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Traders Bullish on Risk as U.S. Goes on Labor Day Holiday

Tue, Sep 7, 10:21 AM ET, by

U.S. markets are closed today which seems to have given some confidence to speculators around the world to load up on risky assets without the threat of a reversal in the NY session. A majority of markets are up, as currencies in Asia and the rest of the emerging market world take some boosting from optimism about the EURUSD earlier in the day. Later, some disappointing sentiment data from the Eurozone deflated the exuberance of Euro buyers a bit, but it looks like that will still be a good day. Corporate CDS are also tighter, continuing Friday's trends.

Belgian government talks break down

It looks the long lasting efforts to set up a government in Belgium have led to yet another breakdown, but it is not clear if this means a permanent split or not. We find the intractable nature of the disagreements there as yet another sign of the times to come. It is of course true that local issues predominate in the Belgian case, as opposed to the more general, economically rooted problems being faced by the Japanese, or Americans, for example, but we prefer to take note of the inrreconcilible positions taken by the two sides as a confirmation of the general political and social trends being established around the world at the moment. So, while the crisis itself is of no significance to FX for the moment, its implications in a wider context are valuable from a longer term point of view. The harder it is to reconcile opposing camps in economic or political matters, the longer it will take to sort out existing issues, and the longer these issues last, the deeper they will become, leading to a further hardening of positions, and creating yet another vicious circle that jeopardizes a return to long term stability. We believe political problems to be as detrimental and dangerous to growth as any economic issue.

As one would expect, Eurozone CDS and the EURUSD rate have not reacted by much to the news, but spreads for most European borrowers, including Germany are wider today. Problems in the periphery continue to predominate in calculations, while Belgian issue does not seem to be big or serious enough to shift focus, at least for now.

Eurozone Sentix indicator at 7.6

The Sentix indicator was released today to show that sentiment was almost unchanged against expectations of a significant improvement. On the other hand, both the Eurozone services PMI and Q2 GDP were released with better than expected final results.

Meanwhile, the recent optimisitic news from around the world have helped keep 3-month Euribor at its current levels below 0.90, with the rate today at 0.882, barely changed from Friday. Finally, in the Euro area we have ECB governing council member Ewald Nowotny on the lines saying normalization will not begin until December, that the recovery is weak, export dependent, and "not self-sustainable". We of course concur with this cheerful assessment of the situation, and remain pessimistic about the Euro's future

USDCNY fixed lower, as the next phase of U.S. China dialogue begins

The central parity rate for the USDDCNY pair was fixed at 6.7838 today. The latest movements are the result of the currency basket determining Yuan value being given a more prominent role in setting the actual rate announced by the PBOC, but be it as it may, the lack of decisive action on the Chinese side towards reducing the trade surplus will not be appreciated by American officials who are soon to meet their counterparts in a series of meetings extending into November, according to the WSJ.

Larry Summers has of course already commenced his visit to China today, where he is expected to emphasize the deep feelings of frustration felt in Washington over the inability of the Chinese to do anything of note, on the whole, about the Yuan issue. Some important, yet minor steps have been taken on the road to full convertibility, such as the recent announcements on interbank Yuan trading, and the measures aimed to extend the scope of bilateral trade settlements in Yuan, but the size of these measures is definitely small, and what is more, the focus seems to be the improvement of the profile of the currency as an alternative to the USD, rather preparing the ground for the eventual elimination of the peg. While the Chinese do recognize the impossibility of maintaining the status quo for a very long time, they also are aware that their options are very limited. The pricing advantages that they enjoy are already being eroded by rising wages at home as many regions come close to saturation point in providing labor at abysmally low prices, and other locations, such as some South and Central American nations, become more attractive for labor intensive, relatively unsophisticated manufacturing businesses. This is, of course, an irreversible, and unavoidable trend for an industrializing and rapidly enriching nation such as China, but the authorities want to make it as smooth and painless as possible, which requires a slow unwinding of domestic excesses, and does not favor an aggressive currency policy. It is not clear to the cautious Chinese that the economy can avoid a situation similar to the experience of Japan if the fast track is chosen. On the other hand, of course, populist pressures force politicians around the world to exploit the China issue to appease and profit from domestic discontent, making it hard to maintain the present pace of appreciation regardless of the concerns that the Chinese have.

Apart from being cornered and essentially out of options in the USDCNY issue, the Chinese appear to be doing their best to reverse whatever diplomatic gains that they had made during the boom years. The South China Sea issue, now familiar to some due to occasional naval confrontations between Chinese and U.S. ships in the area, threatens to seriously undermine the way in which PROC is regarded in the region. By limiting their options, as with the Taiwan issue, through extremely reckless and naive use of rhetorics with respect to their territorial claims in the region, the Chinese have unnerved Malaysia, Taiwan, Japan, as well as Vietnam, and have suffered some damage to their good, cooperative neighbor image (they claim almost the entire area as national territory). The U.S. on the other hand, has successfully exploited the situation by declaring through the mouth of the Foreign Secretary in July, that the South China Sea issue is a national security subject for the U.S. According to reports, Yang Jiechi, the Chinese counterpart of Mrs. Clinton, who is also responsible for some of the most unwise statements from the Chines side, got so angry that he even shouted at the delegates at the ASEAN meeting. Problems in this region are of long-term significance and deserve close observation.

Yen buying remains brisk in the options market even as the spot rate relaxes a bit

Newswires report strong activity in the options market during the Asian session, driven mostly by hedging demand, even as the spot and Euroyen futures weaken for now. It is clear that Japanese exporters are not convinced that the Yen story is over, and neither are we, but in spite of the favorable positioning of long-term fundamentals, the short term trade is a bit overcrowded right now, and it would not be surprising to see the yen decline for some time in response to optimistic risk sentiment. Yet the long-term scenario still favors the continuation of the existing trend, where corporations reduce external investment due to contracting margins(in Japan itself, capital investment has contracted by 11.5 and 1.7% in the first two quarters), speculators buy the yen in anticipation of low global interest rates, and the Japanese government itself contributes to the trend, ironically, by engaging in further easing, and solidifying the global central bank outlook (i.e. If even Japan is easing, with rates at zero already, one can expect that major central banks will at least maintain rates at their present levels. The Japanese are not the only ones addicted to easy money.)

As this article is being written, an influential manager from PIMCO is being quoted by Bloomberg saying that the risk of a Greek default is substantial. Not really big news for us, since we don't expect Greece to experience normalcy for much of this decade being engulfed by political turmoil and social unrest. Greece can have two outcomes. One is a massive bailout at little to no cost by external actors, which would save Greece but probably break up the Eurozone itself eventually as Germans vote the Euro out. This is less likely than the alternative, which just has Greece defaulting, causing a huge shock to the Euro, but also increasing the chance of survival. But for now we will let markets focus on the upside; it is not a bad time to establish additional longer term short positions.

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This Article's Word Cloud:   Belgian   China   Chinese   Euro   Eurozone   Greece   Japan   Japanese   Yuan   about   also   another   around   being   central   course   currency   even   expect   from   government   have   issue   issues   itself   long   longer   market   more   options   other   political   positions   rate   sentiment   situation   some   take   term   that   their   they   this   time   today   trend   which   will   with   world

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