After a relatively encouraging first month of the New Year, the dollar index has fallen by 3% since mid-January, in part due to the Fed’s surprising endorsement of more quantitative easing.
Last Friday’s GDP numbers were remarkably weak, confirming the prognosis of a number of Fed officials who feel that the economy could do with some further assistance. In addition, the dollar has been sold as a counterpart to the sharp short-covering rally in the euro; recall that two weeks ago, euro shorts registered a record high. Video:
The EUR had another look above 1.32 yesterday but ran into heavy selling traffic once more. Of interest is that the likes of the pound and the Aussie have essentially been steady against the single currency since mid-January, confirming that this is mostly about the dollar. It could well be temporary weakness, especially if the economy shows some resilience again. Friday’s January payrolls figures could re-shape this debate.
Guest post by FxPro
Chinese economy holds up in January. More so than usual, markets are sensitive to signs of slowing output in China, so the latest manufacturing PMI data have offered some comfort to those who fear a sharper slowdown. The manufacturing PMI data increase by 50.5, a marginal increase from the previous 50.3, but going against fears of a fall below the 50 level. The data does contrast with some other indications of softer activity for January but, given the New Year holiday, there are inevitably some issues around seasonal adjustment. There has also been news overnight of a fifth consecutive month of falling property prices, according to the latest data from SouFun holdings. The Chinese leadership remains confident that it can fine-tune policies in face of slower demand and they have been implementing measures designed to dampen property prices. As such, the data is likely to be welcomed in official circles, although it’s a fine balance between whether the authorities or market forces are more in control and the government remains vulnerable to a more aggressive decline in property market activity.
Greece buffeted by new troika demands. With Germany almost declaring diplomatic war on Greece earlier this week with its proposal to appoint an EU budget commissioner to sanction fiscal breaches in Athens, Prime Minister Papademos must have been hoping for some respite after a very testy meeting with Angela Merkel. Now however, another firestorm has broken out on a separate front, with the troika apparently making some new strident demands. These include additional spending cuts of EUR 2bln, and a 20-25% wage cut for private sector workers designed to rebuild competitiveness. Both the EU and the IMF have told Greece that unless the new fiscal package is agreed, no debt restructuring can proceed. Monday’s undertaking by Papademos that a debt deal would be done before the end of the week still looks far from assured. At present, bond-holders are reportedly looking for elements in the deal that would increase what they get back should GDP recover more strongly than expected.
Portugal peers over the precipice. Greece dominated discussions at Monday’s EU Summit but not far behind was Portugal which is also staring into the void. The yield on Portuguese 10yr bonds soared to 17.4% on Monday, up 400bp this year alone, with the two-year yield reaching 21.5%. Compounding Portugal’s difficulties over recent weeks was S&P’s recent decision to downgrade the country’s debt to below investment grade, forcing many money managers to offload the bonds they hold at almost any price. With the economy set to contract by at least 5% this year and a further decline likely in 2013, and with a private/public debt mountain of 360% of GDP, Portugal’s debt dynamics are rapidly becoming unsustainable. Although European leaders deny it, investors clearly believe that, like Greece, Portugal will soon need to impose a significant haircut on bond-holders. Credit default swaps for Portugal imply a 72% probability that the government will default within five years. All of this is very hard to swallow for Prime Minister Pedro Passos Coelho who implemented significant austerity measures as a condition for receiving EUR 78bln from the EU/IMF last year and who firmly believes that he has delivered his side of the bargain. Last week he intimated that international creditors may need to provide Portugal with further support because austerity had failed to placate investors or reduce borrowing costs. The Prime Minister has vowed to undertake a second round of asset sales, including the government’s stake in an airport-management company and a rail-freight company; the first round of privatisations is proceeding well. Finance Minister Gaspar claimed recently that Portugal was still on track to achieve a fiscal deficit of 4% of GDP this year, well below the 5.9% target. Uppermost amongst investor concerns is the dreadful growth outlook. In Portugal’s case the underlying structural issues and lack of inherent wealth-creation render the implementation of significant austerity measures especially problematical. Like Greece, Portugal is likely to remain in intensive care for a very long time.
The difficulties of lending to the IMF. Having exhorted the eurozone to come together and create momentum towards fixing its structural-deficit problems, talk of maintaining the EFSF alongside its successor, the ESM, seems to have been enough of a display of good intent by euro members for the UK Chancellor to publicly consider dipping into the UK wallet for that GBP 10bln loan to the IMF. However there are four conditions attached to his largesse and two not insignificant hurdles to overcome before any concrete pledge is made. The stipulations are: that there will be conditions attached to any IMF lending (not exactly unusual but still vague); that the UK will not contribute unilaterally – other G20 nations must participate (Lagarde was in Davos with her oversized begging bowl); that there will be no unique vehicles set up purely for the benefit of the eurozone and, in the same vein, any new funds must not be used as a substitute for eurozone self-funding.
As well as conditions there are hurdles – both major and minor. Merkel’s own CDU party is adamantly opposed to the proposal to run the EFSF alongside the ESM due to the EUR 211bln cost. Osborne’s willingness to contribute may well diminish if Merkel is unable to deliver the increased firewall that would be created by a twin-track rescue/stability fund strategy. Without that green light the conditional premise for UK participation falls apart. To add to Osborne’s difficulties, the eurosceptics in his own Conservative party are banging their war drums, arguing – as is Germany – for greater material progress by eurozone members but also pinning much of the responsibility on Germany itself. Despite Osborne putting his money where his mouth is, it is likely, as usual, to be Merkel who decides the next step.