Greece and Japan in Focus

Currency in Crisis

There are two main forces at work today in the global capital markets. The first is the signal from various sources that the aid package for Greece is at hand, following new substantial savings by the Greek government. It now looks like something could materialize over the weekend.

The second force is month-end consideration as positions and hedges are adjusted. The combination of these two forces may discourage resisting the moves in the foreign exchange market today. We do think this is what will take place even if not today.

Nearly everyone realizes that the short euro position was a crowded trade. It is evident not only by its persistent downtrend, as momentum and trend followers participated, and the Commitment of Traders in the futures market, but we also note that the premium of euro puts over euro calls, equidistant from the forward strike, were at their largest premium yesterday since Oct 2008. The euro has rallied a little more than 2 cents since Wed’s low near $1.3115. There has been talk today of European sovereign euro demand related to month-end considerations and this may be helping fuel the euro’s short-covering bounce.

Calling what is taking place a “Greek bailout” is a misnomer. The funds that the European governments and the IMF are going to make available to Greece are not going to stay in Greece. The money will used to service Greece’s debt, of which something close to 70% appears to be in foreign hands (admitted estimates vary). With various spending cuts, wage cuts and job losses, it is hard to see how Greece itself is being bailout out. Instead of Athens that is being made whole, it is Greece’s creditors that are.

The so-called Greek bailout is essentially another bank bailout and a transfer of (European) government funds to European banks. Greece is merely a middleman. While other bond markets in southern Europe are benefitting from strong ideas that a Greece will be given funds in time to avoid problems with the May 19th maturity and coupon payment, it is far from clear that investors will be satisfied for long.

News today that Spanish unemployment rose to 20.1% in Q1 from 18.8% in Q4 09 illustrates the kind of economic headwind the periphery of Europe faces. This was a larger rise than economists expected and is around 7 times the EU average. Consider that since joining the euro zone Portugal has averaged less than 0.5% growth a year or that S&P expects Spain to average around 0.7% annual growth through 2016. It is difficult to see how the European/IMF package is scalable or how it really gets ahead of the curve of expectations or shows any appreciation for the fact that underlying the debt/deficit issues is really a competitive issue. So, there is a small reprieve, but color me skeptical about real closure.

Japan released a slew of economic data, none of which was particularly inspiring. Unemployment ticked up to 5.0% from 4.9% in January and February. The job-applicant ratio rose to 49 from 47, but it is still dismal (49 job opening for every 100 applicants). Industrial output rose 0.3% in March. The market had expected a 0.8% increase after a 0.6% decline in Feb. The MOF survey picked up expectations of a further decline (-0.3% rather than -0.1%) for April’s manufacturing output, but a large rise in May (3.7%). Core inflation fell for the 13th month in March with little change in the pace and, if anything, deflationary forces strengthening in Tokyo in April.

New BOJ forecasts were largely in line with expectations GDP revised this year to 1.8% from 1.3%, but next year’s forecast was shaved to 2.0% from 2.1%. Core CPI, which excludes fresh food, is expected to fall 0.5% this year before rising to 0.1% next year (previously was -0.2%). Bottom line here is that pressure is likely to remain on the BOJ to take additional steps to spur lending and arrest deflation.