WISE MONEY

USA politicians moved one step closer to approving an eleventh hour deal to raise the country’s debt ceiling and avoid the prospect of a default that would throw the global markets into chaos. Member of the House of Representatives voted 269-161 in favour of the proposed plan, which will lift the debt ceiling by $2.4 trillion before the end of the year through a programme of spending cuts that politicians have spent weeks debating.

The bill will still pass through the Senate who must approve it before tonight’s midnight deadline.

The Dollar gained through much of yesterdays trading and continued those gains today as investors garnered confidence from the announcement.

Sterling suffered yesterday with the shock manufacturing figure showing a contraction in the industry and the lowest recording for over 2 years.

The markets were expecting a figure around 51.00, but the actual was 49.10, a very disappointing number showing the UK economy is still struggling to grow.

The Pound has received a small boost this morning with the construction sector beating estimates at 53.50.

The Euro continues to get knocked around with the manic movements in Eurodollar.

This is set to continue with the ongoing debt problems in the Eurozone combined with the announcements from the US.

Currency exchange money markets continue to dither between the US debt ceiling issue and eurozone peripheral debt worries.In spite of a lack of agreement to raise the debt ceiling, with House Republicans failing to back a bid by House speak Boehner, the Greenback in fact strengthened towards the end of last week as eurozone peripheral issues came back under scrutiny.

The strength of the Dollar to the lack of progress in raising the debt ceiling is remarkable and exposes the single European currency even uglier than the US Dollar, in many investors’ eyes.

The key drivers for the week ahead will depend on the scale of any boost in the debt ceiling and additional budget deficit reduction methods.

If a deal is reached ahead of the August 2 deadline it is not clear that the Dollar and risk currencies will enjoy a rally unless the debt ceiling deal is a solid and major one.

Given the limited market follow through, following the recent deal to provide Greece with a second bailout, the EUR remains wholly unable to capitalise on the USD’s woes.

A reminder that all is not well was the fact that Moody’s ratings agency placed Spain’s credit ratings on review for possible downgrade while reports that the Spanish parliament will be dissolved on September 26 for early elections on November 20 will hardly help attitude for the EUR.

Compounding the Spanish news doubts that the EFSF bailout fund will be ready to lend to Greece by the next tranche deadline in mid-September and whether Spain and Italy will participate, have grown.

The potential danger for the USD this week is not only that there is disappointing result to the debt ceiling discussions, but also that there is a weak outcome to the US July jobs report.

An increase of around 100k in payrolls, with the unemployment rate remaining at 9.2%, will fixate market attention on weak growth and if this increases expectations for a fresh round of Fed asset purchases the USD could be left rather vulnerable.

So far today we have had UK CPI manufacturing which came in at a disappointing 49.1 down from revised 51.4 in June and some way below median forecast of 51.0.

Sterling now currently sits at 1.6417 from a high of 1.6475 and 1.1390 against the Euro from a high of 1.1450….bad start to the week for the Pound.

The Dollar has made consistent losses this week and the continued stalemate on the subject of extending the US debt ceiling, the greater the problem for the currency. Without a doubt, it appears that the Greenback is taking the brunt of the pressure compared to other assets.

For example, although US treasury yields have edged higher, there appears no sense of panic in US bond markets.

Failure to agree on the debt ceiling does not naturally mean a debt default however it will increase the chances should an agreement not be reached in the weeks after.

Nevertheless, the impact on US bonds maybe countered by the increased potential for QE3 or safe haven flows in the event that no agreement is reached.

The worst case scenario for the USD remains no agreement on the debt ceiling ahead of the August 2 deadline but a short term solution that appears to be favoured by some in the US Congress may not be that much better as it would effectively be seen as ‘kicking the can down the road’.

The better than expected package to help resolve Greece’s debt problems last week dealt a blow to the USD as the almost perfect negative relationship between the USD and EUR over recent months.

Furthermore, the debt ceiling deadlock is making matters worse.

However, the situation can change very quickly and should officials surprise us all and find agreement the USD could rally sharply.

Things are not looking great for the EUR as most of its gains have mostly come by courtesy of a weaker USD rather than positive EUR sentiment.

The news hardly bodes well for the EUR, with data in the Eurozone looking somewhat downbeat.

For example, the Belgian July business confidence indicator dropped to a 9-month low in line with the weaker than expected outcome of the July German IFO survey last week.

In addition, there are still several questions about last week’s second Greek bailout agreement and contagion containment measures including parliamentary approvals and lack of enlargement of the EFSF which could keep markets nervous until there are clear signs that implementation is taking place successfully.

