THE EURO’S SOVEREIGN DEBT PROBLEMS ARE HERE TO STAY

By Andrew Wilkinson at IB:

Fears of a further meltdown for Euroland debt obligations caused further pressure on the euro on Tuesday falling beneath $1.3300. A senior Christian Democrat spokesman apparently said that Chancellor Merkel would press the IMF to consider debt rescheduling a first step for Greece. Existing investors would thereby receive fewer pennies back at maturity than the full payment. The emerging ‘haircut’ scenario lent further pressure to Greek and other peripheral nations’ debt prices forcing yield premiums to rise against them. Such a widening created added rationale to further sell the euro.

Euro – On Monday Chancellor Merkel told supporters at a political rally in North Rhine-Westphalia where elections are due in two weeks that Germany would withhold financial aid from Greece until she says a “sustainable” deficit-reduction plan is in place. As the bailout situation facing Greece turns from murky to opaque and as investors began to factor in the potential for extensions to prevailing debt maturities, the path of the euro worsens. The “rather you than me” approach from Ms. Merkel has raised anxiety about the willingness of core Europe to put their money where their mouths are.

U.S. Dollar – As the FOMC starts a two-day monetary policy meeting the dollar is on the rise. This is not so much due to any signs that the policy statement might be changed as it is due to a higher degree of perceived risk in the market today. Asian stocks fell along with commodity prices and bond yields are lower, which means the dollar comes off the sidelines and in to the fray. The dollar’s performance was accentuated against the pound and the Swiss franc while it held relatively steady against the other risk aversion play, the Japanese yen.

Japanese yen – The yen rose sharply across the board as the risk aversion theme became more dominant on Tuesday. Asian stocks were mainly lower although not so in Tokyo where the Nikkei 25 index added 0.4%. Chinese stocks fell as investors took profits on commodities driving prices lower, while investors fretted that banks may need to raise additional capital through share sales. Gains for the yen were also inspired by an unsourced Nikkei news story stating that the Bank of Japan might upgrade its inflation forecast at this week’s monetary policy meeting. The central bank currently projects falling prices for fiscal 2011 and may raise that to a flat profile later this week hinting strongly that there is little need for fresh policy initiatives if the battle against deflation is currently showing some signs of success. The yen rose to ¥93.97 per dollar, to ¥124.77 per euro and to ¥143.72 per pound. Against the Australian dollar the yen rose to ¥86.57.

Aussie dollar – The Aussie dollar along with other Asian units found it hard to stave off prospects of increasing contagion from the Greek bond crisis. Traders were so fixated with threats to global risk appetite that the Aussie dollar remained lower even after the release of inflation data strongly hinting at future policy tightening. Against the U.S. dollar the Aussie slipped to 92.37 U.S. cents. Producer price data for the first quarter came in above expectations rising at a 1.0% pace against an expected 0.6% gain. Year-over-year that means a decline of factory gate prices of just 0.1% compared to a forecast decline of 0.6%.

Canadian dollar – Investors have to wind in their expectations for the rampant Canadian dollar under the risk aversion scenario. The loonie pulled away from par at the first hint of weaker commodity prices and stands this morning at 99.58 U.S. cents. Crude oil prices are lower by around 1% helping further restrain Canadian dollar appetite for now.

British pound – The pound fell back into the “risky bet” category in Tuesday’s environment after a fresh round of opinion polls indicated a likely political gridlock after next week’s British election. The pound slipped to $1.5344 against a risk aversion-fuelled dollar today as the opinion polls pointed to the Labour party remaining the largest party after the count despite the prospect of receiving the least number of votes. Against the euro the pound slipped to 86.82 pennies.