Bearish Euro Trend Intact
The dollar was mostly firmer vs. its major rivals Friday as the euro/dollar (EUR/USD) currency pair gave up early gains on negative European news to close lower on the day.
With the negative news stream likely to continue, we believe that the bearish euro trend remains intact. The yen was firmer too and kept up with the buck, and so the dollar/yen pair (USD/JPY) stayed around 91.
Emerging-market forex was mixed. The biggest gainers on the day vs. the dollar were the won (KRW), rupee (INR), Philippine peso (PHP), rupiah (IDR) and Taiwan dollar, while the biggest losers vs. the greenback were the koruna (CZK), zloty (PLN), Mexican peso (MXN), forint (HUF) and pound (GBP).
U.S. economic data were mixed, with personal spending and the Chicago PMI weaker than expected and the University of Michigan consumer confidence survey stronger than expected.
Czech elections had no clear winner, but center-right parties have the best shot at forming a coalition (which would be positive for the koruna).
In Colombia, former Defense Minister Juan Manuel Santos holds a big lead (47% vs. 22% for Antanas Mockus) in the presidential election with 89% of vote counted, but Santos needs 50% to avoid a second round.
The Bank of Korea urged central banks to make swap lines permanent, which contrasts with Federal Reserve Chairman Ben Bernanke's recent opposition to giving permanent access to Fed lines.
U.S. equity markets were lower, with the Dow falling 1.2%, the S&P 500 losing 1.2% and the Nasdaq declining 0.9%. European markets were down too, with Euro Stoxx 50 falling 0.2%.
Asian equities are likely to open lower Monday as Asian ADRs were lower during North American trading Friday. Nikkei futures point to a down open for Japan, and the strong yen should hurt Japan exporters.
The U.S. bond market was higher, as two- and 10-year yields were down 11 basis points and 8 basis points, respectively. European bond markets were mostly higher, as 10-year yields were down 3 basis points in the U.K., 2 basis points in France and 2 basis points in Germany. 10-year yields fell 5 basis points in Greece, 1 basis points in Portugal, 2 basis points in Ireland, 4 basis points in Italy and 2 basis points in Spain.
The euro was also hurt by news from Germany's BaFin, the financial regulator, that the government remains committed to the naked-short ban despite the lack of international or even European support.
BaFin's head has gone even further to suggest that the government is considering making the ban on some EMU debt securities permanent, while currently there is a March 2011 expiry, according to Reuters. A couple of days ago, a draft document suggested that euro derivatives (we're not exactly sure all that is included) and additional equities could be added to the banned naked-short list. With month-end at hand, holidays in the U.K. and U.S. on Monday, and the consolidative tone, many participants lack near-term conviction, but we do not see a serious change in market sentiment or fundamentals (yet).
Moody's was constructive on Turkey, saying it would likely upgrade the country from its current Ba2 (equivalent to double-B) if it passes a fiscal rule that has been in the works.
Moody's noted that the rule "would support the medium-term plan to rein in the fiscal stimulus of the past few years and reverse the deterioration in debt metrics." The agency added that further upgrades would depend on labor market reforms, improvements in tax administration and improving debt ratios.
Our sovereign ratings model puts Turkey at BB+/Ba1, and we note that Fitch has Turkey correctly rated at BB+, while Moody's and S&P (BB) should move it up a notch. The IMF team just left Turkey, but was there for its annual Article IV consultation. A standby IMF deal is no longer on the table. The Turkish government is trying to pass the fiscal rule in June, which it says was drafted in consultation with the IMF.
Rather than trying to play the Turkish lira (TRY) vs. the dollar or euro, we think investors should go long the Turkish lira against the koruna or forint. We are maintaining our long TRY/HUF recommendation and would use this pullback to establish a position. The break of the 2009 high of 145.50 in early May now targets the 2008 high of 152.67. Investors get some carry here as well (6.5% vs. 5.25%).
The Turkish lira/koruna pair broke higher and tested 13.5 in May. We target a move back to the 2009 high around 14 followed by the mid-2008 high of 14.48, and so this pullback offers a good opportunity to go long. With Turkey rates at 7.0% and Czech ratesnow at 0.75%, investors will get a whole lot of carry, and the Turkish central bank will be among the first to tighten in the region, possibly ahead of Poland.
The koruna remains our favorite short in the Europe, Middle East and Asia region, not only for the low rates (0.75%) but also for what we see as deteriorating fundamentals. General elections are underway Friday and Saturday, and most polls show no clear winner emerging.
Recall that the current government is a caretaker one, which became necessary back in March 2009 when the previous government collapsed. That government was formed after elections in June 2006 (also triggered by a government collapse) were inconclusive, which led to seven months of jockeying before center-right Civic Democrats patched together a coalition in Jan 2007 that held creakily until March 2009.
Most would agree that lack of a strong, stable government has hindered the Czech Republic's efforts at serious fiscal reforms. The years 2004-2007 saw a narrowing of the budget deficit, but this was a cyclical improvement as GDP growth soared to 6%-7%. With slow growth expected for the region, we believe the Czech fiscal trajectory won't improve much over the next couple of years without structural reforms.
The zloty/koruna is another favored trade of ours. The recent pullback gives investors an opportunity to go long the zloty before this pair resumes its upward move. With high Polish rates (3.5%) and a good economic outlook contrasting with low Czech rates (0.75%) and a relatively weak growth profile, we look for an eventual move higher back to 7.0 and then to the 2008 high of 7.5.
Commodity Futures Trading Commission data show that for the week ended May 25, speculative accounts' dollar bets were mixed. Net short euro positions fell to -106,736 from -107,143 previously, Swiss franc net shorts decreased to -12,619 from -14,558, and sterling net shorts eased to -75,079 from the record -76,745 previously. However, the dollar bloc saw its net long positions cut in half. The Australian dollar (AUD) was at 19,523 vs. 38,380 previously, the Canadian dollar (CAD) was at 23,872 vs. 44,885 previously and the the Mexican peso (MXN) saw net longs decrease again to 28,857 from 35,702 previously. Speculators cut net short yen positions to -10,238 from -34,289 previously. With the yen strong at the start of last week, net yen shorts should decrease more in the next weekly report.
Upcoming Releases
Asia: Japan, Korea industrial production; Australia current account; India GDP; Thai trade, current account, industrial production, retail sales
Europe/EMEA: South Africa money and credit growth, trade; eurozone M3; Norway retail sales; Poland GDP; Hungary central bank meeting
Americas: No U.S. data; Canada GDP; Chile unemployment, central bank minutes; Colombia unemployment. No U.S. speakers of note due to U.S. holiday. U.K. closed for bank holiday.