A clear indication that the EU agreement has failed to inspire as much confidence as officials had hoped for is the lack of traction in terms of narrowing peripheral bond spreads, with the exception of Greece.

This partly reflects a renewed ‘risk off’ tone to markets but this is not the sole reason.

The race to be the biggest problem child currency has once again been set in motion as last Friday’s weak Non-farm payroll, which exposed a measly 18k increase in June payrolls and an increase in the unemployment rate, actually left the Greenback relatively unperturbed.Where as closer to home, Europe’s problems outweighed the negative impact of more signs of a weak US economy, leaving the euro as a bigger loser.

The Dollar’s toughness was even more remarkable bearing in mind the drop in US bond yields in the wake of the data.

Nevertheless, the news over the weekend that talks over the US budget deficit and debt ceiling broke down will leave US Dollar bulls with an unpleasant taste in their mouth.

Should weak jobs recovery hurt enthusiasm for the Dollar?

To the extent that it may raise expectations of the need for additional Fed asset purchases, it may prove to be a barrier for the Dollar.

However, there is adequate reason to look for a bounce back in growth in 2011 and in any case the Fed has set the hurdle at a high level for more quantitative easing (QE).

Fed Chairman Bernanke’s response and outlook will be under scrutiny at his semi-annual testimony before the House (Wed) although he will likely stick to the script in terms of US recovery hopes for next year.

This should leave the USD with no great concerns.

There will be plenty of other data releases this week to chew on including trade data, retail sales, CPI and PPI inflation and consumer confidence as well as the kick off to the Q2 earnings season.

Fresh worries in Europe, this time with contagion spreading to Italy left the EUR in bad shape and powerless to take advantage of on the soft US jobs report.

In Italy high debt levels, weak growth, political friction and banking concerns are acting in unity.

The fact that there is unlikely to be a final agreement on second Greek bailout package at today’s Euro group meeting will act as a further weight on the EUR.

The Wise Money markets have made its move and has priced in a positive resolution for today’s crucial Greek vote on austerity due at 12:00 GMT.Risky assets and the euro have been subsequently bought back into and EUR/USD has pushed back up from 1.41 to 1.44 on the prospect of a yes vote.

The market is clearly in a situation of buying the rumour and a sell of the fact could be on the cards – the yes vote is not a foregone conclusion as the socialist ruling party only have a tiny majority of six in 300 seat parliament.

It is squeaky bum time for Greece and the Euro- for now.

Even in the light of today’s critical vote it is the Pound and not the euro which looks as though it has been through 12 rounds.

The beleaguered Pound has fallen 8.9% in the last year and covets the accolade of second worst performing currency among 10 developed market currencies behind the US Dollar according to Bloomberg.

So why is the pound so weak?

Well in a nutshell we have recently seen GDP dip further against forecasts, mortgage approvals are set to remain near a 4 month low in May (data due at 9:30) and interest rates are set to remain low.

However the nail in the coffin is the retail sector which is struggling and consumer confidence is waning fast- the Asda CFO summed it up well today in the Telegraph stating that British consumers are starting to ration as fear and uncertainty grips consumers.

This certainly challenges the government’s austerity plans- if this mood prevails, plan A will certainly fail as growth will be hamstrung by a lack of consumer appetite and with no plan B the UK could be in for a rough ride.

Following Friday’s risk positive afternoon and news over the weekend that argues for further buying of the currency, the Euro was the big winner.
The Dollar on the other hand has lost significant ground to both the single currency and Sterling after a sharply weaker than expected US employment report.

The data disappointed investors hoping for signs of a recovery in the US economy.

Perception of the immediate situation relating to Greece improved following reports that the next tranche of aid scheduled for payment by the IMF/EU over the coming weeks was now likely to go ahead.

This is allied to the view that whilst official confirmation of a new deal for Greece is unlikely before the ECOFIN summit, a deal will have been agreed by then. It is therefore unlikely that traders will find reasons to muster a Dollar recovery over the next couple of days ahead of the ECB meeting on Thursday.

Over the weekend, the Portuguese electorate got the chance to express its concern over the austerity measures introduced by Jose Socrates’ government as part of the EU/IMF bail out deal.

Voters accordingly threw the Socialist party out, opting for a majority coalition government made up of the Social Democrats (40%) and the conservative Democratic and Social Centre Party (11%).

This perversely now leaves the Greek PM, Mr Papandreou as the only surviving premier of the countries that have had to seek financial assistance from the EU/IMF.

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.

Yesterday we heard the particulars of recent the UK’s MPC and the US’s FOMC meetings and we also had euro ratings action from Moody’s, with very little resulting movement.The Pound dropped slightly following poorer than expected UK employment data but only lost ground following hard fought gains from Monday and Tuesday.

