Welcome to Kit Juckes's Market Commentary blog. This page is updated regularly to cover events impacting the global financial and currency markets.

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Investors and market participants are behaving like a man who is wandering around in thick fog, in the knowledge that somewhere – perhaps quite close by – there is a cliff edge. What I mean by that is that whatever central case forecast people have about the outlook (from ‘normal economic recovery’ to Armageddon), they are afraid that things could go very wrong, very quickly. The UK could end up with a currency crisis either because fiscal policy is tightened too fast, or not sufficiently; Greece could bring down the eurozone; China’s bubbles could explode; the US residential housing crisis could be followed by an equally horrific commercial real estate bust; or we could all follow Japan into deflation. Some people think any or all of these risks will materialise. Others think they are unlikely. But everyone is scared of them.

This week it was the turn of the UK to fret about monsters in the shadows yet again. Weak economic data, warnings about the possible need to re-ignite the Bank of England’s asset purchase programmes, political uncertainty and the continued losses of the major banks are all playing to peoples’ fears. This morning I hear that house prices fell in February for the first time in ten months and the FT says the data raise questions about the stability of the market (click here). Never mind that a 1% monthly decline still leaves the annual rate of increase accelerating to 9.2% from 8.6%, and never mind that house purchase data in the middle of the worst winter in a generation are utterly meaningless. The market has now cut back its expectation for rates in two years’ time by a further 50bp since the start of the year to around 2%. Now at one level that may seem quite high because I can’t imagine rates going up at any point in 2010, but this really does represent the capitulation of anyone who thinks there is any chance of rate increases on a forecastable horizon because, with rates so far below ‘neutral’ levels, the market needs to carry some sort of risk premium for what happens in two years’ time. On that basis, the decline in market rates must nearly have run its course.

The final piece of economic data for the week – the revised Q4 GDP data – came in slightly better than expected at +0.3%, though previous quarters’ data were revised lower. I suspect this isn’t the last of the upward revisions to the Q4 data but it is now history.

In Europe the fear is of Greece’s woes causing the collapse of the euro, or indeed of the European Union. There may be some people who actually believe this will happen but most know it is very hard to conceive. Untangling yourself from the euro is much harder than entering it. And the implications for the European economy and in particular the European banking system are truly horrific. There are legion reasons to keep the system together. The legacy of Greece’s woes is going to be, across Europe, greater pressure to tighten fiscal policy than in the US and perhaps even than in the UK. Bad news, social unrest, interest rates anchored and modest growth are all likely and are negatives for the euro. But the Armageddon scenario is a nightmare, not a realistic prospect.  

The key to the end of the week will be how the US equity market reacts to a modest economic calendar (revised GDP, University if Michigan consumer confidence, Chicago purchasing managers’ survey and existing home sales) and whether there is follow-through from the strong close last night. Sentiment remains incredibly nervous. But the commitment to asset reflation remains exceptionally strong and I still favour the upside for asset prices as a result. One small piece of encouragement last night came from the news that the amount of commercial paper outstanding in the US increased for the third week in a row. Commercial paper is a key part of US companies’ financing and the collapse of this market back in 2008 was the first sign of the credit crisis. Its return to health is a positive sign, though doubtless one that those who are terrified off falling of a cliff in the fog will ignore.

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Click here to download the text from a speech given by Philip Manduca, ECU's Head of Investment, to a select audience of ship-owners and financiers at Howe Robinson's 9th Annual Speaker's Dinner in Hamburg on 24th February 2010.

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Greece is back on the front pages of the newspapers this morning and for the first time in this move I think we are seeing hysteria. Ratings agencies are warning of further downgrades if Greece can’t cut its budget deficit, workers are protesting at austerity measures and politicians are involved in a mud-slinging exercise of a schoolyard nature (click here for the Telegraph’s take on this). None of this is very new but there are more and more people talking about how – if this spreads – it could bring the eurozone down and cause a break-up of the system (click here).

Sorting out Europe’s finances will cause political unrest and will be a major challenge given the size of the welfare state. It will hamstring the ECB and keep rates on hold for as long as they are down here in the US or UK. And those are reasons to be bearish of the euro, as well as favour German Bunds over UK Gilts. But an Anglo-Saxon view of the collapse of the system is still nonsense. This crisis would have been far worse for everyone in Europe in the old ERM regime. The single currency remains a great success, whereas the fiscal architecture of Europe badly needs mending. On that basis, I suspect this current slide by the euro may now be getting ahead of itself. Greece’s woes won’t go away and we will see concerns about deficits and debts spread around Europe – which can keep the medium-term euro trend downwards – but somewhere here we will see the low for a while.

Meanwhile, the UK remains utterly devoid of any good news. The latest move in the currency – which I have discussed for the last couple of days – was triggered by yet more talk of quantitative easing being extended. That wasn’t ‘news’ in the sense that is has been a talking-point for some time. However, we have now seen a very sharp drop in short-term market rates, taking 2-year swap rates under 1.5% for the first time. The release of very weak business investment data for Q4 (down 5.8%, where the market expected +0.1%) doesn’t help.

In most economic cycles, the low point for market interest rates comes before (or just after) the final rate cut. This cycle is, we all know, different. But since rates can’t fall further than they are now, it is surprising (to me, anyway) that market rates can fall to new lows at this stage. Policy rates are unlikely to rise in 2010. And if fiscal policy is tightened aggressively they will stay lower for a lot longer. But we knew that already. So I have been caught by surprise by this move. That doesn’t mean I am becoming fond of Gilts, whose yields have dipped this week but are still (at 10years) over a percentage point higher than their lows. But it does mean that the rates market needs to turn around before the pound finds a base. I thought that should have happened by now.

Equity markets, meanwhile, are behaving themselves. The US S&P moved back through 1,100 last night and the FTSE is up this morning boosted in part by RBS losing less money than expected. The US gets another round of Fed Chairman Ben Bernanke’s testimony on monetary policy this afternoon but yesterday’s round was exceptionally uneventful.

