WISE MONEY

A surprise increase in the US ISM manufacturing survey yesterday evening was enough to push the Dow Jones industrial average to its highest level in four years, dragging European bourses higher this morning along with the high risk currencies. Due to the May Day bank holiday in Europe, markets on the continent are playing catch up with the US and UK and are performing very strongly in early trading.

Chinese manufacturing PMI also showed a slight improvement overnight, but is still below the 50.0 level, signifying a contraction in manufacturing output.

This afternoon the ADP employment report is released in anticipation of the non-farm payrolls on Friday with expectations of 175K jobs created in April, not quite the numbers we saw in the first three months on the year but positive non-the-less.

Portugal goes to the market today, issuing six and twelve month treasury bills.

The target amount is only €1.25-1.5 billion, but the auctions will be closely watched as ever and expect overblown hysteria if we any signs of weakness.

Ahead of the auction the spread between the benchmark ten-year bonds is slightly higher, sitting at 902 bps in current trading.

The euro is marginally weaker this morning against the US Dollar and Sterling.

From the data just out, French and German PMI were broadly in line with the flash estimates but German unemployment rose in April and it is this that is leading the Euro weakness this morning.

Against all the odds the single European currency has been resilient this week moving up towards the year to date highs of 1.3068, clawing back its losses and more.

The euro’s ability to defend bad news in Europe has been remarkable and its gains have reflected a speculative market that has been extremely short.

As we are light on headline data today the markets will have to observe the outcome of the somewhat positive Spanish and French debt auctions while keeping one eye on Greek debt talks with private investors.

But for yet another failure of talks in Greece the EUR should continue on a positive footing.

How long this will last is uncertain, particularly given the dangers ahead but at a time when investors have become progressively more bearish on the euro it may just extend its bounce over the short term.

One country to watch is Portugal whose bonds have underperformed recently as markets speculate that it could be the next contender for any debt note.

Back to the UK and Retail sales have come been announced close to median forecasts of +0.6% m/m and +2.6y/y.

Sales have improved in December but the improvement is likely to be short-lived, suggesting any support to the Pound will be brief.

Sterling has underperformed even against the firmer EUR of late but this is supporting better levels for the market to take long positions versus EUR.

This explains the move in relative European/US interest rate differentials, which has been linked with the move in EUR/GBP.

Overall Sterling could outperform EUR over coming months to around 0.80, with the former continuing to benefit from the simple fact that it is not in the Eurozone and has therefore acquired a quasi safe haven status.

A new shockwave filtered through the markets on Friday as the credit agency Standard & Poors (S&P)- downgraded France, stripping them of its prized AAA rating. The decision to remove this vital asset in keeping borrowing costs to a minimum left France with a AA+ rating, a judgment that will likely cost billions in higher repayment costs.

S&P said “Europe’s austerity and budget discipline alone were not sufficient to fight the debt crisis and may become self defeating”.

Alongside France, S&P cut the rating of Italy, Spain, Cyprus, Portugal, Austria, Slovakia, Slovenia and Malta though it was expected that these countries would have their ratings lowered.

Overall, the picture isn’t looking good for Europe and with further downgrades likely over the next few months, it will be important to see how the ECB reacts in keeping this ongoing debt crisis under control.

The main winner from this continues to be the US Dollar with further gains against most currencies likely as investors pile more money into the global reserve currency.

For as long as the Greenback keeps this status, it will remain the market leader in these testing times as Europe sits on a knife edge between growth and recession.

There is very little data out today with the only comment of note coming from a speech by ECB President Mario Draghi due at 6pm UK Time.

It is likely he will focus on the downgrade on France and how the ECB will look to repair the damage it has caused.

The president of the European Council has said that a summit of EU leaders to discuss the eurozone debt crisis has been delayed by a week.Herman Van Rompuy said more time was needed to finalise a plan to give money to Greece and bolster debt laden banks.

The summit, originally planned for next Monday and Tuesday, will now start a week later on 23 October.

European regulators and the leaders of Germany and France have been engaged in intense talks for several days.

Mr Van Rompuy said in a statement that the delay will allow the EU “to finalise our comprehensive strategy on the euro area sovereign debt crisis covering a number of interrelated issues.”

The 27 nation EU, and in particular the 17 country eurozone members have found themselves under growing market pressure to finally act.

Fears that Greece and other highly indebted countries will default on their debts, and cripple the banks that hold their bonds, have sent shockwaves through financial markets.

On Sunday, German Chancellor Angela Merkel and French President Nicolas Sarkozy said they were close to agreeing a comprehensive new package to ease the eurozone’s debt crisis. However, they gave no details.

