Much Heat, Little Light

There have been a number of important developments, but the US dollar remains confined to relatively narrow trading ranges.  There is a heightened degree of anxiety that does not appear to be being reflected in the currency markets.  It is not simply Bernanke's Jackson Hole speech on Friday, ahead of which markets are trading as if they are anticipating QE3 or some other bold action to be announced/signaled (I still am not convinced).  Yesterday, for example credit default swaps on Bank of America surpassed levels 2008 when both Bear Stearns and Lehman Brothers ceased to exist. 

Moody's downgraded Japan to AA3, the second cut of the year and the third since 2004.  The market largely yawned.  With the vast majority of Japanese debt held locally and its status as the world's largest creditor (net international investment position), it is not surprising.   

When everything is said and done, the S&P downgrade of the US also had little market impact.  Look at the US 5-year CDS.  It peaked near 65 on July 28.   It finished last week just below 47.  Only one country has a lower priced 5-year CDS and that is Norway (just above 44). 

The Japanese government also responded to the strength of the yen by unveiling a new $100 bln program to help facilitate foreign direct investment.  It will tap into its massive reserve holdings.  Japan Bank for International Cooperation will contribute $150 bln in what appears to be guarantees.  This is not the stuff that will be able to blunt the demand for yen as a safe haven.  Even if it further encourages and facilitates the moving of production offshore, it is an analog solution in a digital world. 

The poor string of European economic news continues today.  The German IFO survey was weaker than expected and IFO officials like PMI officials warns that a Q3 contraction in Germany is possible.  Separately EMU industrial orders in June fell 0.7%, while the consensus had been for a 0.5% increase. 

The market seemed more impressed with the fact that unlike last week there were no takers at the ECB's weekly dollar auction.    Last week when both dollars were taken from the SNB and ECB, it had heightened concern about the funding of European banks.  

The market has also largely shrugged off the deteriorating situation in Greece.  Finland's collateral deal with Greece has erupted into a full fledged crisis that has lifted Greek 2-year yields to new record highs and 10-year yields pushing close to the mid-June record high of 17.68% (now ~17.40% on-the-run issue.   Finland's government is expected to meet later today to discuss their course of action.  If they refuse to participate in Greek 2.0, it may lead to other defects.  I suspect that such news could disproportionately weigh on French bonds as less positioned to shoulder a greater burden. 

I look for the euro to come off during the US session today.  Curently it is near $1.4460.  Stops are likely just above $1.45.  Potential today to $1.4360-80.    Sterling is capped in the $1.6540-80 area.  A break of $.16440 is needed to signal anything important.   US-Japanese 2-yr spread is near 8 bp, compred with 3 bp in the middle of last week.  However, the dollar cannot get off its trough and with minor and brief exceptions the dollar has been largely confined to the JPY76 handle., for the seventh day running.