WISE MONEY

Moody’s downgraded Greece to Ca from Caa1 and there is only 1 more notch to go before the rating sinks to rock bottom. This has coincided with a statement from the Institute of International Finance over the weekend which implied that they see the probability of a Greek default at virtually 100%.

This follows last week’s announcement from the EU of a second package of assistance for Greece which, upon reflection over the weekend, doesn’t appear to have any substance in the markets.

The Euro closed the week on the front foot and with the talks in the US on raising the debt-ceiling breaking up on Friday with no agreement, the scene was set for a strong week for the Euro.

Moody’s announcement however appears to have scuppered that, especially given additional comments released at the same time as the downgrade.

The ratings agency warned that the Greek package, cobbled together by the Eurozone Finance Ministers, would weigh heavily upon the ratings of other non-AAA sovereign states carrying overly high levels of debt.

This brings the likes of Portugal, Ireland, Spain and even Italy right back into the firing line, and the Euro along with it.

While the Dollar is side-lined during the ongoing negotiations and the Euro largely unloved, where does the short-term money go?

Ahead of expected weak UK economic data this week and expressions of concern over the effects that a Euro collapse will have on the UK outlook as a whole, Sterling is being largely ignored.

This leaves the Yen, Swiss Franc and the commodity currencies as the investments of choice.

It was a turbulent day for markets yesterday, as they ponder over the escalating European debt crisis and the evident failure to reach agreement on raising the US debt ceiling. As it stands Europe’s crisis looks to be going from bad to worse, as suggested in the record breaking higher costs of French, Italian and Greek debt yesterday.

The situation reached breaking point as Italy suspended trading on government and corporate bonds following last weeks release of EU stress tests.

The panic led to billions wiped off the value of European banks with the UK alone losing £6.3bln with Lloyds falling 7.5%, with RBS and Barclays losing 6% and 3.7% respectively.

Despite Italy grabbing the headlines attention is still very much focussed on Greece and reaching agreement on a second bailout for the country, with further discussions at the special EU summit on Thursday.

The hot issue remains the extent of private sector participation in any debt restructuring.

The assessment to improve the flexibility of the EFSF bailout fund to embark on debt buybacks has not helped.

As a result contagion risks to other countries in the Eurozone periphery are at a heightened state.

In spite of this the EUR has shown a degree of resilience, having failed to sustain its recent drop below 1.40 versus USD and currently trades at 1.4156.

A possible reason for the EUR’s bounce is that the situation on the other side of the pond does not look much better.

Murmurs of QE3 in the US and the stalemate between Republicans and Democrats on budget deficit cutting measures tied to any increase in the debt ceiling are limiting the Greenback’s ability to profit from Europe’s distress.

Furthermore, more weak data including a drop in the Empire manufacturing survey and a drop in the Michigan consumer sentiment index to a two-year low, have added to the worries about US recovery prospects.

On Friday wise money saw the release of the widely anticipated results of European banking stress tests. All the UK banks passed, with RBS posting the lowest Core Tier One ratio under the so-called adverse scenario.

8 of 90 banks failed the tests, which was around the number estimated before the results were announced but rather worryingly a further 18 barely scraped through.

We expected volatile Euro trading this morning on the back of the uncertainly that the stress tests provided and that is exactly the case.

The Euro was off over a cent early in the session but has regained ground over the last hour.

The main criticism of the tests is the lack of clarity that the models reveal about the institutions being modelled.

The tests did not allow for a default by any of the bailed-out nations (although they would have been run behind the scenes) and many in the market believe getting the information out in the open would be better for the banks in the long term.

Th US Dollar movement is almost all political at the moment.

The trinity of Europe debt worries, the impeding debt ceiling hike (or not if certain republicans get their way) and trying to second guess the Fed over QE3 is meaning we are experiencing huge movements in the Dollar as new information on each is revealed.

Unfortunately we are no clearer to a resolution in any of the main drivers of the USD and we can expect volatile trading to continue.

A US default would be catastrophic, but there is a real possibility that it could happen so USD buyers and sellers should keep a close eye on the rate and consider hedging their bets if this continues.