Mr Van Rompuy also said he had asked for an additional meeting of EU finance ministers ahead of the 23 October summit, so they can lay the groundwork for the leaders’ decision.

After dipping briefly  under 1.60 over the past week, the Sterling-Dollar pair snapped back sharply in late trading last night as firstly Fed Chairman Ben Bernanke refused to rule out further QE and secondly, after threatening to do so last month, Moody’s placed the US on review for a downgrade of its credit rating. Although Mr Bernanke did not outline much more than the market already knew from the minutes from the last Fed meeting, the fact that the words came from his mouth and not in text seemed enough of a reason for traders to sell the Dollar off against the Euro and Sterling, with cable jumping one and a half cents in quick time.

The potential ratings downgrade came as US President Barack Obama walked out of budget talks, raising the fear that a deal on raising the US debt ceiling before the US Government runs out of money is looking increasingly unlikely.

Later today US retail sales are due, and will probably show a modest decline, as retail sales ten to do over the summer months.

On Friday we also have the US CPI number and the U of Michigan confidence survey.

With EU banking stress tests due late on Friday evening, we’ve had the first indication that some of the banks are struggling to pass.

German public sector bank Helaba is rumoured to have pulled out, giving regulators a real headache the day before the results are due.

The key point in doing a second round of stress tests was their credibility, and the fact that it would cover all systemically important EU banks.

If Helaba pulling out marks the first of several banks following suit, the whole purpose of the project, namely to restore confidence in the European banking system will be undermined.

After the market volatility in Italian bonds and bank shares, this morning’s Italian Debt auction takes on more significance.

With many economists suggesting Italy is too big to fail, any sign of weakness will be magnified hugely.

Speculation is mounting that the ECB or Italian central bank may buy some of the bonds to signal to the market that demand is high and to keep yields suppressed.

As we know with Greece, Ireland and Portugal when the cost of insuring the bonds raises above 400 basis points bad things start to happen; both Spain and Italy remain around 300.

Even with all the negative Euro news, the news from the US yesterday evening has pulled the Euro higher against both Sterling and the Dollar.

As much as European bankers try to stop it, contagion appears to be spreading through the Eurozone with Italy’s high debt burden and lack of political will leading to more emergency meetings.  Reports that their debt stands at double Greece, Ireland and Portugal combined led to equity markets slumping and bond spreads jumping.

Europe signed a treaty to establish a permanent €700bn bailout fund, but this is only available from 2013.

In the meantime, a second bailout for Greece is still being agreed with the hope this will shield Italy.

Last night, Moody’s downgraded Ireland into the junk territory saying “it is likely that, like Greece and Portugal, Dublin will need another bailout before it can return to the markets.

Meanwhile, the UK received some unexpected news with a fall in inflation; the first negative number for June since 2003.

The figures showed CPI inflation rising by 4.2% against expectations of 4.5%.

This gave a mixed view for the UK economy as on the positive side, it shows the huge rise in inflation potentially starting to tail off and drop towards the target level.

Unfortunately, the main reason for things becoming cheaper is retailers having to slash prices to entice the public to spend what little cash they have.

Overall, Sterling was pretty steady after these figures and moves were mostly as a by product of massive swings in Eurodollar.

The volatility has continued today as the uncertainty surrounding many of the worlds markets has left traders and investors with massively diverging opinions.

It seems to be “watch this space” at the moment while we wait for more news out of Europe.

EU members scrambled yesterday to avoid the debt crisis in Greece from destabilising the currency union, threatening credit-rating agencies with possible retaliation following the decision by Moody’s to lower Portugal’s debt to junk status.With the downgrade came a warning that Portugal similar to Greece may require a second bailout pushing European equities lower yesterday and bond spreads higher.

The interest on Portuguese debt rose 220 basis points to 16.7% with equivalent Spanish and Irish debt rising 130 and 250 basis points respectively.

This was met with signs of growing frustration among EU officials, in particular Jose Manuel Barroso as he accused ratings agencies for being anti-European.

“It seems strange that there is not a single rating agency coming from Europe” he said “It shows there may be some bias in the markets when it comes to the evaluation of specific issues in Europe.”

In our Loans Calculators blog we posted a few days ago: Desperate ECB shoots messenger over Greek debts and nothing that the ECB has done since gives any confidence to the investing classes.

The news has placed increased pressure on the Euro now sitting at 1.4296 against the dollar and approaching 1.12 against the pound.

So far today we had UK May industrial production +0.9% m/m at 9.30am slightly weaker than median forecast of +1.1% yet still the highest reading since March 2010.

In addition we had manufacturing data production +1.8% m/m, stronger than median forecast of +1.0%, also highest since March 2010.