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Markets continue to struggle to establish clear trends. In the UK the FTSE index reached 5,600 in early January before slipping to 5,033 a fortnight ago. It almost made it back to 5,400 yesterday morning before being undermined by a series of events. Today, at 5,304, it is almost exactly half-way between 2010’s high and low points.

The news that undermined markets started with a soft business confidence report from Germany’s IFO which I mentioned in yesterday’s blog. It continued with dovish comments form Mervyn King and other members of the MPC which have prompted headlines such as ‘Mervyn King says Bank of England may have to extend QE’ (click here). But the real damage was done in the afternoon when the US released consumer confidence data showing a sharp fall to its weakest level since last April (click here). The result was a fall in equity indices and on Bond yields, while the USD and JPY benefited at the expense of most other currencies including GBP and EUR.

I think the euro remains vulnerable to adverse relative economic trends. However, I don’t think the IFO index had much meaning, reflecting weakness in retail industries that was largely weather-related. Likewise, the US confidence data tells me little – equity indices were lower and the US weather was horrible. And in the UK,I learnt even less from the absence of mortgage approvals during January’s blizzards. So what have I learnt? Firstly, the MPC is still very finely balanced when it comes to a decision about whether or not to extend quantitative easing. I think they will probably not extend until or unless things get a good bit worse and I expect the next few months’ economic data to post a rebound (as a result of better weather, if nothing else). But uncertainty on this score will remain. Secondly, I was perversely impressed by the fact that equity markets didn’t fall back further yesterday. With rates stuck at near-zero levels and central banks ready to add more liquidity to asset markets if necessary, a dip in confidence took a few points off the S&P and FTSE but not more. So I remain confident that the next move is a re-test of the highs in FTSE and S&P during the coming months. And finally, I have learnt nothing new about Europe but remain pretty solidly bearish of the euro.

Today sees sales of 9-year Gilts in the UK, of 5-year Notes in the US and the delivery of Fed Chairman Ben Bernanke’s semi-annual policy report to the House Financial Services Committee in Washington. This is normally a much-anticipated event and markets tend to react to it. However, it seems clear to me that he will provide measured optimism about the economy, talk about the lack of inflationary pressures and stress that monetary policy can remain accommodative for an extended period. I struggle to see how markets can take much from this, but on balance comforting words about the economy and a commitment to keep rates low would seem to be positive for equity markets and ‘risk’ assets in general.

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Financial markets are lacking a theme and volumes this week are pretty poor. For myself, the main story is the gradual divergence between US and European economic prospects. The release of the German IFO index of business sentiment for February continued this theme, dipping back slightly to 95.2 from 95.8 (click here). This index is remarkably well correlated with the trend in European GDP and would suggest that while recovery continues, it is losing a little momentum. Another European story that will increasingly do the rounds, is the need for the banking sector to raise capital – in competition with the European states. There’s a piece about this in the Telegraph (click here) that quotes from a Morgan Stanley research report. European banks have been slower to reveal the scale of their bad loans but that doesn’t alter the need to raise fresh capital and, with the sovereign debt crisis still rumbling away in the background, we’re going to see plenty of competition to get hold of investors’ cash – and continued limits on the ability or willingness of European banks to lend money. Against this backdrop the ECB is set to keep policy on hold for the rest of 2010 and may well have to extend some of the unconventional policies that are in place to make it easier for banks and governments to fund themselves. I can’t see this as anything other than negative for the euro, relative to both the US dollar and, in due course, the pound.

In the UK, there are two topics for the markets to digest today. The first is another opinion poll (in the Guardian – click here) pointing to voters moving away from the Conservatives and into the growing ‘other’ category. I think this will ultimately mean a poor turn out as voters, disappointed by the main parties, opt for the local pub. The other event is testimony by MPC members to the Treasury and Civil Service Select Committee. The headlines are, as usual, pretty dovish and the pound is weakening slightly. It is clear that the MPC still sees the decision about whether to expand its asset purchase programme as a close call. It is also clear that they feel the main burden of policy tightening will come from fiscal policy not interest rates in the coming years. Is there anything new in this however? We will see whether it causes more than a tiny blip in current markets – I suspect it’s a storm in a teacup at most this morning.

The US has a limited calendar this afternoon with house price data, the Richmond Fed manufacturing index and consumer confidence. These are all second division indicators but the story is still one of economic recovery. The bigger question is whether that matters for markets, as so many people see the stronger data and dismiss it as being temporary. I don’t know how long people can go on doing that but while they do, US interest rates stay low and US equity indices climb ever-so-slowly towards 1,150.

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Those looking for the next leg down in the global economy, global asset markets and global risk appetite may have to wait a bit longer. The Chinese have come back from their Lunar New Year with their buying boots on, or so it would seem from Asian equity market performance this morning. Strong regional economic data and positive earnings reports globally are helping, while the first monthly fall in the US core consumer price index since 1982 has done a great deal to calm any fears they may have had about the US Federal Reserve tightening monetary policy, irrespective of last week’s Discount Rate increase.

I think the Discount Rate increase is important in the sense that it is a vote of confidence by the Fed that the financial system is still normalising. It should not be mistaken as a signal that policy rates will rise at all this year. There is just too much slack in the economy for that to be necessary but I don’t think rate expectations are what is driving markets at the moment. The very front end of the US yield curve needs to build a bit of a risk premium back in and that can see market rates edge marginally higher, but they are essentially in a range. What is striking however is the growing divergence within the G7 between the US – where recovery continues to out-perform expectations – and Europe, where it doesn’t. So while neither the Fed nor the ECB is going to do anything with rates in 2010, the spread between US and European market rates will go on moving in the dollar’s favour and the downward pressure on the EURUSD rate will continue for a while.

This week there will be the two main market themes: divergence between the US and European economic outlooks driving the euro down; and a continuation of the bounce in equity markets which has been underway for a few weeks now. I am targeting EURUSD to get to 1.30 in the next few weeks and the S&P to have another look at – but probably not to break –the 1,150 level.

