WISE MONEY

Festive cheer in the money market seem to be running out already as we move towards the end of the first trading week of 2012. Disappointing Italian and Spanish PMI data more than offset a decent German figure and the eurozone is looking more and more likely to be heading into another recession.

The euro was under pressure for most of yesterday as risk was dumped and the US Dollar strengthened.

The theme is continuing this morning as the single currency continues to be sold; European banks continue to make headlines for the wrong reasons as they park newly created ECB cash back at the central bank rather than lending or investing it in the real economy.

Retail gloom continues to hang over the UK with many of the retailers reporting crucial Christmas figures this week.

Next shares were pummelled after they reported disappointing sales over the festive period and set a gloomy tone as we wait for results from rivals M&S.

John Lewis were a ray of light in the gloom, posting impressive sales growth compared to last year, but most if not all retailers are suggesting that economic conditions remain a real concern and are expecting a challenging year.

The Pound has opened the year in much the same way as it finished the last, namely taking a back seat to the Euro and Dollar with economic fundamentals remain less of a driver than politics.

The wise money is hoping for a clear sign of the economic picture on Friday from the Non-farm payrolls, either showing the recovery continuing or a worsening picture and the prospect of further QE this year.

More likely is that the number shows the US economy to the chugging along slowly, leaving both the Fed and the markets disappointed.

Things seem, for once, to be moving quickly in the eurozone. After high drama in Slovakia over ratification of the enlarged bail-out fund last week, this week looks set to be all about leverage.

More specifically, it will be about how the eurozone makes sure the EFSF has enough fire power to assure the markets that if things begin to unravel, Spain and Italy will be able secure funding without leaving the cupboard bare.

The plan gaining most traction was proposed by Allianz and involves the EFSF guaranteeing the first wave of losses on Greek, Portuguese and Irish bonds.

This would see the funds boosted to around €3 trillion.

Sounds good in theory doesn’t it? Except the structure looks eerily similar to the instruments at the heart of the sub-prime meltdown – collateralised debt obligations or CDO’s for short.

The CDO’s were supposed to spread risk around the system making it safer overall.

What they did, along with industrial scale securitisation was disconnect the borrower from the lender, mask the risks behind complex mathematical formulas and in turn removed all due diligence procedures about the credit worthiness of the borrower.

The risk with the EFSF insuring debt is that if we move back into a serious recession and other eurozone countries look to default because it is suddenly easier to do so, all the losses will simply have been moved from lots of smaller place to one huge pot.

Despite the worries over the structure of the newly enlarged bail-out funds, euro sentiment continues to improve and lift the Euro against both the Dollar and Sterling.

The G20 finance ministers start a two day meeting today and the main point on the agenda is to tackle Europe’s debt woes.  The Euro has pushed higher on the expectation that the meeting will help boost the IMF’s lending resources.

Yesterday the euro slipped back into risk off mode as equities slumped and banks again came under pressure- today the G20 has turned the mood, hopefully they can back it up with solutions.

By the end of this month a plan is set to be announced on Europe and the market is pricing in a credible and concrete plan currently, however the proof will be in the pudding.

The Euro initially came under pressure as S&P again downgraded Spain by one notch to AA- and placed them on negative outlook.

The EUR/USD slipped 40 pips on this news but then steadied and turned the loss to a gain as the expectation of G20 help for the Eurozone lifted the single currency.

High yielding and commodity currencies are benefitting form the expected progress on Europe- the AUD and NZD in particular have posted weekly gains.

Today apart from the G20 meeting there is not too much on the agenda.

Later today we have US retail sales and the market will be looking for a number in line or hopefully better than expected.

Last week the non-farm number was not as bad as expected and this led to optimism in the markets and we are looking for a similar outcome today.

The euro pushed towards a 3 week high against the US Dollar as the markets became more optimistic on a concrete deal by the end of the month for Greece and the Eurozone.  IMF officials indicated that Greece will get an 8 billion euro loan next month despite the fact that it will miss key deficit targets.

ECB president Trichet also stated that commitments made by Greece should mean that it can avoid default.

This flurry of optimism does not eclipse a still sceptical market, but it has given a boost to the single currency- so far the euro has pushed up over 1% against the USD in early trade.

Despite the above positives for the Eurozone in other news Slovakia voted no to a legislation to increase the firepower and guarantees for the European Financial Stability Facility (EFSF).

All other countries have ratified the changes but resistance from Slovakia has raised tension.

It is expected that another vote will pass the changes tomorrow- however this is at the expense of the opposition getting their back scratched in a coalition reshuffle.

In addition European banks still remain on alert as Spanish bank Banesto missed its profit targets and the Bank Of Ireland was downgraded.  In a nutshell the mix is now good news/bad news as opposed to bad news/bad news and so the Euro has managed a move to the upside.