The main points from May’s MPC meeting were as expected and indicated no change in voting from April’s outcome.

However, the meat on the bones was always going to be the interesting facet, and so it proved.

The minutes suggest that the majority of members on the committee remain in no hurry to raise interest rates and although it is apparent that a wide division in views still exists, it is obvious that more members remain concerned about the downside risks to growth than about the dangers of stubbornly high inflation.

Moreover with the most hawkish member, Andrew Sentance, now set to be replaced by Ben Broadhurst, who seems to have a more balanced view on the economy, the make-up of the MPC would seem to be moving even further towards unchanged policy.

As a result, interest rates in the UK appear set to remain at the current low levels until the Autumn at least, with the November meeting now touted as the favourite for a tightening of policy.

The FOMC minutes, like those of the MPC, produced nothing earth shattering as the Fed Chairman, Ben Bernanke, had already prepared the market for a less dovish stance in his first press conference although again, the detail, when you dug down, was more revealing.

Markets were surprised by the extent of the discussions concerning exit strategies with officials outlining several guiding principals for the process of normalising monetary policy.

It was also clear that the majority of voting members favour raising interest rates prior to any asset sales as a means of tightening liquidity conditions.

Moody’s were also active, downgrading by 1-notch the credit ratings of the 6 largest Danish banks on fears of declining financial resilience.

None of this dented the Euro’s continued strength however with Asian markets preferring to focus on a report in The Times of China’s continued appetite for Eurozone sovereign debt as a means to diversify its foreign currency reserves away from the Dollar.

The news that Osama Bin Laden has been killed by US security provided the Greenback a lift and its gains have continued for a second day. Acute short market positioning coupled with increasing risk aversion (perhaps due to security concerns following Bin Laden’s death) have helped the US Dollar.

However, the boost to the US Dollar could be brief in the current environment in which it as it remains the global funding currency.

Without a doubt, the fact that US bond yields have fallen severely over recent weeks continues to challenge the USD against various currencies.

The Greenback rose in spite of the US ISM manufacturing index dipping, albeit from a high level.

The survey provided some useful clues to Friday’s US jobs report with the slight decline in the employment element of the ISM survey to 62.7 inline with a 200k forecast for April payrolls.

US Dollar /Japanese Yen is trading dangerously close to levels that may provoke FX intervention by the Japanese authorities.

General USD weakness fuelled a drop in USD/JPY which has been exacerbated by a rise in risk aversion over recent days (higher risk aversion usually plays in favour of a stronger JPY).

The biggest determinant of the drop in USD/JPY appears to a narrowing in bond yields (2-year bond yields have narrowed by around 20bps over the past month) largely due to a rally in US bonds.

As US corporate results continuing to surprise on the positive side the wise money is increasing their investment risk profiles. The Dollar accordingly came under renewed pressure with investors again off-loading the Greenback to invest in equities and commodities as well as in the commodity based currencies.

This latter strategy is especially attractive at present with these currencies currently offering a big pick up in yield when compared to that of the US currency.

So, the Aussie reached a post-floatation high at 1.0775 and with the Dollar index hitting a 3-year low, both the Euro and Sterling touched 16-month highs at 1.4640 and 1.6517 respectively.

Gold was up again and USD/CHF hit an all time low.

One can argue that with ongoing developments in the Eurozone debt market and continued evidence of economic recovery in the US that the spot market has got it wrong but that would be a bit like King Canute trying to turn back the tide.

Go with the flow but watch carefully for the turn in sentiment.

Back to Europe. The 2 debt offerings, from Spain and Portugal were better received than had been feared with the former successfully auctioning 10 and 13-year bonds, admittedly needing to pay a higher yield but on the positive side, garnering better coverage than at the last similar offering.

Portugal also achieved its desired cash raising, via a 3 and 6-month bill sale, but in this case, not only was demand down but the yield demanded was higher than the last, pre-bail-out, rate.

This doesn’t make any real sense and obviously indicates the market’s trepidation over the future path of the country’s financial well-being.

With a further escalation of fears of a Greek debt restructuring as well as concern over the Irish demands for a renegotiation of the terms of its own bail out, the correlation between bond yields of the Eurozone constituent states was become fractured.

Yields on 10-year bonds issued by Greece, Ireland and Portugal are respectively 15%, 10.5% and 9.3% compared to the yield on 10-year German bunds of 3.3%.

If the market’s perception was that the current problems were containable then spreads of this magnitude would not exist. Numbers say more than words ever can…..