Global capital markets are finishing the week without a clear direction or focus.
One theme that has become clearer this week and is likely to influence activity in the weeks ahead is the continued cyclical divergence between the strength of the U.S. economy and the weakness in Japan and Europe. This will have ramifications for interest rates and currency valuations.
Japanese government bonds slipped for the third consecutive session amid signs that the government was preparing to expand size of the monthly 10-year bond auction. Since April, the
Ministry of Finance
has reduced the size of the monthly 10-year bond sales to 1.4 trillion yen from the 1.8 trillion yen previously intended to be sold to help prevent a sharp backing up in long-term interest rates. Finance Minister
suggested that although a decision has yet to be made, the market could absorb an increased supply after July, when the current cutback expires.
The yield on the benchmark 10-year bond rose 2 basis points to 1.35%.
Meanwhile, the yield on the one-week certificate of deposit yield fell to 0.025%, which is below the overnight rate. The low money market yields are expected to continue prevent a sharp backing up in yields as investors have little choice but to lengthen maturities.
Government data confirmed that the extra liquidity that the
Bank of Japan
has pumped into the banking system is being recycled back into the securities market rather than made as new loans to the private sector. Money supply as measured by M2 plus CDs fell 1.1% in April, the first decline in a year. A broader measure of liquidity that includes flows into the government bond and equity market held up better, falling 0.3% on the month. It is the first time in at least a year that liquidity growth exceeded growth in M2+CDs.
The Nikkei rose 0.6%, led by pharmaceutical issues, on healthy foreign sales.
subindex of pharmaceutical companies rose to its highest level since being formed in July 1993. Bank shares snapped an eight-day, 11% losing streak and closed mostly higher.
European bond markets are little changed, while most bourses posted early by modest losses.
Pharmaceutical issues were a bright spot amid ideas that the industry's restructuring is not complete and more mergers and acquisitions are likely. Technology shares were mostly heavier, though
relative strength continued. Prices of its shares were holding on to this week's more than 11% rise.
lost ground on the back of press reports suggesting that German regulators were going to reject its proposed $1.85 billion sale of its non-U.S. soft drink business to
on grounds that it would limit competition in Germany. Given the wide scope of these companies' operations, the approval of many national regulators is required. According to reports Germany is likely to join Australia, Belgium and Mexico in opposing the sale. Finland, Ireland and Norway have given their blessings.
Economic news from Europe is light and not much of a factor for the markets.
The first two German states (Hesse and Bavaria) have reported that inflation was unchanged in May. France reported a larger-than-expected rise in March industrial production. The 0.8% rise was more than twice what the market had expected, but was not sufficient in itself to renew hopes that growth in the eurozone was about to pick up in a significant way.
The U.K.'s broad money supply M4 rose a strong 1.2% in April for a 7.4% year-over-year rate. Although the relationship between M4 and retail sales has loosened in the current business cycle, the rise coupled with the improvements in consumer confidence reported yesterday and other data recently continues to fan hopes that the U.K. economy is on the mend. That said, central bank policy appears to be more influenced by the subdued price pressures and the strength of sterling, rather than the performance of the real sector.
The currency market is more interesting.
Comments by Japanese officials emphasized the need for stability and this encouraged participants to buy back previously sold yen positions. The yen has depreciated by 3.5% so far this month. The dollar closed above the 124-yen level on two consecutive sessions, but the momentum has faded and there's potential now for profit-taking to push it back toward the 122.75-123-yen area over the next couple of sessions. Only a weekly close today above the 124-yen level would offset these corrective forces. Over the longer term, a move toward the 130 area remains my preferred scenario.
The unwinding of short yen positions and the disappointing economic performance of the eurozone economy as a whole is pushing the euro lower for the third consecutive session. The year's low set earlier this month near $1.0550 is coming back into view.
The Australian dollar is enjoying an advancing session
, helped by supportive comments from the central bank, which sought to assure investors that the country's asset markets were not overheated and that inflation would remain tame. A move above the $0.6650 area would signal a retest on the recent high near $0.6750. Despite gold being near the 20-year lows set earlier this week and the sharp drop in copper prices since the beginning of the month, Australia's strong underlying fundamentals should continue to keep Aussie's bull market intact.
The market has worked itself into quite a lather about the possibility that Argentina may break its eight-year peg to the dollar. It seems that many are willing to accept that Germany's hyperinflation of over a generation ago gives it privileged position in seeking to avoid inflation now. But they seem unwilling to recognize that Argentina's more recent experience with hyperinflation in the 1980s continues to be a major influence on its policy choices. The peso's peg to the dollar grew out of the desire to avoid such ruinous conditions again.
In a departure from crises that have swept the global in the past two years, domestic investors in Argentina do not appear to be leading the capital flight.
Instead, reports seem unanimous in attributing the selloff in Argentine capital markets to foreigners. On one hand, foreign flight is rational. No one wants to get bitten by the same dog twice. On the other hand, the foreign flight reflects a profound misunderstanding of Argentina's commitment to the currency peg and its fear of a return to the hyperinflation of bygone days.
The government has vociferously denied plans to break the peg, but of course no government preannounces such intentions. Argentina holds presidential elections on Oct. 24 and all three leading candidates have endorsed the peg, which despite taking its toll on the domestic economy seems to have the wide support of the public. Argentina has the will and capability to convert most of its peso deposits into dollars. The peg will hold.
The spread between Argentine and U.S. eight-year bonds widened 100 basis points this week to 679 basis points. This crisis will blow over and the backing up of yields offer an attractive opportunity for those with brave hearts and strong stomachs.
Marc Chandler is an independent global markets strategist who writes daily for TheStreet.com. At the time of publication, he held no positions in the stocks, currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at