Market Lacks Short-term Conviction

The US dollar is consolidating yesterday’s decline and has largely been confined to narrow trading ranges. With the Greek bill auction behind it, the market may lack a clear focus, but sentiment towards the euro remains poor, even though there had been some short-covering in the futures market in the most recent reporting week that ended April 6. Key euro support is seen in the $1.3480-$1.3500 area. Resistance is seen in near $1.3640-60. A smaller than expected trade deficit lent sterling support, but it too looks capped ahead of yesterday’s European high near $1.5465. In Japan, a DPJ panel called for JPY120 level and 2% inflation target to help break deflation. The market was unimpressed and the yen is firmer against the dollar and against the euro.

There was much drama around the Greek T-bill auction today, which ended up going off better than expected. The amount of money that Europe and the IMF are willing to commit to the backstop facility is enough to substantially lower the risk of default by Greece this year. The cautious assessment is that the conditions that Greece has to meet to tap the facility are unclear.

Moreover, the political dynamics in Germany further complicate the issue. Germany’s large state (by population) North Rhine-Westphalia go to the polls on May 9. Chancellor Merkel’s government has seen support deteriorate in the opinion polls and the moral hazard of Greek assistance is well appreciated. It is a hard sell. German workers are being told that part of their efforts will help finance the relatively early retirement of the Greek civil servant. Although the reality is more complicated than this, on some level this is how it appears.

Greek T-bills were oversubscribed. The 26-week bill sale raised 780 mln euros, with a 7.67 bid-to-cover. The bid-cover at the Jan auction was almost 5 and the auctions last year generated a bid-cover to a little more than 6. However, in Jan these bills paid 1.38%: Today 4.55%. The 52-week bill was 6.5x over-subscribed, which is twice the Jan auction and higher than last year’s auction, But in order to achieve this the EU/IMF had to provide a backstop and the yield was 4.85% rather than 2.2%. The bill auction also does not resolve very much. We do know Greece can raise funds, under the right conditions. However, because the terms of accessing the backstop facility are not obvious, it is not clear that Greece has a choice between the market’s terms and the EU/IMF terms.

Moreover, it is also not clear what the rating agencies are going to do. Moody’s has already indicated that the EU/IMF package does not remove the downgrade risks. Greece is reportedly still preparing for a dollar-denominated bond issue for next month. This may be a more significant test of the market’s appetite for that which is Greek.

Sterling is holding its own against the dollar today with the help of a better than expected trade report. The Feb trade deficit came in at –GBP6.18 bln after an upwardly revised GBP8.07 bln deficit in Jan (initially –GBP7.99 bln). This was roughly 10-% smaller than the market expected. Some will likely play up the improvement as a function of the weaker sterling. Exports did rise 9.5% in Feb. However, this may well be a hasty conclusion. In Jan, exports fell 6.6%. Currency shifts rarely generate such a dramatic swing. The more likely explanation is that January was the outlier, perhaps weather-induced and February represents some sort of snap-back, but perhaps too much. It is the smallest deficit since June 2006. The BOE’s effective exchange rate index for sterling bottomed in January 2009 and is currently about 10% above that low, which is the lowest of the time series that goes back to 1990.

Meanwhile, the polls continue to play up the risk of a hung parliament in next month’s election. Arguably making a virtue out of a necessity, there seem to be an increasing number of observers who are suggesting that a hung parliament could force a broader national government with a strong mandate. It is not immediately clear that this is really the best way to describe a center-right or center-left coalition. However, the point is that sterling has appreciated 4.8% against the dollar and euro since late March despite the polls suggesting that no party will get a majority of the votes or seats in parliament.

Japanese government bonds were firm, but the real interest today in Tokyo was in the corporate bond space. Five corporates issued bonds, raising JPY305 bln, making today the busiest day of the year, thus far, for corporate bond issuance. The spread between corporate bonds and JGBs is a little more than 30 bp, about a third of levels seen last Feb. Also, of some interest , the with the move in the five-month tenor, the entire yen LIBOR curve is now back below the dollar LIBOR curve, for the first time in almost 8 months.

The US reports the Feb trade balance. A slight deterioration is expected from the $37.3 bln shortfall in Jan. The monthly deficit peaked a couple of years before the financial crisis, in Aug 2006 at $67.8 bln. The recent low was set in May last year near $25.8 bln. Growth differentials and the rise in oil prices underscore the risk of further deterioration of the trade balance. The US exported almost $142.7 bln of goods and services in January. This is well above the 12-month average of about $131.1 bln, but also well off the July 08 peak of $164.4 bln. The Obama Administration’s goal of doubling exports seems to be quite a stretch and it is not clear whether the US has the industrial capacity to reach the goal, unless domestic demand would compress and foreign demand would increase markedly.