The credit rating agency Moody’s has downgraded Portugal’s long term government bond rating to junk- this has heightened fears that only eight weeks after their first bailout Portugal may need further help in meeting its debt obligations.This has rattled the euro which was recovering nicely against the US Dollar following the recent Greek fears- it also emphasises that the rot does not stop with Greece.

The Euro has lost over a cent against the US Dollar and has lost against all but two of 16 major currency peers.

The hard line taken by Moody’s in downgrading Portuguese debt by 4 notches sends a message to the markets that the ECB and the EU still have significant work to do and that their methods may not align with the credit rating agencies- a concern for the markets and the euro.

The ECB is expected to raise interest rates tomorrow which will have helped support the Euro even in the light of other issues- but quite how the PIGS will react is an open question.

The ECB is expected to raise rates by 25 basis points to 1.5% even in the light of slowing economic growth- a policy that is currently the opposite of the UK and the US.

However at the moment the euro is on the back foot and any more feedback from ratings agencies could pile on the pressure.

Over to the UK and the Pound has managed to claw back some of its losses against the euro- this is  mainly due to euro weakness as explained above.

Against the US Dollar the Pound is down- this is due to risk aversion which is US Dollar positive and again due to the Moody’s downgrade of Portuguese debt.

Data from the UK showed that UK shop price inflation increased sharply and a survey by KPMG-REC identified a slowdown in fulltime jobs growth.

However the Pound has been largely unaffected by this data- tomorrow we have the Bank Of England interest rate decision and it is expected that no change will be on the cards.

Positive news on the passing of further austerity measures in Greece met EU leaders meeting in Brussels yesterday evening.But the speed at which the Greek budget found a gaping hole of €5.5 Billion should be as telling guide as to the spiral in which the Greek economy is stuck.

Austerity measures aimed at reducing the Greek debt burden, reduces growth and the ability to service the debt, leading to more cuts etc etc.

Leaders will no doubt be discussing how to structure an orderly restructuring of Greek debt, since any unordered default would immediately render all Greek banks insolvent and create massive uncertainty over other banks holding of Greek debt.

More worryingly still, it will put the spotlight on other PIGS- Ireland, Portugal and Spain and increase the probability of their own default or restructuring.

All of this uncertainty is feeding through to extreme Euro volatility.

The single currency is up in early trading after some positive German data at 9am assessing business conditions, and given that Asian Stock markets gains overnight we can expect America to follow suit this afternoon and the USD to slacken slightly, dragging the Euro higher into the weekend.

We are awaiting the Bank of England Financial Stability report which should not cause too much movement unless the Bank starts mentioning Euro-zone bank contagion in the event of a credit event in sovereign debt.

David Cameron announced that Britain will not be involved financially in any second bailout of Greece through the use of the ESFM as the bail out vehicle.

EU President Herman van Rompuy said funds from the ESFM “would not be part of the package”.

Sterling trades down against the Euro and broadly flat against the Dollar today.

With no Sterling related data due until next week, it will be events from the Euro-zone and US that dictate Sterling over the coming days.

Greece’s credit rating has been cut again as the risk of it’s default increases again.Greece’s recovery plans have suffered another hammer blow after Standard & Poor’s cut the country’s credit rating because of “a significantly higher likelihood of one or more defaults”.

The rating agency reduced the long term rating on Greek sovereign debt from B to CCC – only four notches above default.

It added that in its view the country’s credit outlook was “negative”- which in plain English means the odds of a default are almost certain.

The yield on 10 year bonds issued by Greece yesterday soared to over 17% and the country’s sovereign debt is now the lowest rated in the world, ranking below Ecuador, Jamaica and Grenada.

The move also effected Portuguese and Irish bonds, which are also experiencing similar problems to the Hellenic nation.

The downgrade triggered an angry response from the Greek finance ministry which claimed Standard & Poor’s decision was made on the back of “rumours and statements by representatives of the European Commission and European Central Bank”.

The statement added that the Greek government had shown “determined efforts” to “avoid at any costs” a default or restructuring of its debt repayments, as well as a “strong desire” to stay within the eurozone. It pointed to the tough fiscal strategy submitted to the Greek Parliament last week as evidence of its commitment to economic reforms.

The statement came as the euro fell again amid fears that European leaders would not be able to agree terms for Greece’s new bail-out – its second in 14 months.

Traders are alarmed by the division between Wolfgang Schaeuble, Germany’s finance minister, who wants Greek bondholders to extend the maturities on the seven year debt, and Jean-Claude Trichet, president of the ECB, who has argued that any restructuring is the same as a default.

European and international officials are scrambling to agree a plan to stem Greece’s debt crisis by the end of June- when the Greek government will again run out of money.