EURO-Too Big to Fail or Too Big to Bail?

The massive contagion from the small periphery to the big bond markets of Italy and Spain has turned into ‘the’ real problem for policy makers. This is what happens when you treat the symptoms and not the cause. All along the Eurozone has needed strong leadership-demands it, without it, global capital markets are capable of picking ‘off’ one country at a time.

Lagarde’s comments that the IMF is ‘not at the stage of discussing conditions and terms’ for a new Greek package and ‘nothing should be taken for granted’ has given London the green light to compound the EUR’s worries. It’s import that all policy makers should at least be reading from the same script to instill market confidence.
 
Negative headlines on Greece continue to dominate markets and with the EU finance ministers failing to agree a resolution for a second Greek bailout yesterday has investors continuing to price in a tail risk of a Greek default until we see a swift response from ‘someone in charge’.

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘volatile’ session.

The dollar is higher against the EUR -0.73%, GBP -0.46% and lower against CHF +0.20% and JPY +0.62%. The commodity currencies are weaker this morning, CAD -0.46% and AUD -0.76%.

The loonie has dropped against the greenback on demand for safety, amid concern the European debt crisis will worsen and in the wake of a horrid US payroll data last week that trailed even the most bearish forecasts. On the flip side, Canada produced another solid jobs report compared to its largest trading neighbor on Friday, with only a few warnings that dent the headline (+28.4k and +7.4% unemployment rate).

First, most of the growth was in part-time employment (+21.1k). Second, services accounted for the majority of the gains which distorts the ‘breadth of the gain’.  Third, gains were narrowly focused by region. The final concern, wage growth has decelerated to its slowest pace in nine-months. Even with total hours rising slightly, less cash in the hand makes it difficult to increase spending. Despite the upbeat job print, what matters most for Governor Stevens at the BoC is not the headline print, but any evidence of wage motivated cost-push inflation pressures. Currently, Canada does not have any.

The European story and the US debt ceiling debate continues to impeded the risk trade with nervous investors appreciating less riskier investment strategies for the moment (0.9700).

The AUD fell to a two-week lows outright as concern that the global economic recovery is weakening sapped demand for stocks and currencies linked to growth. Domestic data has not helped in the O/N session. A report showed Australian business confidence fell to a six-month low last month. The confidence index dropped to zero from 6 in May. Currently, weaker confidence and slower consumer spending add to the pressure on Governor Stevens to keep its key interest rate unchanged (+4.75%) until December.

Despite stronger Aussie domestic data of late, investors own risk attitude has the growth higher yielding currencies underperforming, with investors looking to cut further their risk exposure, afraid that China, Australia’s largest trading partner, will take further action to cool growth. Currency gains have been capped on fear that Greek austerity plans will not resolve Europe’s sovereign-debt crisis. Concerns that global growth is slowing has prompted some investors to bet that the RBA will cut interest rates some time this year.

Currently, the market is pricing a no hike in August unless both inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite (1.0590).

Crude is lower in the O/N session ($93.91 -$1.24c). Oil prices have fallen to it lowest level in a week after a decline in Chinese imports and when the US created fewer jobs last month, damping optimism for an economic rebound and growth in fuel-demand from the world’s largest consumers. China’s net oil imports shrank-10% in June to the lowest level in eight-months. Lower US payrolls, a higher unemployment rate and no wage growth do not bode well for commodity prices in the short term.

Even last week’s EIA report showing inventories falling more than expected for a second consecutive week, was unable to provide support. US commercial crude stocks decreased-900k barrels to +358.6m last week, but remains above the upper limit of the average range for this time of year. Not to be left behind, gas inventories fell by-600k barrels, after decreasing by -1.4m in the prior week, and is in the lower limit of the average range. Oil refinery inputs averaged +15.3m barrels per day during the week, which were +68k barrels per day above the previous week’s average as refineries operated at +88.4% of their operable capacity.

The market is concerned that the ‘tightness’ in the oil market will continue to undermine the fragile global economic recovery. This is why the IEA and its members agreed to release crude from their SPR’s to ease some of this market tension. This year’s energy spike is being cited ‘as the reason for the global economic slowdown.

Gold prices remain elevated and are preparing to make new record high all week, as interest-rate increases heighten concern that the global economy may slow and as the European sovereign debt crisis increases demand for the metal as a haven. A rate hike from China and the Euro-zone has dragged inflation concerns back into the spotlight. The PBoC and ECB are clearly stating that ‘taming inflation is a top priority even at the expense of their economies slowing gently’. Investors have been demanding the metal as a protection of wealth.

In real terms you are not making any money by just holding cash, so there is demand for gold as a store of wealth. Even a stronger dollar has found it difficult to stall the metals rally. Longer term, weaker global fundamentals are expected to support this crowded trade during the second half of the year. The commodities dependency on the buck and the outlook for US rates is likely to remain its biggest supporting factor. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on these deep pullbacks until proven wrong ($1,544 -$4.70c).

The Nikkei closed at 10,069 down-68. The DAX index in Europe was at 7,335 down-67; the FTSE (UK) currently is 5,975 down-15. The early call for the open of key US indices is lower. The US 10-year eased 13bp yesterday (2.96%) and is little changed in the O/N session.

Treasury 10-year yields remain under pressure as the Euro-zone debt crisis intensifies amid speculation that data this week will show that the US economic recovery is slowing. Risk investors have been racing to the exits, seeking some surety amid European sovereign-debt turmoil. Investors are trying to come to terms with what if the ‘too big to fail’ ends up being ‘too big to bail’.

Last Friday, the 10-year benchmark happened to drop the most in three-months after the US unemployment rate ticked up again +9.2% and after China hiked their lending rate for the third time this year to contain inflation, spurring concern that economic growth will slow.

The US government will issue $32b 3’s today, $21b 10’s tomorrow and $13b 30-year bonds on Thursday. Previously, the Fed had been the only consistent buyer of product. Now, this week’s supply under these conditions may be well received!

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