The US’s Federal Reserve Board Chairman Ben Bernanke hinted in a speech last night that there are no current plans for further monetary quantitative easing.

He also said that he is satisfied that the economic conditions in the US remain positive for growth, even in light of the recent weak employment and manufacturing data over the past few weeks.

Mr Bernanke continued to suggest the US economy is producing well below its potential but the current weak data flow is a “soft patch” and there would be a pick up in activity in the second half of 2011.

US stock markets immediately reversed small gains once the Fed Chairman began his talk and finished down on the day.

The US Dollar also strengthened on the news and looks set to continue that path today with Bourses in Europe opening the day down and the risk-on risk-off see saw continuing to play out across the markets.

With the ECB not likely to raise rates this Thursday, the closely watched press conference by ECB President Jean-Claude Trichet becomes the potential market mover.

The market seems to be suggesting there is a high probability that Mr Trichet will indicate a rate increase in July.

In the strange world of Central Bank communication, he will not say this directly but indicate this by mentioning “vigilance” when talking about the Banks stance towards inflation.

Given the size of the move in the Euro against the Pound and Dollar there seems to be a big chance that the market will be disappointed.

The Greenback lost some ground as risk appetite increased but markets remain lively as attitude switches between ‘risk on’ and ‘risk off’.As US Q1 GDP was left unchanged as jobless claims astonishingly increased together with continuing Greece worries suggests that a risk off mood may filter into markets despite positive US earnings.

Although the USD has not particularly benefited from any rise in risk aversion lately, worries about the next IMF tranche being withheld from Greece will likely play more positively for the USD.

Nonetheless, lurking in the background and helping to keep the USD restrained is the Fed’s ongoing asset purchases as QE2 remains in place until the end of June.

Moreover US data disappointment points to risks that the Fed will only slowly embark on its exit strategy.

Additionally any agreement towards extending the US debt ceiling appears to be far off, and threatens to go down to the wire all the way to August 2.

US debt markets and the USD appear to be downplaying this issue at present but it remains a clear threat to US markets.

Continuing to limit any upside in the EUR is the fact that officials and markets continue to gyrate on whether Greece will or will not restructure its debt.

Apparent divisions between the view of some officials and the ECB are adding to the confusion whilst fresh worries about the IMF withholding funding for Greece will likely keep EUR/USD capped.

The Bank of England minutes, released today showed that the MPC has not come any closer to raising rates. The vote as expected showed the split remaining at 6-3, with Spencer Dale & Martin Weale voting for a 25 basis point rise and Andrew Sentance for a 50 point rise.

Data this month has shown the economic recovery stalling somewhat, and the surprise drop inflation (although probably temporary) should be enough to postpone any rise in interest rates.

The Pound is being pushed around by the Euro-Dollar pair, which has rebounded from the lows yesterday after strong earnings from IBM, Intel and Yahoo boosted risk appetite in the Asian session.

One would have expected the S&P downgrading of the US outlook to negative from stable to push up US rates.

But there was almost no reaction.

Whether this reflects S&P’s standing in the market post crisis, or the fact that the Fed is the only buyer of Treasuries currently is difficult to assess.

But the Dollar has reacted negatively, and may come under further pressure this afternoon if existing home sales data fails to impress.

Recent US Dollar movements seemed to be reflecting hopes that the Federal Reserve would curtail its asset purchase scheme before the official deadline in June.But just released minutes of last months FOMC meeting seem to have put to bed any notion that QEII will be curtailed, with most members seeing no reason to end quantitative easing early.

The Dollar immediately weakened against Sterling and the Euro on the announcement, with a larger divergence in views between members more apparent than in last months minutes even though the overall tone of the minutes was more upbeat on the economic recovery.

There was also mention of the size of the balance sheet and the Fed’s credibility.

We expect this to become a major issue once QEII does eventually end along with the Fed’s plan for selling all of its holdings back into the market.

Sterling gained two cents against the Dollar after strong service sector data yesterday.

After the snow induced contraction in the 4th quarter, the first three months of this year have shown strong levels of growth, with March reading 57.1 against last months 52.6.