UK data was again poor this morning with UK unemployment hitting a 15 year high at 8.1%.

The Pound has still managed to push up against the USD this morning- this is tracking the move higher in risk on EUR/USD and is not due to pound strength.

MPC member Dale noted that the vote for more QE in the UK was due to the UK economy slowing in Quarter 3 and the expectation that it will slow on Quarter 4.

Today’s unemployment certainly backs up this slowdown, however the key test for the MPC is whether CPI will remain above 5% for the medium term as the expectation is that it will fall towards 2%.

Yesterday saw the world’s main central banks announce joint action to provide US Dollar liquidity, aimed at securing the funding needs of euro banks struggling to meet american funding requirements.  The money markets had been showing signs of stress, with several measures at their highest level since the financial crisis.

The loans will have three month maturities in contrast to the normal one week limit in central bank market operations so banks are given time in the run up to the end of the year to finish window dressing their results without worrying about funding issues.

The news gave a boost to the Euro against the Dollar, rising almost 2 cents in the course of the afternoon before falling back in the overnight Asian session.

The announcement was also good if you own bank shares, which clawed back recent losses especially if you bought the French lenders after their recent crashes.

More than £4 billion was wiped off UBS shares, however, as losses of $2 billion were uncovered stemming from trades put on by rogue trader in their London office.

The bank has not announced where the losses were made, but there is speculation that it could have stemmed from trades in the Swiss Franc which moved over 10 cents in a matter of minutes after the SNB announced it was pegging the currency to the Euro.

Have UBS not announced where the losses were made because of the potential embarrassment of a Swiss bank losing money as a direct result of the SNB intervention?

What the news has done is presented an open goal to all of the advocates of the ICB report on the ring fencing of retail banks from the “casino” investment banking side.

The timing was impeccable, not only was the fraud uncovered 3 years to the day of the Lehman bankruptcy, but it came in the same week as the report was published.

Developments in US monetary policy last night make it unlikely that the Greenback is going to see much improvement over the coming months; at least until there are more positive signs of a US economic recovery.The US news has lead to a general rebound of exchanges around the world following heavy losses last week and early this week on fears there could be a new recession due to the euro zone and US debt problems.

Markets in London and Paris are up1.8% in opening trade, as shares in Frankfurt jumped over 2%.

The Dublin market had gained 1.9% in the first few minutes of trade.

Overnight Asian stocks fought back some recent lost ground, following a rebound in US shares, after the Federal Reserve’s unprecedented pledge on rates.

Tokyo’s Nikkei index closed 1% higher, while markets in Australia rose by 2.6% and shares in Hong Kong finished 2.3% higher.

The single European currency has been given a let off following the judgment of the ECB to purchase Spanish and Italian bonds – even though this will be short lived.

Sometime in the future EU officials will need to make tough decisions about the Euro’s future but the European Central Bank decision has given them some breathing space.

This will likely reinforce the support levels for the Euro against the major currencies for the next 2-3 months.

Finally, Sterling has enjoyed a rare period of stability, if not demand, whilst pressure mounts on the Dollar and Euro, with Gilt yields falling on an almost daily basis as overseas investors rush to buy the perceived safe haven Government bonds (still AAA …..).

The outlook for Sterling is less clear however, especially given the recent evidence weak outlook for the UK recovery and continued civil unrest.

So where does that leave the market?

Well, buying Swiss Francs and Yen primarily, with both currencies continuing to appreciate despite the best efforts of the respective Central Banks to curtail the move – the Yen is now just stronger than prior to the BoJ intervention last week, whilst the Swissy has made considerably gains since the SNB tried to hold the EUR/CHF at 1.1000.

Gold has also maintained its strong run ….

The deteriorating situation in Japan continues to drive market conditions and the markets are extremely volatile. Investors continue to ponder the various pieces of news on the nuclear situation in Japan.

Therefore, risk aversion remains highly on the agenda and the usual cocktail of safe haven assets such as US Treasuries, German bunds and the CHF are the main benefactors.

On the other hand, risk assets including global equity markets and risk currencies have been subject to increasing pressure.

Pre-earthquake risk aversion was already on the agenda amidst renewed eurozone peripheral bond tensions however the consequences of the earthquake has seen our risk gauge rise to its highest level since the end of August last year.

Any fall in risk aversion will now be based on the nuclear situation coming under control but until then the general “risk off” market tone will continue.

In the same way currency and equity instability will also remain relatively high.

Overnight the US Dollar/JP Yen exchange rates hit a low of 76.25 during an unstable session but Japanese powers that be noted that rumours of Japanese life and non life insurance companies returning funds back to Japan are “groundless”.