Meanwhile, I have returned to the UK to find both major political parties trying hard to lose the general election, most of the top football sides trying not to win the Premiership, and the weather trying to persuade me to stay in bed. The economic story is still one of unremitting gloom while the nation’s economists (I never realised there were so many of them) have caught a strange letter-writing disease and are having a public debate about when to start getting to grips with the huge public sector deficit. My university tutor, Victoria Chick, is a signatory of the ‘give the recovery a chance’ side of the debate, but the best of the City’s UK economists, in my opinion, (Geoff Dicks at Novus Capital) makes a strong case for ‘getting on with it’ and tightening policy while also reminding us that the current ‘bumping along the bottom’ period of the recovery is usually ended with a strong acceleration. His piece in the Sunday Times is worth reading (click here). There is no doubt that last week was dire for the UK with poor data on retails sales, public finances and unemployment. And these figures all played to the grandstand whose gloom is all-pervasive. There’s a  piece in the Telegraph that captures this mood – UK businesses ‘blinkered’ on state of economy (click here) and my conclusion is that UK markets are ripe once again to be surprised by the fact that the world isn’t actually ending. The pound is the most undervalued of all the major currencies on most measures and it only takes a normal seasonal rebound in the data after the snowstorm effect wears off – let alone Mr Dicks’ strong recovery – to make GBP look cheap.

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The Federal Reserve announced a decision late last night to increase the Discount Rate by 25bp to 0.75%. The Fed was at pains to stress that this is a technical move, merely another step towards normalising lending policies, but markets have reacted anyway.

The Discount Rate normally applies to borrowing from the discount window by banks which find themselves short of liquidity at the end of the day, so it acts as emergency overnight borrowing at a penal rate. In the wake of the credit crisis, the gap between Discount Rate and normal Fed Funds lending was reduced and the term of discount window lending was increased. So this move is, indeed, just a step back towards normality at a time when borrowing from the discount window has decreased sharply. 

That's all well and good. However, short-term rates have no risk premium priced in for tightening and a reaction (flatter curve, higher rates) is inevitable.

Higher US rates – even modestly higher ones – are good for the dollar. EURUSD seems to be headed for 1.30 and GBPUSD remains under the cosh. USDJPY can break higher, though that depends on the reaction of equity markets: I don't think this move is enough to trigger the next downleg in equity indices but this bears watching today.

I described the week's UK data calendar as a minefield, but I hadn't expected the biggest shock to come from the public sector borrowing figures. January saw a deficit for the first time in a decade as tax receipts suffered. The data don't change funding arithmetic but they do add to concern about the state of the public finances and sterling suffered accordingly. They also show how the UK's tax and spending regime is now very sensitive to the economic cycle which is making things worse. I suppose it means that if we do get a recovery in activity, public finances will recover faster than expected too, but of course no-one is interested in that at the moment. This morning's FT does, however, have letters (click here) urging against fiscal policy being tightened prematurely.

The retail sales data are today's UK highlight with CPI the focus in the US. Retail sales fell 1.8% – a bigger fall than expected – but were very distorted by the weather and this morning's John Lewis data (click here) indicate a bounce once the snow ended.

Overall, this week's UK data have been disappointing – for Gilts, whose yields are set to rise further and for GBP, which has fallen. The economic recovery, albeit anaemic, is however on track and sterling is now close to a point where all the bad news is priced in. 

I have enjoyed a week of exceptional snow, but normal blog service resumes from Monday.

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I have mentioned before how correlation between different asset classes has reached unprecedented levels. One of these is now breaking down as equity indices rally in tandem with the dollar (at least within G10).

Dollar strength is most (but not only) evident against the euro. With robust US economic data coming in (industrial production and housing starts yesterday, for example) and the FOMC minutes not showing any signs of renewed dovishness, the macro backdrop is dollar-friendly. In the past though, this would have been ignored as long as equities rallied (which would have been dollar-negative).

What does this tell me? I think it is telling me that while it's premature to look for equities and other risk assets to weaken, the current rally is short term and position-driven. The euro is being sold because European fundamentals are not sound and sovereign risk fears are not subsiding. Equity prices are rallying and CDS spreads tightening because short risk positions are being squeezed by a lack of bad news (and by half-term's impact on trading volumes).

The conclusions are two-fold. Firstly, I am treating this equity bounce as temporary even if it has a little further to go. Secondly, I am viewing the euro's woes as persistent with EURUSD heading to 1.30 and EURGBP towards 0.80 once the UK negotiates this week's data.

Yesterday's UK data wasn't very good. I received numerous emails telling me that the employment figures were 'as expected' and the MPC minutes were a non-event. I thought the jump in unemployment, which undid the two previous months' falls, was disappointing. This morning saw UK money supply and mortgage approvals, which remain moribund. Tomorrow we get retail sales which are so weather-distorted as to be meaningless. The market's ability to brush the jobless data aside still suggests a deep-seated negativity towards the UK.

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A nice move higher in US equities yesterday saw the euro bounce and risk assets everywhere are doing better. Even Greek credit default protection has moved – 5-year CDS spreads are back at 350bp from a peak near 500bp.

Here are two stories that suggest caution. The first, covered in this morning's FT (click here), highlights Chinese selling of US Treasuries. The second, in the Telegraph (click here), highlights the divergence between credit (still pointing to stress in markets) and equities (complacent).

The Chinese authorities have no choice but to accumulate dollars, given their balance of payments and the commitment to a pegged exchange rate, but where they invest that money is a different story. They may not much like the yields on offer, or may be putting reserves into cash in order to send a political message to the US administration. Either way, it's a reminder that once the current benign conditions ease off, yields could spike higher. And the thought of Sino-US geopolitics being a driver of the world's bond markets makes me uneasy. A significant increase in the cost of funding the USA would have a knock-on effect to every other market in the world.

