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Probably not by accident, yesterday’s Brussels dinner party of EU leaders ended too late for the European press to pass judgement. There was a weight of expectations, which was largely misplaced given this was an informal meeting to pave the way for the main summit of leaders at the end of next month.

The same differences remain on common bonds and the financial transaction tax (UK opposing) and more subtle differences on the growth agenda. Of course, everyone would like more growth but delivering it alongside a program of continued austerity is naturally a different matter and, for now, it remains the impossible dream for European leaders and a balance which Europe (and indeed others) has yet to achieve. In the FX markets, after the push lower through the 1.26 level into the European close yesterday, EUR/USD has held steady overnight, but activity elsewhere shows that dollar-dominance remains the underlying theme.

Guest post by Forex Broker FxPro


More European bond-bifurcation. Yet another extraordinary day of bond-bifurcation in Europe yesterday with yields of the likes of Germany, the UK, Sweden and the Netherlands all registering new record lows while those of the fiscal miscreants in the south continued to climb. In Germany, the 10yr yield fell to just 1.39% while in the UK it touched 1.76%. Germany issued a zero coupon 5yr Bund on Tuesday. Soon, the UK might be able to do the same if funds continue to poor into London – the 5yr gilt yield is now just 0.75%. Meanwhile, the spread between southern and northern European bond markets continues to widen – the IT/GER 10yr and SP/GER 10yr spreads were out by another 15bp to 422bp and 470bp respectively. There is no reason to think that this leakage of capital and wealth from Europe’s south to the north will not continue. Indeed, there are signs that it is quietly accelerating. As such, we may well find that European bond yields soon fall to levels deemed unimaginable not long ago. The 10yr Bund yield could soon be below 1.0%, as could that of the 10yr Gilt.

A horrible mess in Japan. It remains the case that Japan’s economic fundamentals look extremely challenging. Firstly, the public sector finances are a train-wreck. By the end of the current year, gross government debt in Japan is projected to reach an extraordinary 239% of GDP. The sharply upward-sloping trajectory of government debt will not change any time soon – the budget deficit has averaged 9% of GDP over the past four years and there are no signs that Japan’s current government is in any hurry to reverse the spending largesse. Currently, tax revenues only cover one-half of spending, the rest is borrowed. To put this borrowing binge into perspective, the gross government-financing task this year is expected to reach 59% of GDP, or around USD 3.3trln (roughly the size of the German economy). Secondly, the once invincible Japanese trade sector is unravelling, due to a huge hit to competitiveness because of a significant appreciation in the real effective exchange rate, rising energy prices and a significant loss of productive capacity after last year’s tragic earthquake and tsunami. Exports over the past 15 months have been stagnant, while the import bill has been climbing steadily. Japan has recorded an adjusted trade deficit in every month since March 2011; the cumulative trade deficit over that time has been around USD 66bn, or a little more than 1% of GDP. Given these pressures on the trade side, Japan’s current account surplus is diminishing rapidly. Relative to GDP, it fell to 1.7% at the end of Q1, whereas at the end of 2007 it was just under 5%. Finally, the economy is still extremely weak. Notwithstanding the slight bounce in output in recent quarters as Japan attempts to rebuild, nominal GDP is still 8% below the peak registered five years ago. Moreover Japan has, at the same time, a population that is both ageing and declining, never a helpful combination for growth. Against the backdrop of these dreadful domestic fundamentals it is mystery to most commentators why the Japanese yen is not a lot weaker. Indeed, the yen’s obituary has been written many times over the past decade. What many have apparently missed is that Japan remains the world’s largest net creditor, a mantle it has now held for 21 years. Net assets held by the private and public sector in Japan totalled JPY 253trln at the end of last year, or around USD 3.2trln. Also, in part because Japan’s banks are well-capitalised, both foreign and domestic investors are content to park their cash there, especially over the last couple of years during which many have been frightened by Europe’s worsening sovereign debt and banking crisis. Based purely on long-term fundamentals, the Japanese yen looks decidedly vulnerable. The one major saving grace has been the fabulous net-creditor position accrued over the last three decades. If this exalted status is challenged over coming years (probably because of deteriorating domestic fundamentals), then this ought to weigh on the yen. However, the yen bears need to be conscious that they have been wrong many times before. As always, currencies are a relative game, and it can hardly be said that the fundamentals for the other major reserve currencies looks that special either.

Even lower lows for the Aussie. Australia might be the nicest place to live on the planet (OECD Your Better Life Index), but these days the currency is really suffering. Yesterday, the AUD dropped to a 6mth low of 0.9690, a loss of more than 10% in less than three months. In that time the Australian currency has been comfortably the worst-performing of the majors. It has even underperformed the battered euro, and by nearly 5%. The current month has been especially problematic, with the Aussie down by 7% already. For those like ourselves who have been consistently bearish on the Aussie over that time, the demise is no surprise. Appetite for risk around the globe has been scuppered by both Europe’s slow-motion sovereign debt implosion and China’s much weaker growth picture, with fall in PMI data overnight adding to this perception. Domestically, the economy is looking none too flash either, with the non-mining economy in recession, house prices declining and the consumer saving like there is no tomorrow. Interest rate differentials, which in the past were so supportive for the Aussie, have collapsed. Perpetuating the AUD’s slide this month has been a sharp reversal in positioning by traders. In addition, many real money managers down under, who had become accustomed to a strong currency, have been madly hedging, again contributing to the downside pressure on the currency. Finally, after a protracted arm-wrestle, the bears have a really firm grip on the Aussie. It may well be a while before they let go.