USD/JPY pushed higher from its lows yet there looks to be no sign of interference even though there may have been Bank of Japan rate check, which reduced some fears about looming intervention.

There is a high risk of FX intervention providing USD/JPY remains below the 80.00 level.

In other news yesterday the Organisation for Economic Co-operation and Development (OECD) stated that Chancellor George Osborne must continue with his budget cuts and reform strategy despite a slow down in economic growth.

The OECD maintained that the cuts “will bring long term gain” even though growth forecasts have been reduced to 1.5% from 1.7%.

Ireland blamed Germany for stoking fears that holders of government bonds could be forced to suffer losses as the cost of Ireland’s borrowing hit fresh highs.
Markets worry whether Ireland will be able to repay its debts, given its costly bank bail-out, weak growth and a huge budget deficit of 14.4pc of GDP, the eurozone’s highest.

Brian Lenihan, Ireland’s finance minister said the spike in borrowing costs was partly driven by “unintended” German comments proposing bondholders be forced to take losses if sovereign debt is restructured.

The market nerves pushed the spread between Irish 10-year bond yields and German yields to well over 6 percentage points, a new record. The cost of insuring Irish debt against default also hit a fresh high.

Germany has indicated the proposals would not apply to existing debt, but fears over potential losses are high after France said on Wednesday that investors must share in the cost of safeguarding debt.

German Chancellor Angela Merkel argued last week that taxpayers could not keep being told they “have to be on the hook for certain risks, rather than those who make a lot of money taking those risks.”

Although the Irish government is fully funded into the middle of next year, analysts warned politicians’ talk of losses risked creating a self-fulfilling prophecy that Ireland and other debt-laden nations will have to restructure.

Irish yields are now well above the levels Greece faced just before it saved from defaulting through a £100bn loan in the spring, according to Capital Economics.

There were warnings solvency fears were spreading as Portugal and Spain also saw the cost of insuring their debt against default soar, which kept the euro under continued pressure.

The gap between what is promised before a G20 finance meeting and what is announced afterwards seems to be growing.The theme at this meeting was, unsurprisingly, currencies and specifically how to stop nations engaging in beggar-thy-neighbour competitive exchange rate devaluations, to keep exports cheap in the face to falling domestic demand.

This path would be disastrous for world trade and global growth in general, which need stability to allow goods, services and capital to flow freely from country to country.

What was agreed by the G20 was that the scenario above would not be allowed to happen, but the agreement stopped short of actual commitment.

The US proposed that export surpluses be capped at 4% of GDP, a sensible idea, but the current global imbalances mean that is about as likely to happen as the G20 coming up with a concrete commitment on anything.

Although it is disappointing that nothing solid was agreed, the news is generally positive and has helped stocks to gain in nearly trading and the Dollar and Euro to gain against the Pound.

The US seems satisfied that China will allow the Yuan to appreciate and it now looks unlikely that the punitive import taxes the US were threatening to slap on Chinese exports will go ahead.

Sterling has opened up the week on the back foot as continued selling pressure stemming from last weeks Public Spending Review work through the system.

The market is waiting to see if the Bank of England is seriously contemplating another round of QE and tomorrows GDP figure will probably give us a good indication of the Banks next move.

The forecast is for 0.4% on a quarterly basis but after the previous retail sales figure disappointed, we are bracing for a number showing a further weakening in growth.

The International Monetary Fund says the global financial system remains the problem area for the economic recovery.In a new report, the IMF predicts a gradual improvement in the financial system, but adds that there is a substantial risk of further problems.

The warning is not one of panic, but they are clearly nervous.

The IMF says that in the last six months there has been a setback to financial stability, which may affect the recovery from global recession.

That has been highlighted by the continuing turmoil in European financial markets. In these markets, government debt has combined with the weak banks to undermine stability.

Jose Vinals, the senior IMF official responsible for the report, said that some of the most vulnerable countries have taken important steps to deal with government debt and problem banks.

Greece is moving “forcefully” and Ireland is taking “very decisive actions”, he said.  So he expects “things to get better not worse”, he said.

Nonetheless, the financial system remains fragile, the report warns.

There is also a warning that some developing countries could be destabilised by large financial inflows, as investors seek higher returns in fast-growing economies. That is particularly a concern in Asia and Latin America.

One important theme underlying this report is the continued divergence between the unconvincing economic recovery in rich countries and the more robust performance of many developing nations.

Low interest rates in the developed world, intended to spur recovery, mean there may be more money to be made in Asia and Latin America.

The IMF points out that quite modest shifts by rich country investors could have a large impact on developing-world financial markets.

Such inflows have the potential to lead to financial instability.