Firms increased hiring for the first time in nine months, one of the key drivers in the Pounds move yesterday.

As tends to be the way at the moment, one positive piece of news is immediately followed by a negative one.

Manufacturing and industrial production figures have just been released and they have failed to impress – month on month manufacturing figures showed no growth and industrial data showed a slight fall from January and the retail sector continues to struggle.

Household’s disposable income is officially on the slide according to figures from the Office for National Statistics yesterday. Real income dropped by 0.8% over last year with a 0.5% in the final quarter which suggests the living standards in the UK are on the slide.

There was a slight reprieve on the GDP front as the dire 2010 last quarter results were revised up to half a percent contraction from the original 0.6% estimate.

Despite the effects of the bad weather in December the economy stood still in the last quarter of 2010 it said, a slight improvement on the previous calculation.

Poor growth is not the only headache for the Bank of England as inflation remains well above the 2% target level and there appears to be rumblings of how serious the BoE are taking this level.

Martin Weale yesterday reiterated his point for a rate rise stating “Continuing above target inflation could lead to inflationary expectations becoming entrenched”. Weale is concerned the sustained inflation pressure could be even more severe than a figure tracking below the 2% target.

Over the US and last night saw a couple of Fed members cement their hawkish tones by talking about a removal of the current QE measures.

Both Fisher and Bullard recommended that they would not vote in favour of additional QE in June while a move to begin a reversal of the current policy looks unlikely.

Employment data over the next couple of days will be crucial with the ADP survey today and the non-farm payroll numbers on Friday providing a much clearer indicator of the way things are going.

The FOMC have for a long time suggested the importance of US employment recovering before they will consider starting to normalise monetary policy.

The Dollar has had a good couple of days on the back of Yen, Swiss and, to a lesser degree, Euro softness and should pressurise better levels leading into the Friday numbers.

Higher equity prices in US and then Asian markets helped the Aussie and New Zealand Dollars to touch new highs this morning but as mentioned yesterday, an enforced slowdown in growth in China will likely reverse the currencies’ recent bull runs.

Warren Buffett, the billionaire investor, has urged Americans at his annual general meeting to ignore the “prophets of doom”, and to believe that the country’s “best days lie ahead”.
In an upbeat annual letter to the shareholders of his investment firm, Mr Buffett said he was itching to make more large acquisitions.

The 26-page letter is seen as an authoritative guide to the state of the world’s biggest economy.

He is one of the world’s wealthiest and most influential investors. As such, his opinion is closely followed.

Despite the American economy struggling to emerge from the recession following the financial crisis, Mr Buffett believes the time is now right to make some major investments.

In his annual letter to his Berkshire Hathaway investors, he said his trigger finger was now itchy to invest in new projects, using some of the fund’s £23 billion dollars in cash reserves.

The news that Mr Buffett is seeking substantial new opportunities will be welcomed by many global investors.

Shares in the benchmark Dow Jones Index are roughly at the same levels as they were three years ago.

The Greenback fell to a two month low against the euro yesterday as speculation that the US economic recovery will remain sluggish and mounting speculation that European officials are successfully addressing the region’s debt crisis. The dollar weakened against 13 of its 16 most-traded counterparts as housing starts declined to the lowest level since October 2009 and before data later today that may show continuing jobless claims increased.

The Chinese Yuan also reached a 17-year high against the Dollar as Chinese President Hu Jintao met with President Barack Obama at the White House.

Meeting yesterday for the eighth time, both leaders emphasised the importance of increased trade and said their two countries can keep building commercial ties while working through differences on currency policy and human rights.

The forex markets took a bit of a back seat during the day whilst attention turned to interest rates in general and monetary policies in particular.

With global central banks starting to look at normalising policies and thus interest rates, traders have edged yields higher almost across the board.

The next step looks likely to be the re-introduction from investors of carry trades and in order to achieve this, a funding currency must be sought.

The obvious choices are the popular Yen and Swiss Franc but there are perverse arguments for using the Dollar or Sterling as well.

Could be interesting once rates start moving higher