Newstream Turns Market Cautious

Many if not most foreign exchange participants understand that the short euro position is a crowded trade and that this leaves the market vulnerable to a short-covering bounce on a favorable news development. However, fundamentals and sentiment suggest there will be selling into euro bounces. In the European morning euro has been lifted through yesterday’s highs, we suspect this will give North American operators a better selling opportunity. Sterling too appears to be running out of steam after Europe bid it through the $1.5250 area. Stops on new short positions should be placed above $1.53.

There is much speculation around a larger Greek package, with rumors of as much as 120 bln euros. This would ostensibly be conditioned on additional savings measures by Greece. Market talk suggests Greece may be considering a 2% hike in the VAT and another round of wage cuts among government workers. A Reuters poll found 30% of those surveyed expect Greece to restructure its debt in the next five years. News that Fitch reaffirmed its AAA rating for Spain after S&P’s downgrade yesterday also is seen as a break in the negative news stream. Our proprietary assessment warns that Fitch’s affirmation notwithstanding, Spain does not deserve triple A status.

The FOMC statement contained no surprises. Nor did it elicit a market response. However, it again noted that bank credit was not growing. That is to say, that credit conditions have tightened by the private sector not by the Fed. We suspect this is a development that the Fed is watching closely. With the banks doing some tightening already, inflation subdued (illustrated by the large number of goods in the core CPI basket and core PCE basket still falling on a year-over-year basis), the market recognizes the Fed is in no hurry to raise interest rates. A Reuters poll found a majority now expecting the first hike toward the end of Q1 11. The survey found about a 1 in 3 chance of a hike at the end of this year, down from about a 2 in 3 chance earlier this month.

The contraction in bank credit is not simply a US phenomenon. The euro zone reported that money supply continues to contract. On a year-over-year basis M3 has fallen 0.1%, which is the same rate on a 3-month year-over-year basis, which is often used to smooth out the time series. Lending remains poor in Japan and weak in the UK. Part of this may simply be a function of the unwinding of the deluge of liquidity officials made available during the darkest days of the financial crisis. Most measures still show liquidity even if not as much as previously, but the longer it persists, the more disconcerting it becomes.

German economic data were stronger than expected and this may also be encouraging the short-covering bounce in the euro. Seasonally adjusted unemployment figures showed a 68k decline (162k decline on an unadjusted basis) with the unemployment rate slipping to 7.8% from 8%. The consensus called for around a 10k decline after a 42k decline in March (revised from -31k). It did not expect any change in the unemployment rate. Although there may have been some distortion by the early Easter, the German labor picture, even with the short-term scheme, where the government subsidize wages to minimize lay-offs, continues to show some resiliency.

Separately the VDMA engineering association reported that plant and equipment orders rose 21% year-over-year in March, with domestic orders up 28% and foreign orders up 18%. The VDMA’s data seems to confirm our point that after poor finish to 2009 and a weak start to 2010, the German economy gained some momentum in late Q1 and this appears to be carrying into Q2.

Norway, in contras,t today reported disappointing March retail sales data. The 0.1% decline contrasts with consensus of a 0.5% rise. This is important because the Norges Bank meets next week with widespread expectation of a 25 bp rate hike. A Reuters poll found 8 of 11 expect the hike. Given the uncertain growth outlook for much of Europe, and the mixed nature of the recent Norwegian data, the market appears to be too confident of a hike. The krone seems vulnerable to a reassessment in the coming days. The euro finds support near NOK7.86. The nearby cap around NOK7.89 needs to be taken out to signal a more serious short-covering move.