Global Briefing: The Bark Is Worse Than the Bite

Brazilian debt woes are overplayed, worrying a market leery of bad news.
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The dollar has stabilized as Japanese asset markets head south and Germany released a weaker-than-expected employment report.

The

Nikkei

shed a percent and Japanese government bonds suffered their largest decline in two weeks. Rumors that a major credit rating agency was considering downgrading Japan's sovereign debt weighed on prices. Denials by both

Moody's

and

S&P

rating agencies helped stabilize the market, but as is often the case, the rumors reveal more about sentiment and psychology than they do the veracity of the talk.

Recall that Moody's downgraded Japan's rating in the middle of last November. The market remains concerned about the imbalance between supply and demand for Japanese government bonds, even though yesterday's 10-year bond auction went off without a hitch. More bonds will be auctioned throughout the month, including another 10-year bond. The yield on the benchmark #203 rose 17 basis points today to 1.825%.

The dollar is once again trading near the 112 level against the yen. While additional position squaring ahead of the weekend could help extend the dollar's recovery, selling pressure is likely to re-emerge in front of the 113 area.

Germany reported a 34,000-person rise in its December seasonally adjusted unemployment.

This brings the rate to 10.8% from 10.7% in November. This is a much larger rise than the consensus had forecast and continues the recent string of weaker-than-expected reports. European bond yields have eased 1-2 basis points and equity markets are higher.

The euro is finishing its first week in unspectacular fashion. While

EMU

and the euro are indeed historic events, the market's response has been anticlimactic. The euro is trading comfortably in a $1.16-$1.18 range. In terms of the old Deutsche mark, the dollar is marking out its range between 1.65 and 1.70.

Rumors that Germany was considering raising its

VAT

(value-added tax) to 18% next year from 16% was denied by government officials. Germany has been pressing for some degree of tax harmonization, but its focus has been primarily on corporate tax rates. Yet, its VAT, hiked to 16% last April from 15%, is still among the lowest in Europe and may come under scrutiny as well.

Lastly in Europe, sterling has slipped to its lowest level against the dollar since the end of August, following yesterday's 25 basis point interest rate cut. Talk that the U.K. may join in targeting the EU's harmonized measure of consumer prices (1.4%), instead of core retail price index (2.5%) may create scope for even lower rates going forward, and this is helping underpin the short end of the yield curve.

The release of the U.S. employment report for December will be the main focus of the U.S. session. The market consensus calls for about a 200,000 rise in nonfarm payrolls after the 267,000 rise in November. While the marginal value of another forecast may be near-zero, it is worth pointing out that the market has consistently underestimated U.S. economic activity (and overstate price pressures). The risk then is for a stronger-than-expected report.

The combination of the recent string of strong economic data and the surge in share prices has already encouraged many market participants to expect that

Fed

policy will remain on hold for Q1. Barring a significant surprise, today's report is unlikely to change this. U.S. Treasuries are largely steady ahead of the report. The March bond futures contact has held above support seen near 126. A break of this, perhaps on a stronger-than-expected report, could see the bond lose another couple of points in the near term.

It is important to keep developments in Brazil within the larger context.

Despite yesterday's slide in Brazilian equity prices, the Bovespa is has held up better than other regional markets this week, including Mexico and Argentina. Capital outflows continue, to be sure, but at a comparatively moderate pace. Preliminary reports place yesterday's outflow at around $180 million, after $210 million outflow on Wednesday. This compares with an average daily outflow of about $240 million in December.

The central government has assured investors that it is prepared to make good on the $100 million Eurobond issued by the state of

Minas Gerais

that comes due on Feb. 10 and on a coupon payment due then as well. Brazil's former President Franco is the governor of that state and although he initially appointed

Cardoso

, the current president, as finance minister, there has been a falling out between the two. Franco's decision to suspend debt payments to the federal government is largely, but not solely, political grandstanding. What is at stake is how the burden of the fiscal adjustment and reform should be shared between the federal government and the states.

Most of Brazil's state government had their debts nationalized and are servicing their obligation by turning over to the federal government 1/8 of their tax collections and are paying below market rates of about 7.5%. The squabble also overshadowed some good news: Brazil's December trade deficit shrank by almost 40% from November as imports fell and exports rose.

Marc Chandler is an independent global markets strategist. At the time of publication, he holds no positions in the currencies discussed in this column. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to him at

mchandler@erols.com.