The credit/equity divergence is a reminder, I suspect, that this 'risk rally' reflects 'short risk' positions being unwound rather than new risky investments being made. Longer term, I find more value in equities than corporate bonds at current yields, or, to put it another way, renewed market turmoil will be felt in credit even more than equities. For now, though, the brighter mood should be welcomed but not taken for granted – a test of 1,150 in the S&P is possible but the conditions for a sustained rally in equities aren't here yet. Underlying economic improvements need to emerge and I would like to see how markets cope with quantitative easing ending before looking for ranges to break.

There will be plenty of data today. The UK could see a dip in unemployment but that will be tempered by the BoE Minutes. The US should see a strong increase in industrial production. For now, I favour upside to USDJPY, EURJPY, and to government bond yields – especially Gilts. GBP has a minefield of data to negotiate and may be able to rally once it has done so.

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Pancake Day: the last gasp of Carnival. Writing in bright (but very cold) sunshine amidst spectacular alpine scenery, it's hard to imagine austerity, though I have passed a restaurant advertising a 'Lenten fish buffet lunch' for tomorrow.

Over a decade ago, I wrote a note (well, a rant) asking how the German economy could hope to thrive when they made spending money so hard. A sports shop 200 yards from the ECB had failed to accept credit cards as payment. So far this week, the ski school, the toy shop and numerous restaurants have requested cash. But maybe the solution to the Anglo-Saxon debt crisis is to abolish credit cards. I'm sure the good people at Barclays, whose results this morning show just how easy it is to make money out of banking in the current climate, wouldn't agree.

Markets were very quiet yesterday. Quiet markets are ones where the 'fear factor' inevitably eases off, so it's no great surprise we find equity indices, commodities and even the euro all a little stronger this morning.

ECOFIN has scope to make positive noises about Greece and perhaps sheer lack of new bad news will now set in. Traders are short the euro and need a constant flow of bad news for it to keep falling. The only eurozone data today, the ZEW survey, will show weakness but only because as a survey of investor sentiment it follows stocks.

The UK, by contrast, has scope for bad news to feed the bearish consensus. Today it comes in the form of inflation data that will probably see the headline CPI rate jump to 3.5%. It's temporary, but it's enough to leave my dislike of Gilts intact. Unemployment and BoE minutes are due tomorrow. All these figures threaten sterling but such is the gloom, if they are not dreadful, the pound is due a rally. I don't think asset reflation and economic recovery are fully back on track, but 'fear fatigue' can take the S&P through 1,100, gold to $1,150, and GBPUSD back towards 1.65 from here.

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Good Morning. Risk aversion remains in vogue, though the resilience of equity markets suggests we are seeing nervousness more than outright fear. I sense the dollar's rally may therefore be losing momentum.

Markets are finding plenty to worry about, from Greece (not enough conviction to deficit-reduction plans), China (revaluation speculation), Dubai (again) and in the UK (the effect of the weather on the data).

The UK's woes seem parochial so I'll deal with those first: a host of figures are due and none are expected to be great (click here). The first release (of house prices) suggests those who did buy homes paid up – maybe gardens bedecked in snow were irresistible! As for the rest, upside risks to inflation are huge but temporary. Downside risks to spending data will tell me nothing, beyond the fact that a VAT hike and a blizzard discourage shoppers. Gilt yields are probably heading higher and the pound is mostly in a range until the gloom thaws, when it is cheap.

Jim O’Neill, Goldman Sachs Chief Economist, thinks a Chinese revaluation may be imminent according to Bloomberg's most read story over the weekend (click here). Keeping the currency pegged while tightening lending conditions probably appeals more to the Chinese authorities as long as they can get away with it. The top of an alp is too far from Beijing to know what will happen with confidence, and I am convinced the renminbi will be revalued this year, but patience seems in order. In the meantime, maybe markets are finally getting used to the idea that tighter policy in China is a good thing and not a reason for risk aversion.

Greek woes and sovereign debt worries in general aren't going away. But this week's ECOFIN (click here) provides another opportunity for support. A hiatus would see EURUSD stop falling and could be a trigger for the S&P to test 1,100 again. If that happens, we should be close to lows in GBPUSD and GBPJPY.

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The focus of markets is trying to shift away from the European bail-out of Greece. But with the press reporting a rift between the French and the Germans on how much support and how to provide it, cynicism is setting in quickly. My bigger fear is of contagion but it does seem the 'good news' effect of the support for Greece is running out.

A more positive development, however, is that global equity markets appear to be finding some stability irrespective of Greece. Soft Chinese inflation data yesterday, a bounce in Japanese consumer confidence overnight and perhaps some robust US retail sales data later today, are all helping. We've been having a lively debate about the depth of the equity market correction – I remain nervous that the spectre of sovereign debt default could cause prices to fall again – but we (at ECU) can agree on two things: firstly, that the very near-term outlook is more encouraging; and secondly that, with monetary policy doing all the work to keep recovery on track, we should see the recent highs (S&P 1,150) again in due course.

If equities have finished sliding, the pound should benefit. Gilt yields are edging higher and the UK remains a higher-return but higher-risk investment. I also wonder if there is much more new bad news that can hit sterling. Martin Wolf is the latest to write (in the FT, click here) that a hung parliament is not the end of the world; this week's John Lewis sales data are brighter (click here); and the most recent survey of bankers' pay points to a big rebound – bad for the public mood but good for spending, potentially (click here).

I expect modestly higher equities, higher gold and other commodity prices, and somewhat higher bond yields to end the week.

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We will not get resolution of the Southern European debt crisis today but we will get warm words and some sort of a safety net for Greece at any rate. From there, the crisis may fade for a while but it will re-emerge before long – somewhere. Niall Ferguson wrote a piece in the FT this morning that is worth a read on how the crisis is set to spread (click here). This is a key point about the Greek crisis – namely that it is a global sovereign debt crisis, not a Greek crisis at all. The second point that is important is that for all the short-term inflation spikes we are seeing at the moment in a variety of economies, the medium-term inflation outlook remains incredibly benign. That’s important because it means the solution to the debt crisis will continue to be monetary expansion, i.e., lower rates for even longer and more quantitative easing in due course. So for now, markets are worried about the crisis and the possibility of default, but the next phase is more monetary expansion.

