to purchase sovereign bonds (victory for Sarkozy and Trichet) required unanimity among the member countries (victory for Merkel having a veto).  In earlier post, I recognized that Merkel overstepped the non-binding guidance from her parliament, it seemed that on balance, once again Merkel has out maneuvered her European partners/rivals.  

While implementation risk was widely recognized as a challenge, the very approval of the agreement is being called into question.   If this is not clarified very soon, it may jeopardize what private sector participation that may have been in the first place.  No wonder, Spanish and Italian ten year bond yields are back near 6% and European bank shares remain under pressure.  

The economic news stream itself is not very good either.  German inflation ticks up and money supply (M3) growth slows.   Poor CBI poor suggests that the stagnation of the UK economy is set to continue.  US durable goods orders were disappointing, dropping 2.1% rather than rise by 0.3% as consensus expected. This disappointment was widespread.  Excluding defense and transportation sector, orders fell 0.4% after a 1.7% rise in May, and may need to be understood in that context.  Still the annualized pace of core capital goods orders was 17.5% in Q2 after less than a 1% pace in Q1 and an almost 10% pace in Q4 10. 

Shipments of core capital goods, which is a GDP proxy for equipment spending rose 1% in June and almost 10% in Q2, more than twice the pace of Q1.  Inventories rose 0.4% and the pace over Q2 was slower than Q1, so the inventory component is a drag on GDP though equipment spending was probably a net positive. 

The Australian and New Zealand dollars are the winners today.  Higher than expected Australian  CPI figures are triggering a violent swing in the pendulum of market sentiment back toward a rate hike.  In recent weeks, the market had been discounting a rate cut as early as the start of Q4.  Meanwhile, the strong confidence data in New Zealand shows the recovery is gaining momentum and the next move by the RBNZ is likely to be a hike.  

For anyone but the shortest of time frame traders, I still like the $1.4360-$1.4400 support area for the euro and resistance in the $1.4580-$1.4600 to confine the euro's price action.  I know see support for sterling in the $1,6340 area.   Yen vol is creeping up, but it still remains at levels that suggest intervention remains unlikely.  The same is generally true for risk reversals--the pricing of puts and calls equidistant from the money--shows a growing bias for yen calls over puts, but the readings (near 2% skew) is not at an extreme.  Moreover, the larger political environment also makes intervention difficult.   It is to be sure a dynamic situation and needs to be monitored daily.