Thursday, April 7, 2011

Portugal Submits!

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By Mike Conlon | April 7, 2011

After trying to fight the good fight and delaying what the markets already knew as inevitable, Portugal has asked the EU for a bailout. Borrowing costs have gotten too high for them to be able to service their debt, which would have led to bigger problems down the road.

How do we know that this bailout was inevitable? The Euro is trading only slightly lower in the European session as this has all been priced in already. It doesn’t hurt that the ECB is expected to raise rates later this morning. Now will the markets make a move to try to force Spain to take a bailout, or will this be the last of it?

As I wait for the BOE and ECB rate policy decisions, the Aussie has reached a new all-time high and is trading at just under 1.05 vs. USD after the employment rate showed that the economy added jobs and the unemployment rate slipped under 5%.

In Japan, the markets may have been disappointed with the BOJ response to the crisis over there, as they offered up a meager $12 billion in loans to help in the recovery. They did however lower economic forecasts (as expected) for the first time in 6 months as the Japanese economy faces an uphill battle. Perhaps they needed more time to come up with a credible plan?

As expected, the BOE left rates unchanged, and the ECB raised interest rates 25bp. Stocks and commodities are flat to slightly higher to start the morning.

In the forex market:

Aussie (AUD): The Aussie is mostly higher as the economy added some 38K jobs vs. an expectation of 24K, bringing the unemployment rate down to 4.9% from an expected 5%. These numbers prove that you can move closer to full-employment even with higher interest rates. (Click chart to enlarge)


Kiwi (NZD): The Kiwi is mostly lower as the risk aversion in the market and Japanese yen strength as a result of the BOJ non-action is reducing demand.

Loonie (CAD): The Loonie is mixed this morning, having pulled back for nearly three-year highs vs. USD. Prospects for higher growth and inflation, combined with US dollar weakness and higher oil prices make the Loonie a safe bet at this point.

Euro (EUR): A lot going on in the Euro zone this morning. First, Portugal is officially asking for a bailout as borrowing costs have become too onerous. Secondly, German industrial production came in much better than expected showing signs of economic life. And most importantly, the ECB raised rates 25 bp to 1.25%, as expected. So all this adds up to a slightly lower Euro this morning, with Portugal risk being offset by higher rtes.

Pound (GBP): The BOE on the other hand, decided to leave rates and asset purchases unchanged despite the fact that they are facing worse inflation than the Euro zone. I think they are going to try to wait it out until the end of QE2 here in the US, in hope that rising rates in the US will squash inflation. (Click chart to enlarge)


Dollar (USD): It is no secret that Dollar weakness has been driving markets higher, however now the threat of a government shutdown could dampen the party atmosphere. Initial jobless claims are due out late this morning and are expected to show the usual 385K have lost jobs.

Yen (JPY): The Yen is mostly higher after the BOJ disappointed last night with adding a paltry sum to the mix to help support the disaster recovery. Perhaps they need more time to put a credible plan together, though more accommodative policy may not be necessary as the banks are awash with cashâ€"but they need to start lending. The rebuilding effort should increase borrowing.

Across the pond, it is basically a tale of two economies. The ECB is trying to get out in front of inflation despite the debt problems its members face, and the BOE is content to sit back and let inflation take care of itself.

If the ECB can come up with an agreeable plan for the Portuguese bailout, then this could be the end of the problems. However, if Germany takes a hard-line approach then this could actually exacerbate the issue and could turn market focus to the debt of Spain.

The BOE has probably gotten too cozy with the US Fed and is hoping that the end of QE2 will provide the respite for inflation. What they don’t know is the extent of asset bubbles that we have here in the US and that Bernanke is going to be hard-pressed to raise rates any time soon for fear of another leg down for the housing market which could takes banks along for the ride.

When this ploy doesn’t work in the UK, I expect that they may have to begin raising rates aggressively. Until that time comes though, just hang on to the QE2 ride higher, but be prepared to abandon ship at the first sign of trouble!

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