Fourth of July Note

The US dollar is mixed against the major and emerging market foreign currencies. It is largely consolidating the losses suffered in recent sessions as the Greek government survived a vote of confidence and parliament approved a new austerity program in the face of public protests. 

This led to the EU approval of the next tranche of aid under the plan developed last year. The IMF is expected approve its disbursement on July 8th even though next year's funding of Greece has yet to be determined, and this had been previously cited as one of the pre-conditions. In this case, as we suggested, the IMF appears willing to accept the EU's commitment/intention in lieu of a hard plan.

Indeed, that plan does not look like it will be immediately forthcoming. The European finance ministers meet again next week (July 11th) and are unlikely to resolve the situation. A second package for Greece may cobbled together for a couple of months. S&P joins Fitch in warning that various scheme, including the much touted French proposal, will likely be viewed as a selective default. 

Asian equity markets advanced. The MSCI Asia Pacific Index rose 1.4% and is at its highest level in since early May. The strong gains in the US equities before the weekend, coupled by China's decision not to hike rates, as some had feared, and the electoral result in Thailand, which is seen as easing fears of military intervention, helped boost sentiment. European bourses are narrowly mixed near midday in London. Technology and financials sectors were the main drags. 

Major bond markets are mostly firmer. Of note, however, Irish, Italian and Spanish bonds are under-performing today and yields are a few basis points higher. While Greek bonds are firmer, the 5-year credit default swaps are higher. The US-German 2-year spread, which continues to do a fair job tracking the euro-dollar exchange rate is flat around 118 bp. A week ago it was just below 100. However, some of the safe haven flows into the short-end of the German curve have reversed in the wake of the Greek developments. 

The ECB's council meeting on Thursday is widely expected to result in a 25 bp rate hike. While this seems to be discounted in the front end of the curve, we note that implied yield on Dec Euribor futures contract had fallen nearly 50 bp in the first part of Q2. Over the past week or so, it has been rising again and is now almost 20 bp above where it was a week ago. We argue that the decline was not about shift views on rates as much as it was anxiety over Greece and technical factors. 

Last week, most countries reported weakness in the manufacturing PMI. The US bucked the trend, but the bulk of the rise was due to an accumulation of inventories. Some suspect this was a rebuilding of inventories that had been run down due to the Japanese supply chain disruptions, but the fact that US auto sales disappointed warns of sluggish start to Q3. Not only was manufacturing unexpectedly weak globally, but May retail sales are disappointing as well. Household spending fell 1.5% France during May. The consensus had expected a 0.8% increase. In Germany, May retail sales fell 2.8%. The consensus had expected a 0.5% rise. 

Earlier today, Australia reported retail sales fell 0.5% in May. The consensus had expected a 0.5% rise. Switzerland reported May retail sales fell 4.1% year-over-year. The market had expected a +5.0% year-over-year pace (down from a revised +7.8% pace in April from 7.5%). Separately, the UK today reported a slightly softer than expected construction PMI (53.6 vs expectations for 53.7). Note that on Friday, the US construction spending report was dismal. The 0.6% decline in May contrasts with a +0.1% consensus expectation, but even more disappointing was that April's 0.4% rise was revised to a 0.6% decline. This news likely shaves as much as a quarter percentage point of Q2 GDP. 

Four developments in emerging markets to note. First, China did not hike rates as some speculated ahead of the weekend. The PBOC has moved to inject liquidity into the banking system and these considerations have seen short-term Chinese rates soften considerably. Continued normaliztion is likely near-term. The campaign of criticizing the required reserve increases continues. Second, in Thailand, the electoral results are seen as positive for sentiment, lifts uncertainty and reduces the risk of military intervention. Third, Turkey, the lower than expected CPI (6.24% vs consensus 7.0%) not blunted out bullish lira outlook. The strength of last week's GDP and PMI suggest tighter policy is likely and we expect this to underpin the lira in the period ahead. Fourth, Mexican state elections underscore the ascendancy of the PRI who are positioned to recapture the presidency from PAN in next year's national election. 

In terms of price action, note that the euro initially rose through the down trend line drawn off of the early May and early June highs. It came in around $1.4540-50. However, the break was not sustained. This seems rather typical of the recent price action, where Monday has often seen some follow through from Friday's action, but limited in scope before a consolidative tone sets in. Initial support for the euro is seen in the $1.4480-$1.4500 area. Anticipation of ECB rate hike and soft US employment data will likely encourage buying on dip strategies. 

Meanwhile, the dollar appears to be comfortable in the JPY80-JPY81 range, more or less. Sterling is holding its own. After moving below its 200-day moving average, it succeeded in closing above it on the week. It now comes in near $1.6040. A close above $1.6130 would help lift the tone further, while a move above $1.6180 would boost confidence that an important low is in place.