Monday, December 20, 2010

Strategic Currency Briefing : We are all about to get a lesson in public finances

USD/JPY83.76LONG USDWEAK11/15/1082.511.49%
GBP/USD1.5562LONG GBPWEAK12/14/101.5870-1.94%
EURO/USD1.3161LONG EUROWEAK12/14/101.3459-2.21%
EURO/JPY110.20LONG EUROWEAK12/15/10111.71-1.33%
EURO/GBP0.8455LONG EUROWEAK12/15/100.8466-0.13%
GBP/JPY130.35SHORT GBPWEAK11/24/10131.330.75%
USD/CHF0.9660SHORT USDSTRONG12/14/100.9624-0.37%
USD/CAD1.0122SHORT USDWEAK12/13/101.0086-0.36%
AUD/USD0.9902LONG AUDWEAK12/14/100.9993-0.91%
AUD/JPY82.93LONG AUDSTRONG12/09/1082.550.46%
USD/MXN12.4028LONG USDWEAK11/30/1012.5035-0.81%


We are all about to get a lesson in public finances, whether we like it or not. The eurozone countries need to raise about €3 trillion (or $3.9 trillion at the current euro level), the US needs to raise about $4 trillion, and US states and cities need to raise about $1 trillion, for a total of $5  trillion for the US. The EMU and US combined need to raise $8.9 trillion NEXT YEAR. We have a hard time understanding the bond market but it seems clear that overindebtedness and the need for such mammoth issuance is what is behind rising rates everywhere, even countries like Germany with an unquestioned commitment to fiscal probity. Even Japanese yields are rising, and they have been on the floor for over a decade.

It also seems clear that the ratings agencies are, as usual, far behind the curve in judging both US muni ratings and European sovereign ratings. Ratings agency incompetence or crookedness were  a primary cause of the mortgage-backed crisis that triggered the global financial crisis and yet they escaped without a scratch. Here they are doing it again, over-rating issuers but starting to get handed a slap by the market. In the case of France, the market thinks French bonds should be rated Baa1, SEVEN steps below its actual top ranking of Aaa at Moody’s (Remember, Moody’s shocked with a 5-step downgrade of Ireland on Friday.)

Until we get greater clarity on whether Congress really will seek deficit reduction (and really will  eschew threatening default by refusing to raise the debt ceiling in March), the US is running on better economic data. Eventually the debt problem has the power to overwhelm any and all signs of recovery, but for the moment, good data is dollar-supportive. This week we get weekly store sales and the next revision of GDP (Wednesday), probably from 2.5% to 2.8%. Personal income and spending (due Thursday) will probably show a rise of 0.5% in spending in Nov from 0.4% in Oct, according to Bloomberg. On Thursday we also get Nov durable goods and new home sales, if there is anyone still around to notice.

The euro faces upside resistance around 1.3425 and the previous high (from last week) at  1.3497. We can’t imagine what bad US news or good European news would cause a test of these levels, at least not this week. On the downside, we expect a test of the previous low, 1.2966 from Nov 30. We may not get a dramatic downside breakout but rather a low-energy drift.

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