The pound was hit hard yesterday by Bank of England Governor Mervyn King’s presentation of the Quarterly Inflation Report. Here is the link to the BoE site, with the document and the webcast of the press conference (click here). The press coverage is captured by this quote from Chris Giles at the FT: “Financial markets bet on Wednesday that the Bank of England would keep interest rates extraordinarily low for a protracted period, after the monetary policy committee ditched its forecast that the economy would boom.” I was a little surprised by the reaction, having highlighted how far the bank was from the City in terms of its growth forecasts in yesterday’s blog. The central point of the BoE’s fan charts points to growth forecasts of 1.7% for this year and 3.3% for 2011, still slightly above the City consensus. But King sounded even more dovish, saying it was far too early to rule out further asset purchases and expecting demand to remain below supply throughout the forecast period. Those City economists who had expected rate hikes before the Summer are pushing their forecasts back. The rest of us – who didn’t really expect a rise in rates at all before the very end of the year at the absolute earliest – are left wondering whether rates will rise from current levels in 2011, let alone in 2010.

The focus today will all be on Greece. There is little other news to watch. At the margin, I expect warm words to send equities higher and that will correlate with a weaker dollar. As rate expectations are driven lower and lower in the G7 economies, the case to own equities, commodities and emerging market assets where returns will be higher is being reinforced and on any day when risk aversion is not the main focus this will be the dominant theme. In the UK, the question for the currency is when rate expectations are so low they cannot fall any further. Political uncertainty remains and will not go away until after the election (when whoever is in charge will need to tackle the size off the budget deficit) and fears of a debt crisis will remain, but the driver of the currency has been the downward march in rate expectations. I’m not sure this is completely over yet but the point at which sterling is cheap relative to the G7 currencies is getting closer.

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All I can remember about Greek Fire from history books is that it continued burning on water and scared the Byzantine Empire’s enemies (and its allies). The sovereign debt crisis has a similar effect on me because I don’t think it can easily be extinguished even if the latest incarnation, in the form of Greece’s woes, may be partially resolved this week. This crisis started in Dubai with the realisation that some sovereign or quasi-sovereign borrowers were less creditworthy than investors had supposed. It has migrated to Greece but that is a ‘solvable’ problem to the extent that Greece is a relatively small economy whose fiscal survival is critical to its (much bigger) eurozone partners. From here, the problem will likely migrate further. The question is how long it takes for sovereign credit fears to resurface, and where they do so. As with Greek Fire, I don’t think these fears can be easily extinguished.

The EU Summit starts tomorrow morning. Today’s fodder for the rumour-mill will be a meeting between French Prime Minister Nicolas Sarkozy and his Greek counterpart George Papandreou; and a briefing of German lawmakers by Finance Minister Wolfgang Schaeuble in which he will go through the options available to Germany. The press has highlighted the different views of the eurozone members and the rest of the EU, with Sweden and the UK favouring the idea of Greece getting help from the IMF rather than the eurozone. To my uneducated eye, that seems implausible. The negative impact on eurozone credibility would be huge. The alternative is for an EU guarantee which is pushed (apparently) by Germany with stringent conditions. The possible compromise between these two positions is to resort to bilateral help for Greece (from Germany and perhaps France) rather than explicit EUhelp. That is allowed under EU rules and would not require UK or Swedish support. What does seem clear is that there will be plenty of horse-trading in the next 24 hours but in all probability a ‘solution’ will be announced tomorrow afternoon. After that, the question (to my mind anyway) will be how long it takes before contagion and cynicism replace the initial euphoria. For those who want another view to mine, the FT has a different take on the subject (click here) and the US view from the Wall Street Journal is also worth reading (click here).

The UK released industrial production and manufacturing output data for December which saw a 0.5% increase in industrial production and a 0.9% increase in manufacturing output. There were significant revisions to past data and the annual decline in manufacturing output has now slowed to 1.9%. On the negative side, this is still an annual decline. On a positive note, it’s a lot better than it looked before the revisions and puts the data more in line with the stronger evidence from business surveys I have written about in the past. At a cynical level, the pound has not benefited from the revisions to the same degree as it suffered from the original data when they were released last year. But that’s life. I am sure we will also eventually see the GDP data revised higher but that will also come too late to have any impact on markets.

The Inflation Report is the next key event. The Bank of England was much more optimistic about growth than the City in the last Report (the ‘rivers of blood’ that show their forecast in a band of probabilities was centred around 2.1% this year and 4% in 2011) and will probably have revised its expectations down. It was insufficiently pessimistic about how high inflation could rise this spring (they were looking for 3%, and 3.5% to 4% seems more likely). It is hard to see how the Inflation Report can represent ‘good news’ for the UK, though perhaps that is already priced in.

The US has no major economic data due for release, though 10-year Notes are being sold this evening. An old friend sent me a chart of 10-year Note yields and the spread on Greek credit default swaps last night. It shows that the creditworthiness of a small European country is the main driver of the biggest asset market in the world. On the grounds that a deal will be found, equities can prove higher and Treasury yields will edge a bit higher too.

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The global sovereign debt crisis is in temporary abeyance. Two pieces of overnight news are causing a short-covering rally for risk assets including equities and the euro. The first is the news that ECB President Jean-Claude Trichet is leaving a central bankers’ conference in Sydney a day early to return in time for an EU Leaders summit on Thursday. The second is an article in the FT entitled ‘Traders make $8bn bet against euro’ (click here).  

The EU leaders’ summit will discuss the economy, climate change and Haiti, apparently. Trichet’s decision to change his flights (he was always scheduled to attend) has triggered speculation that a solution to Greece’s fiscal crisis will be found. The G7 meeting at the weekend saw pleas to the Europeans to tackle the crisis but I am sceptical that a credible solution can be put together this week. A credible solution needs to have sufficiently stringent conditions attached to force Greek deficit reduction and dissuade other countries from allowing their finances to deteriorate to the same degree. Things may need to get worse before such a solution is palatable. On an utterly prosaic level, the flights from Sydney to Europe leave in the evening and arrive the next morning with connections to get to Brussels. If I had a 10:15 a.m meeting in Brussels on Thursday I would rather fly on Tuesday, arrive in Europe on Wednesday and pick up a change of shirt, then catch a connecting flight out of, say, Heathrow at 6:00 a.m. on Thursday morning.

The percentage of the global currency market that flows through the US futures exchanges is very small. So the FT story represents a survey of global currency positioning rather than any real indication of positioning. However, it is a reasonably unbiased survey of the speculative positions of the market. Speculators are short of the euro and are probably being squeezed. The same is true of risk assets overall. Markets cannot travel in a straight line without ever correcting.

Overall, it seems to me that we are once again in a position – as has happened frequently in recent years – when politics rules markets. That is a dangerous position. Optimists hope the politicians will make the right choices. Cynics know that politicians usually need to exhaust all other avenues before they make the right decisions. We are not there yet. So I expect the short-covering rally to continue for a few days but not for many weeks before risk aversion and sovereign credit concerns come back with a vengeance in the second half of February and through March.  

As far as news is concerned, we saw awesome car sales data from both India and China: India’s up 32.2% year on year; and China’s up 113% to 1.32m units. Chinese car sales are now running at an annualised rate well ahead of the US. The economy is clearly overheating. Nearer to home, the UK RICS survey saw surveyors getting more optimistic, the balance reporting higher prices up to 32% vs. 27%, which sounds as though two-thirds of surveyors are now optimistic. By contrast, the BRC retail sales survey was very weak, indicating sales growth slowing to 1.2% in January from 6% in December. The weather is clearly a huge factor. How this plays out in official data I simply do not know, given that the official data have been a fair bit softer than the surveys in recent months.

The UK DMO auctions £2bn of 25-year Gilts this morning, and the US sells $40bn of 3-year Notes. I will be watching to see how demand for Gilts evolves and I still look for yields to trend higher in the months ahead.

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I have never seen markets so correlated, with all other assets seemingly taking their cue from the S&P index. I can also barely remember a time when the financial community had so little conviction about anything – confidence levels are very low. This is making for a very skittish market, but behind it all the global sovereign debt crisis gathers momentum.

The G7 Finance Ministers and central bank Governors met in Iqaluit (escaping the snow storms that struck the Eastern coast of the USA). Nothing they said is inspiring me with much confidence. The FT write up of the G7 meeting is worth reading (click here). The plan is to manage a delicate balancing act, supporting growth now and simultaneously maintaining the credibility of deficit-reduction plans. The Europeans, meanwhile, provided assurances that the Greek fiscal crisis would be resolved. It all smacks a bit of desperation. There are no new policy initiatives, just a hope that the global economy is getting better (slowly) and a promise that fiscal problems will be resolved. To be fair to the G7, savage fiscal restraint would not be the right policy and there is a case for just biding time now and seeing how things play out. However, markets do not like a lack of action and do not like the sense that policy-makers are increasingly impotent.

The risk this week is that after an initial attempt at a bounce in equity indices, fear about sovereign default returns. And that is where the market’s lack of conviction comes into play. The right policy may be to do nothing and wait for the slow grind of better economic data to calm nerves. But psychologically-important chart levels have been broken in almost every asset class and if we do see prices of equities drift lower again, the move is in danger of gathering momentum like a snowball. A break of 1,050 in the S&P index would signal a move to test 5,000 in the FTSE, and I still fear a breakdown towards $1.30 for the euro. That could see GBPUSD get close to 1.50.

Where does this end up? Ultimately, it heads to even lower rates for even longer and renewed ‘debasement policies’. That could see the US step up their quantitative easing in due course or it could involve more open dollar-devaluation talk. In the US it may involve a further attempt at fiscal largesse, though everywhere else the scope for such action has pretty much run out. All of these policies are bad for the dollar and, in particular, good for commodities and for gold perhaps most of all. However, we must not get ahead of ourselves. For now, fear lurks inches below the surface and I really wouldn’t rule out another sharp fall in equity prices, another move wider in credit spreads and a spike lower in EURUSD this week.

Other news over the weekend started with the US payroll report. Benchmark revisions increased the number of jobs lost in the recession by almost a million but the highlight of the report was a fall in the unemployment rate in January to 9.7%. Monthly payrolls fell but that was partly due to a weather-related fall in construction employment and with hours worked heading higher (including overtime), the overall picture was OK. Politicians are unable to cheer because the unemployment rate is still too high, but Q1 is lining up for reasonable growth. Financial markets, however, just don’t care.

In the UK, the news highlight is the suggestion in the Sunday press that the government could call a general election in April as opinion polls continue to point towards a growing possibility of a hung parliament. My emotional reaction is ‘good’, insofar as the sooner the election is out of the way the better. Markets, however, still fear political paralysis above anything else and will not be very enthusiastic about the UK with this threat hanging over it. Not to mention the ever-so-easy conclusion that the UK is next in the spotlight when the markets stop worrying about European sovereign debt.

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Sovereign creditworthiness shifted to the forefront of financial markets’ awareness yesterday with a vengeance. Fear that governments had taken on too much debt bailing out broken banks and propping up their economies was a localised problem until now – it brought down Iceland and it sent sterling into a tailspin in 2008. It has been a worry for Greece for weeks but it is now spreading like wildfire, driving equity markets lower, causing further concerns both about medium-term growth prospects and in currency markets. Old correlations are back to the fore with the US dollar and the Japanese yen thriving, as ‘riskier’ currencies like the Australian dollar and sterling fall. The euro, meanwhile, remains extremely unpopular.

The cost of 5-year credit default protection on Spain has increased from 80bp in early December to 168bp now, higher than it was at the peak of market illiquidity and fear in February 2009. That matters in part because it raises the cost to Spain of borrowing money, but even more because Spain is a much bigger economy than Greece. As I wrote yesterday, Greece represents under 3% of eurozone GDP. Spain counts for nearly 12%. And of course, as is the way with contagion, now that this is no longer a Greek problem but a broader one, the focus is on the lack of room for fiscal manoeuvre everywhere.

The end result of this new fear will be to keep monetary policy at the forefront of efforts to revive growth. That doesn’t necessarily mean more asset purchases by central banks – at least not yet – since government bond yields are low and extending quantitative easing would be like pushing on a string. But it does mean interest rates stay even lower for even longer. And it also means we should expect very dovish talk from central bankers. This will, in due course and once the current risk aversion fades a little, put gold back in the spotlight. I am not infatuated with gold the way some people are but I can’t think of any central bank at the moment that wants either to increase rates or to see their currency appreciate. Gold is ‘anti-currency’ and shines by default when the need for easier monetary policy is a global theme.

We will have to see how deep current market hysteria proves to be. I am nervous. Today’s US employment report now feels like a side-show, except that the market will probably react more to a weak figure than a strong one. The consensus looks for a small increase in employment of about 15,000. A further fall in employment will increase fear about the lack of job creation and the implications for budget deficits and for demand. A strong figure might be ignored since this latest bout of market hysteria comes within a week of the US Q4 GDP data that showed a 5.7% real GDP growth rate.

Going into the weekend: lower rates for longer; wider credit spreads; softer equity markets; and a stronger dollar and yen seem to be the key themes. The pound is not at the forefront of markets’ attention and is trading with the euro. At some point, EURGBP is likely to move lower as Europe’s problems are increasingly seen to be as big as the UK’s.

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The cost of 5-year credit default protection on Greece has widened again this morning to 410bp – and 5-year government bond yields have edged back above 6.5% in the process. The European Commission yesterday issued its verdict on the Greek deficit reduction plan (click here) and while markets initially reacted positively, the conclusion was soon reached that this was a pretty lukewarm ‘blessing’ from the Commission. The FT reaction is worth reading, and is typical enough (click here). The euro has consequently fallen back overnight.

This crisis isn’t really about Greece however. Any more than the global credit crisis was about Lehman, or the dotcom boom was about WorldCom. Solving Greece’s problems is not all that expensive (Greece accounts for less than 3% of eurozone GDP, after all). But bailing out Greece too easily, and without tough conditions, would send a poor message to the Greek government and a worse one to others with fiscal problems. But even this concern – a major one for the EU leadership – is small, relative to the reality that government debt has ballooned everywhere and markets are going to be increasingly nervous of those lacking the political will to tackle their problems. Strains on sovereign creditworthiness will remain, public sector spending will have to fall across the industrialised world and central banks will respond by keeping interest rates exceptionally low. In Europe, where history suggests that restraining the size of the welfare state is difficult to achieve and where markets had been betting on ECB hawkishness sending the euro higher, we have a recipe for heightened concerns and a weaker currency. The current move has further to run. The ECB will almost certainly leave rates on hold today and Mr Trichet will be asked plenty of questions about Greece in the Q&A at 13:30 GMT.

In the UK, the focus is on the MPC and the probability that they will announce that they are not (for the timebeing) extending asset purchases (QE) beyond the current GBP200bn limit. The Telegraph highlights the  similarities between Greece and the UK (click here) and the Times shadows the MPC’s view (i.e., don’t extend) (click here). I’ve written a fair bit about quantitative easing, but the bottom line is that it has worked insofar as it has sent Gilt yields down, tightened credit spreads, allowed companies to refinance their debts in the bond market and sent equity and house prices higher, slowing the rise in the savings rate that was threatening to turn a recession into a depression. To do more now would be a bit like pushing on a string: yields would not fall further and equity and house prices probably would not get much help either. From here on, the main focus will likely be to keep rates at current levels for the remainder of the year and see how much Gilt yields rise (I am guessing that 10-year yields head to 4.5% in the coming months, from 3.9% now). Sterling should get some help from a QE pause – though today the reaction would be bigger and negative if the MPC were to extend QE further.

It’s US jobs day tomorrow and that is a report which will drive markets in days to come. We have had poor employment data in New Zealand and soft retail sales data in Australia overnight, so equity indices are soft and the US dollar is strong. New trends start tomorrow afternoon. I will write a preview before then.

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So far, economic data for the start of 2010 has suggested that the recovery which got underway in 2009 is continuing to beat economists’ expectations. Overnight we have had releases showing a further rise in business confidence in India and Hong Kong and, while these pale into insignificance compared to the strong US ISM data at the start of the week, they are worth a mention. The global economy continues to prove doubters wrong.

The strong data has not, however, had any impact yet on Bond yields. At 0.86%, the US 2-year Treasury yield is slightly below its average level of the last six months, despite the strength of Q4 GDP and signs that Q1 will be strong as well. There are three reasons for this. Firstly, inflation expectations are incredibly well anchored in this cycle – something which allows a lot of leeway to policymakers. Secondly, without inflationary worries and in the face of uncertainty about the durability of recovery, central banks can keep rates at current levels for a long time. In the US, the FOMC is unlikely to hike rates in 2010 – and perhaps not in 2011 either. And finally, quantitative easing has resulted in fewer government bonds being available for sale to the private sector, at a time when banks are being encouraged to buy more ‘safe’ government debt to improve the quality of their balance sheets. The upshot – and it’s relevant today because it is the driving theme for markets once again – is that we have low yields and strong growth, which is the perfect combination for ‘risky’ assets. This week has seen the price of gold shoot up, the S&P index in the US move back above 1,100 (for now, anyway) and higher-yielding currencies are recovering. That has brought the dollar’s revival to an end too.

The issue going forward is whether this combination of strong growth and low yields can remain in place. The main events of this week lie ahead, culminating in the US employment report on Friday. My suspicion at this stage is that as the US moves from fewer job losses to actual job creation, the interest rate market will react. This may be a ‘jobless recovery’, but we can still see some strong employment data as the firms which are now increasing output to help rebuild stocks start hiring people. If that happens, the equity market – flavour of the month again this week – may just grind sideways as the good earnings news is diluted by higher rates. The ‘risk’ trade could progress, but more slowly, and we should see the US dollar move higher again.

