Position Adjusting Continues--Before the BOE

The dollar is mostly marginally softer against the major foreign currencies as corrective position adjusting continues.  Many suspect that one way or the other, Spanish banks will get the necessary funds and that some how the government will be able to avoid a full burden of conditionality.  The New York Times  is emphasizing the sheer size of Spain.  Simply put, it ain't tiny Greece, and that it says gives it a stronger hand. 

Spain's bonds were well received in today's auction.  Bid-to-covers were firm and while yields rose, investors were relieved that they did not go up more.  For example, the 10-year was auctioned at 6.04%, up from 5.74% at the last auction but below the 6.14% that was in the secondary market.  Moreover, Spanish bonds have rallied strongly in recent days.  Recall the 10-year yield peaked last Wed around 6.7%.  Today, it briefly dipped below 6.10%.  

Spain is going to announce the appointment of a new central bank governor today.  It will be interesting to see, not in terms of monetary policy bias, but in terms of politics.  The ECB, which has been critical, in a diplomatic way of  Spain's Rajoy, has been encouraging the appointment of its Gonzalez-Paramo, whose term on the governing council ended last month.  However, the state news wire Efe reports that the government will likely name Linde, who was director general of the central bank and was named to the board on May 25, seen as a sign he was going to replace Ordonez. 

  

After the BOE, the focus shifts to Bernanke.  The market is looking for insight into the Chairman's thoughts.  It seems clear that many if not most observers are concluding the Fed will respond to the loss of economic momentum.  The issue is how.  Yellen did not shed much light on the issue,   She did seem to suggest that the forward guidance channel may have limited effectiveness.    The real debate among participants is whether the Fed will respond changing the composition of its balance sheet or the size.  

The dollar declined 7.8% against the yen from March 15 to June 1.  That move seems to be over; arrested as it were not so much by the recent escalation of verbal intervention, after all material intervention itself has a poor track record (from a medium term perspective), but by the position adjusting phase ahead of the Greek elections and amid rumblings of (yet) another triage-induced European reforms and institutional capacity building. 

The conventional narrative of yen strength as a function of safe haven does not jive, however, with the weekly MOF portfolio flow data.  During the yen's rally, foreigners actually bought fewer Japanese bonds and stocks than in when the yen had been declining earlier.   

The most recent data covers the week through June 1.  Foreigners have bought an average of JPY71 mln a week for the past four weeks and were net sellers of JPY69.5 Japanese bonds and stocks on average over the past 12 weeks.  For the period ending March 9, the foreigners averaged net purchases of JPY133 mln of the four week period and almost JPY95 mln on average over proceeding 12 week period. 

If the dollar bottomed near JPY77.65 on June 1, it can rise toward JPY81.  It is also predicated on the continued position adjustment of risk assets more broadly.  A pullback in the yen could also help the Nikkei which plunged nearly 20% during this period.  Modest yen weakness should not discourage fund managers from bargain hunting in Japan.

Lastly, Australia continues to surprise.  Yesterday it was Q1 GDP, up more than twice what the market expected.  Today it is the employment report.  Despite the tick up in the unemployment rate, the economy grew 46.1k jobs , well above expectations.  Recall, at the IMM, there were record shorts and the 2.4% rally this week reflect many being squeezed out and bottom pickers coming in.   A 25 bp rate cut in July that was discounted after the RBA cut only 25 bp is being reconsidered.  As long as the AUD stays above $0.9880, the move to parity should be expected.