The quantitative work is still underway in the United States, as China appears to be looking to a shorter term commitment in place of long term Treasury notes. The Euro currency, in the mean time, is again testing key resistance levels against major currencies.

Rumors about the U.S. loosing the triple A credit rating are mounting, as China is becoming more careful on where to invest the large amount of U.S. dollars accumulated each year. Recent data seems to confirm that short term notes, in place of long term Treasuries, are becoming more attractive for the Chinese government, whose concerns about the large U.S. debt creating inflation and panelizing the U.S. dollar are growing every day. In effect, U.S. finances are under tight scrutiny by Moody’s Investors Services, albeit there is not an immediate threat. However, some Fed officials are concerned that inflation will strongly pick up following the huge government spending and Fed funds will at some point be increased again. The Minutes from the April FOMC meeting confirmed that the credit and quantitative work is still underway. Only 35% have been covered so far of the almost 2 trillion of various assets to be bought over a relative short period of time.

Angelo Airaghi is a Commodity Trading Advisor, registered with the National Futures Association and the Commodity Futures Trading Commission. He has been an active professional since 1990 working for major international financial companies. In the past 10 years, Angelo Airaghi has been an analyst and commentator for national and international media.

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Over the last couple months, the Euro has thoroughly outperformed the Dollar, which recently fell to a five-month low on a trade-weighted basis. Over the same period, global stock and commodity prices have also risen quickly, which is not a coincidence.
In other words, investors are allocating capital on the basis of risk, rather than in accordance with (economic) fundamentals. For example, “ICE’s Dollar Index and crude oil have a correlation of minus 0.61 in the past two months, compared with minus 0.26 since the start of the year,â€‌ as rising oil prices and the declining Dollar feed back into each other.

Meanwhile, “Implied volatility on major currencies, which reflects investors’ expectations of currency swings, fell to 13.96 percent yesterday, from…17.22 percent at the end of March. A drop in volatility tends to signal less demand for options to protect investors from currency swings.â€‌ This indicator is now at its lowest level since the days preceding the Lehman Brothers bankruptcy and subsequent stock market collapse. One would normally expect a correlation between risk and return, but in this case, rising returns have been accompanied by lower risk.

Even more unbelievable is that this decline in risk is taking place against the backdrop of declining economic fundamentals. “Risk appetite in the currency market is nothing short of impressive considering the fact that the Fed reduced their growth forecasts,â€‌ said one analyst. However, “The euro-area economy will contract 4.2 percent this year, according to the International Monetary Fund, more than the projected 2.8 percent contraction in the U.S. and 4.1 percent slump in the U.K.â€‌ If investors were focusing on this divergence in economic growth, one would expect the Euro would be falling.

One hypothesis is that inflation-conscious traders are flocking to the Euro, since the ECB remains vigilant about fighting inflation, even in the face of declining prices and aggregate demand. After cutting rates to a record low 1% earlier this month, the ECB unveiled its own version of a quantitative easing plan, involving the purchase of 60 billion euros worth of low risk securities. But this is a pittance, both relative to the size of the EU economy (it represents a mere .6% of GDP) and compared to the Trillion Dollar Fed program. This led one analyst to call the ECB’s plan “chicken feed.â€‌ While all of this is noteworthy, it’s unlikely that this is having a meaningful effect on forex markets, which still remain focused on (avoiding) deflation.

If the Euro is to continue rising, it must overcome some technical obstacles. “The euro could hit a ceiling if the recent resilience of U.S. stock markets faces headwinds. â€کAt some point…stronger nongovernment growth has to show up to sustain and justify these moves in equities.’ â€‌ It’s interesting that the fear of Euro bulls is not that the EU economy won’t recover, but rather that US stock prices are overvalued. Given recent market movements, however, their concerns are reasonable, and “any disappointment [in corporate fundamentals] could provide an excuse to take profit [this] week — benefiting the dollar.â€‌

Euro denominated covered bonds are securities created from either a pool of private or public sector loans. Covered bonds are similar to mortgage and asset-backed securities in many ways.

The primary difference is that the loans backing a covered bond remain on the balance sheet of the issuing bank. The bonds are therefore obligations of the issuing bank, and the issuer retains control over the assets. Traditional mortgage and asset-backed securities are typically off-balance-sheet transactions in which lenders sell loans to special purpose vehicles that issue bonds, thus removing the loans—and the risk associated with those loans—from the lenders’ balance sheets.

Many European governments have introduced covered bonds.

According to PIMCO:

Germany introduced covered bonds, known as Pfandbriefe, in 1770 to finance public works projects. Since then, 24 other countries in Europe have adopted the covered bond structure, each with its own unique laws. In Spain, for example, covered bonds backed by mortgages, known as Cأ©dulas Hipotecarias, were created by a special law in 1981, while in France, covered bonds, known as obligations fonciأ¨res, can be traced as far back as 1852, with the establishment of the first mortgage bank, Credit Foncier de France. All countries with covered bond laws now allow for bonds backed by mortgages, while only a few allow covered bonds backed by public sector loans: Germany, France, Austria and Spain. In Denmark and Germany, covered bonds may also be secured by ship loans.