That is all ahead of us. Today, we have started with a soft services survey from the CIPS. The index of 700 services companies’ confidence fell back to 54.5 from 56.8 last month, in contrast to the strength of the manufacturing survey and suggesting that what the pound did for the latter was not repeated in the services sector. We are waiting for the European Commission to publish its report on Greece’s fiscal plan, but this is likely to provide a qualified endorsement. Anything else would cause chaos in markets and be totally counter-productive. Nouriel Roubini captures the general mood – that Greece will not be allowed to default – in a piece in the FT today (click here). This afternoon we get the US ADP survey of private sector employment which will provide some clues as to Friday’s official data. This survey understates employment growth overall and is expected to come in at around -30,000. We also get the US ISM index for non-manufacturing companies, expected at 51 vs. 50.1.

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The surveys of purchasing managers (ISM index in the US, CIPS index in the UK) are the first major data releases of each month. They are 'only' surveys, and of the 'old economy' manufacturing sector at that. However, they tend to lead the official data and are a better indicator of where it is heading than you might expect. The US index was much stronger than expected yesterday, rising to 58.4 (a reading above 50 implies the economy is growing). That is consistent with an annual growth rate of 4% and has not been seen since 2004. It smacks much more of a V-shaped than a U-shaped economic recovery. There are caveats galore, in that this is driven by the revival in global trade and by the need to rebuild inventory levels, and doubts about the outlook for employment growth and for consumer spending will remain intact. However, the news is undoubtedly positive, gloomy views are being challenged and if the Federal Reserve does wind down its asset purchases as planned, somewhat higher Treasury yields and a stronger US dollar seem likely through the next month or two (click here for the Wall Street Journal's take on ISM).

The UK equivalent, the CIPS survey, rose to a 15-year high, in a sign that the weaker pound is helping exporters. My first reaction was to think this would be good news if the UK had any manufacturing industry left, but that's a bit unfair – manufacturing output is still around 14% of the economy in line with other developed economies. The FT comment is worth reading (click here).

The UK markets were less interested in the CIPS data than in the Bank of England's 'Trends in Lending' report (click here). This week's discussion point will be the possibility of a pause in the Bank of England's asset purchase programme. The weakness of mortgage lending is a reminder that any thoughts of higher rates should be put firmly on the back-burner. That isn't 'news', however, and it doesn't mean that quantitative easing needs to continue.

With European PMIs revised up, the overall story is one of positive growth trends persisting into 2010. Add to that the prospect of monetary policy remaining accommodative and you have a recipe for the current pause in equity prices, commodity prices and asset prices generally to be only temporary.
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Nouriel Roubini, feted at Davos again, was one of those who predicted the financial crisis and has taken on the mantle of arch-bear on the global economy. So, predictably, when told that the US saw 5.7% real GDP growth in Q4 last year, he retorted that the outlook remains very dismal with most of the growth coming from inventory accumulation. He expects a growth rate of 1.5% in the second half of 2010.

It is the nature of journalism that Professor Roubini gets so much attention – bad news sells and last year’s winners get more attention than those who got it wrong. But you wouldn’t want to manage money on the basis of paying more attention to the most recent performance. That the size of the debts faced by governments and households alike will act as a brake on growth is a given. But even the non-inventory aspects of the US GDP data were a little stronger than expected, with final sales growing at a 2.2% rate. And perhaps the brightest part of the Q4 report overall was a 4% annualised growth rate in real personal incomes. Income and employment growth are the recipe for a sustainable demand recovery in a world where we cannot borrow our way to wealth any more. We’ve seen good news on the former and the focus now switches to the latter with the release of the January employment report on Friday. Last month’s data were a little disappointing though as I wrote ahead of the figures, a ‘miss’ of 100,000 is not statistically significant. The market is looking for the improving trend to continue, creating a gain in jobs of some 13,000. Only when monthly increases are above 100,000 can we really talk about employment creation, but the trend is still positive. I expect the Q1 GDP increase to be impressive, albeit perhaps not quite as good as Q4, and as that becomes more apparent we will probably see talk of Fed tightening re-surface. And at a more mundane level, if this week’s data (starting with the purchasing managers’ survey today) are robust, the dollar’s revival can continue and the S&P’s correction may be nearing its end.

If the outlook is bright for the dollar, the euro remains in all sorts of trouble. The conversations I have had about the problems faced by Greece and Spain all centre on their failure to get public sector spending under control during the good times. Spain has suggested a budget to reduce debt levels but there will be concern about whether it is achievable. This is not about what is in the plan but about whether limiting the size of the social safety net that differentiates much of Europe from the US – and to a lesser extent the UK – is politically possible. The Irish, to some degree, have shown us what can be achieved if the government is willing to take really unpleasant decisions. In the UK it has been done before. But in Europe there is a different (not necessarily worse, but that’s another story) political philosophy which makes tackling this budget problem in these economic conditions really hard. It seems likely that things have to get worse for Greece and Spain (and Portugal) before they can really get better. And in the meantime, the euro will remain the most vulnerable of the major currencies and the ECB will have no option but to remain accommodative if Council members want to urge fiscal austerity.

The nature of the UK’s finances was shown up starkly on the front page of the business section of the Sunday Times, with two stories that caught the eye (click here and here). The first is a report of a potential bid for Northumbrian Water. The UK is selling its houses, its football clubs, its chocolate and its water. It isn’t dong so on purpose, but in a world where financial conditions are almost perfect for large-cap companies to go on acquisition sprees, the UK is one of the countries that puts few obstacles in the way of foreign investors. And this is one reason why sterling has stopped falling. The second story is more mundane in that it highlights how close Thursday’s vote at the MPC will be, on whether or not to extend the Bank of England’s asset purchases. I think they will pause, because quantitative easing has served its purpose. And when they do, Gilt yields will rise and, in due course, support the pound. But between now and Thursday, expect the markets to get very nervous about the possibility of quantitative easing being extended.

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