This week I want to cover most of the different things that are destabilizing markets, what trends they are creating and what to look out for as far as their potential to affect different currencies.
There are so many factors it is difficult to know where to start. Last Friday Greek debt default swaps hit an all time high of 68.5 percent chance that Greece will default on its debt in the next five years. Yet with this news the euro finished close to the high of the day, although it was not the high of the week so a follow through from the technical view is unlikely. This morning the euro fell probably for many reasons. European debt levels came back into focus as Italy sold EUR 7 billion in bonds out of EUR 13 billion sold today. The news also came from the London Financial Times that Greece will try and sell EUR 4 billion. The Greek 10-year bond yield rose to over 10 percent last week. The question will be raised whether Greece is willing to pay the high yields likely to be demanded by the marketplace in the first offering since the EUR 750 billion bail out was agreed upon. This Thursday the emergency one year EUR 442 billion funding of European banks matures and no one knows whether the debt will be rolled out. This positions the euro on the slippery slope in July. The euro is trading in a range of 1.1880 and 1.2500. The most likely move is for a test of the low in the next month or so.
The UK budget was received by the markets on Tuesday as a constructive step forward to start resolving the UK's huge budget deficit that was partly incurred by the unwinding of the subprime crash. The UK was just as complicit as the U.S. in lending highly leveraged home loans and they took the same path as the U.S. to stop the severe slump. The new Conservative - Liberal Democrat coalition is likely to try and divest itself of its high percentage of bank holdings once they consider the markets to have stabilized. Like those in the U.S., the sale of the holdings is likely to reap a profit. The difference is that in the U.S. the money has gone back into the government pot, while in the UK it will be used to pay down the debt. With such different economic philosophies, the UK is likely to continue to slowly gain against the U.S. Friday's close above 1.50 is significant. Any opposition to the budget cuts will have a negative affect on the pound, but if everything stays in place look for the GBP to take advantage of its position vs. the euro. Major support is at 0.7694. The pound was trading between 0.6500 and 0.7000 for four years from 2004 to 2007 inclusive, making current levels weak in comparison.
One of the factors that has led to the strengthening of the dollar over the last month is that it appeared our economy was picking up faster than those of other major currencies. The data we have seen recently with lower durable goods, Q1 GDP revised down to +2.7 percent, the exceptionally lower house sale numbers and the lack of pick up in the employment, it is not surprising that the latest Federal Reserve statement changed the wording to say economic conditions were not so supportive of economic growth.
All these different factors have been pushing around the market's view of how comfortable it is about putting money in risky places like stocks and commodities. In other words, risk aversion seems to have slowly been picking up. The levels of bond yields in the U.S. and the fact that UK gilts and European bunds both rallied recently pushing their yields lower, shows the state of the nervousness in the markets. If there was a risk aversion meter, it would be high and trending higher.
The yen indicates risk aversion is in place as it strengthens against the dollar and the euro. The same applies to the Swiss franc as these two safe haven currencies take advantage of the uncertainty in all markets.
It is starting to look as if we are going through another global economic dip, but unlike the first one that was fast and furious, this is like watching a train wreck in slow motion. The reason is the level of sovereign debt that is in place and what the effect will be on economic growth to reduce it.
This leaves the currencies in the position where the dollar is the least bad place to put your money and U.S government debt is, of course, where it ultimately lands. We can see this as 30-year mortgage rates hit a 41-year low last week. This morning the 10-year Treasury fell below its April 2009 support of 3.06 percent. It can be argued this will eventually help housing pick up, but the question is who qualifies. Are there enough people to help house sales pick up after the stimulus expired at the end of April? The purchasing tax breaks effectively used up the inventory of buyers earlier than they would normally have bought, causing this temporary void in demand. U.S. housing should start picking up from here, but the U.S.' other problem of employment seems far behind recovering. Friday, July 2, will see the release of the next nonfarm payroll and household unemployment data currently forecast to be -115k and +0.1 percent at 9.8 percent respectively. This will be the next bullet for the dollar to dodge.
Gold is making the effect of sovereign currency reserve calculations more difficult than normal. Gold is sustainable at these levels that are effectively at an all-time high if central bank demand for the precious metal continues as a way to diversify their portfolios. Gold is a hedge against devalued currencies. It has become “that other currency." At the moment all currencies are devalued, it just happens that the dollar is the least weak due to the U.S. treasury markets capability to absorb the buying.
The G-20 put out the normal lukewarm communiqué after this weekend's meeting saying that they agree to tackle deficits once economic recoveries are confirmed!
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources.