Tag Archives: eurozone

The catastrophe that beset Cyprus’s ‘too-big-to-bail’ banking sector confirmed that the seemingly never-ending crisis in the eurozone is far from over.  Indeed, investors are already busy searching for the member of the single currency that is likely to be next in the firing lining.

The hunt has exposed the Republic of Slovenia as the most plausible candidate for a future bail-out, and the financial markets have responded accordingly.  The yield on ten-year sovereign bonds jumped from below five per cent mid-March towards seven per cent by the end of the month, while the yield on two-year notes registered an even larger increase.  The resulting inversion of the yield curve confirmed that investors believe the risk of default to be high, as too did the surge in the cost to insure five-year sovereign bonds, which rose by more than twenty per cent following the Cypriot debacle.

But, is investors’ heightened concern justified?

The Republic of Slovenia became the first of the former communist states in Central and Eastern Europe to adopt the euro in 2007.  The relatively small country – with a population of little more than two million and an economy that accounts for less than 0.5 per cent of euro-zone GDP – staged an impressive acceleration in economic growth during the years that immediately preceded its accession to the monetary union.

Indeed, annual growth in real GDP accelerated from four per cent in 2005 to seven per cent in 2007; the rapid growth reflected robust domestic demand driven by increasingly leveraged private-sector balance sheets, and vigorous export growth arising from strong external demand.

However, the economic expansion came to an abrupt end once the global crisis struck, as the evaporation of external finance precipitated a sharp decline in investment expenditures, while weak demand abroad caused export volumes to shrink by close to 25 per cent.  All told, the Central European nation endured a cumulative decline in real GDP of about ten per cent from the peak in the third quarter of 2008 to the trough in the second quarter of 2009.

The Slovenian economy limped through most of 2009, but a recovery was underway by the following year, only for it to be interrupted by an escalation of the eurozone crisis during the second half of 2011.  The resulting double-dip has persisted for six quarters and deepened throughout 2012, as weak external demand weighed on exports, while higher unemployment and lower real wages led to a contraction in household consumption.

Persistent economic weakness has placed considerable stress on the banking sector, with a notable deterioration in asset quality.  Indeed, non-performing loans increased to €7 billion last year or 15 per cent of total assets.  Eighty per cent of the impaired credit or €5.6 billion stems from the non-financial corporate sector – almost one-quarter of all outstanding loans to non-financial firms.

The declining asset quality is even more troubling among the country’s three largest banks.  Non-performing loans exceeded 20 per cent of total assets by the end of 2012, with roughly one-third of all outstanding loans to the non-financial corporate sector turning sour.

The banking sector’s credit woes are unlikely to improve anytime soon, and the non-performing loan ratio is virtually certain to increase further during the current calendar year.  Indeed, the economic outlook is far from encouraging, and a return to growth is unlikely before 2014.

Slovenia’s pre-crisis credit expansion was concentrated primarily in the non-financial sector, with the outstanding debt relative to GDP jumping from below 60 per cent to more than 90 per cent by the time economic recession struck.  The rehabilitation of corporate sector balance sheets has barely begun, and the debt ratio continues to move higher, as the cumulative decline in GDP outpaces the overall reduction in outstanding debt.  The deleveraging process seems certain to intensify in 2013, and as a result, investment spending is sure to decline.

Weak investment spending is likely to be compounded by soft household expenditures, as high unemployment continues to weigh on demand.  Further, the external environment is unlikely to provide much support to exports in the year ahead, while efforts to reduce the public sector deficit below three per cent of GDP will act as an additional impediment to growth.  All told, it is not unreasonable to assume that the economic recession will continue throughout the current calendar year.

The continued contraction will place further strain on the beleaguered banking system.  However, it is important to appreciate that the Slovenian banking sector is nowhere near as outsized as Cyprus, or Ireland for that matter, with assets amounting to 130 per cent of GDP, and recapitalisation needs are estimated to be in the region of €1 billion to €2 billion or three to six per cent of GDP.  These sums appear manageable in the context of a government debt ratio below 50 per cent of GDP, but credible action to stabilise the banking system is required sooner rather than later.

Investors view the Republic of Slovenia as the eurozone member next in line to require external financial assistance, given a poor economic picture that continues to weigh on its distressed banking system.  However, the situation appears manageable – if addressed quickly – but ultimately, the financial markets will determine the country’s fate.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

It is only a matter of weeks since European officials openly congratulated themselves on their seemingly successful efforts to bring the prolonged eurozone crisis to an end.  The backslapping subsequently proved premature, as the botched rescue package – designed to help an ailing Cyprus raise part of its emergency funding needs internally and ultimately secure external support of some €10 billion – put policymakers’ incompetence on show for the entire world to see.

The initial proposals are difficult to fathom, given that policymakers’ had months – and not days – to devise a credible plan.  The lack of time pressure should have allowed decision-makers to get ahead of the crisis, but this advantage counted for nothing, as the proposed plan to recapitalise the banking system was virtually certain to prove ‘dead-on-arrival,’ given that it violated the hierarchy of claims in the capital structure.

The original plan envisaged that senior bonds would be made whole, while uninsured deposits would participate in losses, even though these depositors should rank at least pari passu with senior bondholders.  Further, Cyprus’s leadership – in a desperate attempt to minimise the losses imposed on uninsured foreign deposits, and thus preserve the country’s status as an offshore banking centre – decided to bail-in insured depositors, even though such liabilities should be considered sacrosanct, so as to avoid devastating bank runs.

It came as little surprise that the deeply-flawed plan, which was intended to raise €5.8 billion and fill the hole in bank balance sheets left by bad debts and losses on Greek sovereign debt, was rejected decisively by Cyprus’s parliament, with not one single Member of Parliament voting in favour of the proposals.  Sent back to the drawing board, sanity ultimately prevailed among policymakers, as the revised plan unveiled eight days ago, resembled what one would hope to see in an orderly bank resolution.

The revamped plan scrapped the ill-advised idea to impose a ‘stability levy’ on all depositors, and will “safeguard all deposits below €100,000.”  Instead, the banking system will be restructured – the Laiki or Cyprus Popular Bank, the second largest lender, is to be split into a ‘good’ and ‘bad’ bank, with the former to be backed into the country’s largest lender, the Bank of Cyprus, and the latter to be wound down over time.

Both Laiki’s shareholders and bondholders – junior and senior – will be wiped out under the revised plan, while insured deposits, alongside the €9 billion in liabilities that stems from liquidity support provided by both the European Central Bank (ECB) and the national central bank, will be transferred to the Bank of Cyprus.

Meanwhile, Laiki’s uninsured deposits amounting to €4.2 billion will be placed in the ‘bad’ bank.  These depositors can reasonably expect to recoup very little – if anything – as they will eventually receive a sum that amounts to no more than the distressed value of the ‘bad’ bank’s impaired assets.

The enlarged Bank of Cyprus will face a large restructuring effort to raise its capital ratio to EU-mandated levels of nine per cent by the end of the programme.  Since no bail-out funds are to be used to recapitalise the troubled bank, both shareholders and bondholders are likely to lose all of their investments, while the hit to uninsured depositors – via a deposit-to-equity conversion – could amount to as much as fifty per cent.

The revised plan is a vast improvement on the initial policy blunder, since it respects established credit hierarchy.  However, there are still reasons to believe that the Cypriot banking crisis is far from resolved, while the new blueprint could well have far-reaching consequences across the monetary union that are decidedly negative.

The banks may well have reopened last Thursday – with no sign of a disorderly run on bank deposits – but this was purely a function of the €300 daily limit on withdrawals and curbs on cashing cheques.  These measures – alongside capital controls that prevent virtually any cash from leaving the island – are supposed to be temporary and last just seven days.  However, once lifted, panic is sure to ensue, as depositors scramble to protect their savings.

Cyprus’s banking system has already lost access to normal ECB operations, and is dependent upon emergency liquidity assistance (ELA) from its national central bank.  However, a shortage of unencumbered collateral – alongside the haircuts the national central bank applies – limits the availability of ELA, which may prove insufficient to fill the gap left by deposit flight.  As a result, further losses could well be imposed on uninsured depositors.

This means that measures are likely to prove anything but temporary, and remain in place far longer than currently envisaged.  This should serve as a warning to bank creditors in other eurozone states with ailing and oversized banking systems.  Depositors – both insured and uninsured – are sure to be increasingly nervous, and willing to withdraw their cash at the first hint of trouble, which means that banking crises are likely to develop far more quickly than previously.

Further, bank funding costs are likely to increase permanently for troubled banks.  The decline in margins and the resulting downward pressure on already-beleaguered profitability could well prove to be a key factor behind accelerated deposit flight.

It may be a small island, but the precedent set in Cyprus could have big consequences for many years to come.  Cypriot banking woes are a game-changer.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Our Two Cents – Week of 5/21/12

Even though the unofficial start of summer kicks off this Memorial Day weekend in Boston, flip flops and sunscreen were out in full force last weekend. What was the temperature of financial markets from the past week? Read on to find out.

In the U.S., the economy was picking up after an early spring slump. Data showed growth in the April-June quarter is off to a good start, thanks to falling gas prices and solid hiring gains. Manufacturing and housing continued to show signs of economic expansion as factory bookings for long-lasting goods rose 0.3 percent last month, according to a May 24 Commerce Department report. Other numbers showed purchases of existing and new houses also increased. In the business sector, about 72 percent of startup CEOs reported thoughts of economic optimism this year in a study conducted by Silicon Valley Bank.

For the eurozone, unfortunately, there haven’t been too many signs of economic confidence after fiscal turmoil continues in Greece. The country is facing a possible exit from the eurozone that could cost the region hundreds of billions of euros. Greece’s financial minister said he expects the financial disorder to last about 12-24 months, allowing time for Greece to decide if it wants to stay in the single eurozone currency. As Greece struggles with itself, European leaders have prepared crisis-fighting plans for discussion at an informal EU Summit this week. According to the European Central Bank, officials said the eurozone needs growth and austerity.

In April, hedge funds upped 0.12 percent, according to the HFRX Global Hedge Fund Index, which puts their year-to-date gain at 3.27 percent.

 

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Our Two Cents – Week of 5/14/12

Rain, rain, go away. While Boston has been under rain showers for the past week, and recovering from the Celtics loss May 14, we drizzled some of the top headlines from the financial markets into this week’s roundup.

In the U.S. the economy continues to show signs of improvement. Jobless claims now stand at 367,000—1,000 less than last week, and job openings in March are the highest in almost four years, as employers advertised 3.74 million job openings. Additionally, economic confidence remains steady at -18, up slightly from the previous week and slightly better than the -20 average for the month of April.

In the eurozone, the German economy grew by 0.5 percent in Q1 2012 after it contracted 0.2 percent in Q4 2011. Economists predicted a growth rate of 0.1 percent, and some experts speculated Germany—the economic backbone of Europe—could help save the eurozone from recession. Macroscopically for the eurozone, economists predicted an economic growth of 1 percent for 2013, with the European Commissioner for Economic and Monetary Affairs Olli Rehn saying “a recovery is in sight” for the area. After Greece entered its second week without a government, the European Commission hoped the country would remain part of the eurozone, not withdrawing from the region and returning to its drachma form of currency.

For hedge funds, they saw an inflows increase of 1.24 percent so far in May, according to the GlobeOp Capital Movement Index.

 

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

It is only a matter of weeks since a number of European leaders, including the French President Nicholas Sarkozy and Italian Prime Minister Mario Monti, declared the euro-zone crisis to be “almost over.”  Financial markets jumped to the same conclusion following the large provision of liquidity by the European Central Bank (ECB) in two large three-year long-term refinancing operations last December and late-February respectively.

The calm provided by the ECB’s unconventional liquidity facilities proved fragile however, and stress returned to the zone’s sovereign bond markets once data confirmed that economic conditions continue to deteriorate.  The contraction in economic activity is frustrating efforts to meet ambitious fiscal goals, with both Spain and Italy indicating that they will not reach the initially projected deficit targets.  The evidence confirms that the fiscal consolidation strategy is not working, and a less restrictive policy mix will ultimately be required to save the euro-zone’s troubled periphery.

The economic challenge facing the periphery is far more complex than simply reversing the large fiscal deficits and stabilising the outstanding stock of public debt relative to GDP.  The sizable external deficits that persisted in the years before turmoil struck must be eliminated in order to stabilise the level of net external liabilities as a percentage of GDP.

The average current account deficit among the periphery increased from just four per cent of GDP in 2003 to almost eleven per cent by the time the crisis struck, which caused net external liabilities to rise to more than seventy per cent of GDP in Greece, Portugal and Spain.  Meanwhile, net payments abroad averaged three per cent of GDP in Greece, Portugal and Spain by 2007, or one-quarter of the current account deficits in each country.

By 2007, external debt indicators all vastly exceeded levels that had previously triggered crises in developing countries, and continued to deteriorate in subsequent years.  The latest available data indicates that net external liabilities exceed 100 per cent of GDP in both Greece and Portugal, are close to 100 per cent in Ireland, and more than 90 per cent in Spain.  Not surprisingly, net payments abroad are capturing an ever greater share of GDP.

In order to return the external indicators to more sustainable levels and avert a balance of payments crisis, simply eliminating the current account deficits is unlikely to prove sufficient; large surpluses will be required over several years in order to paydown external debt.  However, unlike previous balance of payments crises, this task cannot be accomplished via a substantial depreciation of the exchange rate, which means that the adjustment required can only be realistically achieved in the short-term through a reduction in domestic demand.

A decline in domestic demand however, is virtually certain to lead to a contraction in economic output in those peripheral countries including Greece, Portugal, and Spain, where trade openness is relatively low.  A fall in the overall level of economic activity makes it all the more difficult to meet ambitious fiscal targets, which means that the upward pressure on borrowing costs is unlikely to abate.  In turn, the external deficit is likely to prove more difficult to finance, increasing the pressure to effect the necessary adjustment more rapidly.

Further, the ability to run a current account surplus in the troubled countries – apart from Ireland – is constrained by the de-industrialisation of these economies in the recent past.  This means that the economic structures of Greece, Portugal and Spain are such that they can be expected to run external deficits for a ‘normal’ level of domestic demand.

The bottom line is that a sizable contraction in domestic demand will be required to return external debt indicators to a more sustainable level.  The cost in terms of higher unemployment however, is a cost that the sovereigns in difficulty may not be willing to pay.  The rate of joblessness is already unacceptably high in the periphery, particularly among the young, and further declines in the numbers employed may well lead to social unrest and political upheaval.

The external position has already shown marked improvement in the euro-zone’s periphery – apart from Greece.  The current account in Ireland has been close to balance since the beginning of 2010, while the deficits in both Spain and Portugal have narrowed considerably from almost ten per cent of GDP in 2007 to below four per cent last year.  Nevertheless, despite the impressive progress, further adjustment is required and particularly so in the Iberian Peninsula where the incremental social costs may well prove to be too onerous.

The fiscal consolidation strategy currently being applied in the euro-zone’s periphery is not working, and will continue to fail so long as much-needed private sector deleveraging and a reversal of unsustainable external deficits continue to frustrate government’s best efforts.  A less restrictive policy mix will ultimately prove necessary to save the euro.

Previously posted on www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Our Two Cents – Week of 4/30/12

While we’re still recovering from the Boston Bruins’ devastating playoff loss against the Washington Capitals last week, we tossed the sports pages for the business section to see how the financial markets scored.

While the U.S. economy only grew 2.2 percent in Q1 2012, there were signs that the economy thrived in the right places, including consumer spending. Personal consumption rose by 2.9 percent, exceeding expectations for a 2.3-percent rise, and up from 2.2-percent growth in Q4 2011. Personal incomes in March increased by the most in three months, as the Commerce Department said consumer income rose 0.4 percent last month. Confidence in the global economy grew substantially, according to the Q1 2012 ACCA/IMA Global Economic Conditions Survey, the largest global study of professional accountants. Thirty-two percent of respondents said they saw an uptick in U.S. business confidence, versus 18 percent in Q4 2011.

While Americans are feeling more financially confident, many are still uneasy about investing in the stock market. According to a new poll from Bankrate.com, about three-fourths of respondents said they were less inclined to investing in the stock market than they were a year ago. Perhaps it’s because of the stock market’s volatility, and they should consider methods of alternative investing. Speaking of alternative investments, hedge funds have outperformed other asset classes during the last 17 years, according to new research from KPMG and a hedge fund lobby group.

In the eurozone, Greece held talks with its international creditors about delaying by one year its medium-term deficit goals, working to ease the ongoing austerity measures on the economy. Across Europe, British Prime Minister said the continent was not “anywhere near half-way through” the economic crisis, but the German government said they’re more optimistic than Cameron about Europe’s financial stability. Cameron’s commentary came at a time when his country fell into a double-dip recession.

 


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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Lawrence Peter ‘Yogi’ Berra, a man who earned the respect of American baseball fans first as player and then as manager, declared in the early 1960s that, “This is like déjà vu all over again” as two of his players – Mickey Mantle and Roger Maris – made a habit of hitting home runs game after game.  Berra’s words would appear to be an apt description of renewed stress in the euro-zone.

The euro-zone crisis seemed to ease following the large liquidity injection provided by the European Central Bank in two large three-year long-term refinancing operations, which led some commentators to conclude that the turmoil had come to an end.  Indeed, the yield on Spain’s ten-year sovereign debt dropped from a peak of almost seven per cent at the end of November to below five per cent in early March, while the rate available on equivalent Italian debt securities declined by more than 250 basis points over the same period.

The notion that the crisis was over was to prove decidedly premature, as the siesta was brought to an abrupt end by mounting stress in the Kingdom of Spain, an economy that is twice the size of the combined national outputs of Greece, Ireland and Portugal.  A deepening recession combined with fiscal slippage at the regional level pushed Spain back onto investors’ radar screens, and the resulting jump in ten-year yields close to the psychologically important six per cent level, has prompted onlookers to revisit the possibility that the Mediteranean country might eventually require a bail-out.

In order to appreciate the extent of Spain’s economic malaise, it is important to investigate the large macroeconomic imbalances that accumulated during the country’s long boom that lasted from the mid-1990s until crisis struck in 2007.

Spain benefited considerably from EMU membership and economic growth outpaced the OECD average in nine of the ten years pre-crisis, with the yearly increase in GDP exceeding the euro-zone as a whole by one to one-and-a-half percentage points over the period.  However, the long boom was built on shaky foundations that would be badly exposed once economic turbulence struck.

The stellar economic performance was driven primarily by a classic housing bubble alongside an ill-advised construction boom, which was stimulated by the reduction in interest rates that accompanied greater European integration.  The reference rate on home loans dropped from almost ten per cent in 1997 to just 3.3 per cent by 2007, and the resulting increase in housing demand led to a 115 per cent increase in house prices in real terms over the period.  The true extent of the overshoot in the housing market is demonstrated by the fact that price increases outpaced rental growth by roughly seven percentage points a year from the mid-90s until the bubble burst in 2007.

Strong housing demand enabled the construction market to flourish, and the resulting demand for unskilled labour contributed to a massive influx of immigrants in need of shelter, which perpetuated the cycle.  Indeed, the sustained demand for unskilled labour saw the population expand from 40 to 45 million, as the share of foreigners in the overall population jumped from just one-in-fifty in the mid-90s to almost one-in-eight at the boom’s apex.

The construction boom was fuelled not only by Spanish demand for second homes and immigrants in need of shelter, but further impetus was provided through increased home purchases by other EU citizens.  Indeed, net foreign investment in housing ranged from 0.5 and one per cent of Spanish GDP each year from 1999 to 2007.

The supply-side response to strong housing demand was nothing short of phenomenal.  The housing stock increased from 20.8 million in 2001 to 25.1 million, and the annual new supply regularly exceeded the new construction of France, Germany, Italy and the UK combined.  In fact, Spain added a new dwelling for each addition to the population over this period, such that the number of people to fill each home fell to 1.7 – the lowest in the developed world.

The bubble years were accompanied by a credit boom that saw households and non-financial businesses leverage their balance sheets to dangerous levels.  Indeed, household debt as a percentage of disposable income jumped from just 53 per cent earlier in 1997 to a peak of 132 per cent, while non-financial corporate sector debt jumped from less than 50 per cent of GDP to more than 130 per cent over the same period.  Importantly, a disturbingly large current account deficit meant that the debt-fuelled boom became increasingly dependent upon external financing, which rendered the economy vulnerable to a ‘sudden stop’ that duly arrived in 2007.

Investors’ concerns today are focussed on fiscal slippage and question marks over the true level of government debt, which many believe to be more than twenty percentage points higher than the official public debt-to-GDP ratio of 68 per cent.  However, investors should be equally troubled, if not more so, by the large private sector imbalances that have shown only marginal improvement since the crisis began.

Private sector debt remains unsustainably high, while house prices and the excesses in the construction sector will take several years to absorb.  Investors will be aware that troubled private sector debt has a habit of becoming public debt via an ailing banking system.  It’s déjà vu all over again in Spain.

Previously posted on www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Our Two Cents – Week of 4/23/12

We enjoyed some warm weather in Boston this past weekend before rain pounded the city, but the inclement forecast didn’t dampen our perspectives about the currency markets.

In the U.S., unemployment aid requests remained near a four-month high as weekly jobless claims totaled 386,000. While economists said the March figures were weaker than previous numbers, they downplayed them, saying that the warmer winter may have led to some early hiring in January and February.

In the eurozone, the European Commission said Greece should now have enough money to stick to its economic reform program as the country seeks to improve its financial instabilities. British retail sales increased 1.8 percent, surprising economists because the volume of sales dropped by 0.8 percent last month and were only expected to increase 0.4 percent this time.

For hedge funds, assets rose to new levels as they surged to $2.13 trillion at the end of the first quarter, beating the previous high of $2.04 trillion, set in the middle of last year, according to Hedge Fund Research Inc. The Dow Jones Credit Suisse Hedge Fund Index finished up 0.05 percent in March.

In the foreign exchange space, FXCM reported steady March FX volumes, with retail down 2 percent from February and institutional up 27 percent from February. Retail volume accounted $340 billion, and institutional volume totaled $161 billion.

 

 

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

One of my Treasury market colleagues brought up an interesting subject today by way of asking me how many euros the Swiss National Bank (SNB) owns as a result of its intervention to prevent the franc from being too overvalued against the Eurozone currency (which I’ve discussed before). The discussion point he was working toward was that the SNB likely has been a major buyer of German government debt as a result of its euro purchases. That and the flow of capital out of the EZ periphery (Greece, Spain, Portugal, etc.) in to German paper has served to depress yields there.

Consider this. The ECB has set the overnight rate for the euro at 1%, yet the German 2yr yield is currently running at about 0.14%. Compare that to the US were the Fed has set overnight rates at basically 0% and 2yr yields are currently about 0.27%. This negative yield spread (-13 basis points currently) is part of what’s been keeping EUR/USD under pressure.

The chart below shows the relationship between the 2yr Germany-US yield spread and the EUR/USD rate. The upper plot is EUR/USD. The middle plot is the yield differential. The lower plot is the rolling 20-day correlation between the two. Notice how that correlation has been positive the vast majority of the time.

EURUSD Yield Spread

The big question out there among many market participants is why the euro isn’t weaker given all the problems in Europe at the moment. We can look at the low rates in the US and Germany as part of the equation. It’s hard for the yield spread to go too much lower from here so long as US rates aren’t on the rise and Bernanke (and the last US jobs report) has done a pretty good job of keeping them down. If the positive correlation holds, it will likely take improved US economic expectations driving US yields higher to really help push EUR/USD down.

 

Our Two Cents – Week of 4/16/12

The Boston Marathon has finished, the scorching weather has departed and another week has past. While cheering on the runners battling the heat—and Heartbreak Hill—during the 116th Boston Marathon, the financial markets also made a dash for themselves.

In the U.S., consumer confidence held to a four-year high as more Americans said their finances were in better shape. The Bloomberg Consumer Comfort Index posted minus 32.8 in the period ending April 8, second only to the prior week’s minus 31.4 as the highest since March 2008. Strong U.S. retail sales fueled economic growth in the first quarter, and analysts are optimistic that the economy grew at an annual pace of at least 2.5 percent during January-March. Also, the U.S. Federal Reserve said the country’s economy continued to grow at a steady pace since February. According to its latest national economic performance survey, the central bank said five districts, including Boston, reported moderate growth.

In the alternatives, hedge funds are rebounding in 2012 as investors have put more cash into hedge funds during the past month, according to GlobeOp. Now four months into 2012, hedge funds are off to their strongest start since 2006, with the average fund gaining nearly 5 percent in the first quarter of 2012. In 2011, more than 1,100 hedge funds launched, according to Hedge Fund Research.

In the eurozone, industrial production has risen for the first time since August 2011, showing signs of revived economic life for the region.

Strong retail sales ease growth worries, Reuters, April 17, 2012
Hedge funds attracting cash in 2012 rebound, Reuters, April 13, 2012
Consumer Comfort in U.S. Held Last Week Near Four-Year High, Bloomberg, April 12, 2012
US economy grows at steady pace: Federal Reserve, The Economic Times, April 12, 2012
New Sign of Economic Life in the Euro Zone, Institutional Investor, April 12, 2012
Hedge Funds Off to Best Start in Six Years, Wall Street Journal, April 11, 2012
HFR: Over 1,000 Hedge Funds Launch In 2011, FINalternatives, April 10, 2012

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.