Japan`s Nuclear Crisis Threatens a Financial Meltdown

The focus remains on Japan today. The Fukushima reactors are reported to have gone through another explosion earlier in the day, in addition to a fire breaking out in a storage area where the highly radioactive spent fuel rods of the past 20 years are being kept. The steel cover that isolates the reactor core is known to have cracked in one of the plants. In response, the company that operates the reactors is planning to pour water on the spent fuel depots from helicopters over the next days in the latest of its desperate and unconventional actions. 

Although still in tolerable ranges, measurements in regions as far away as the capital have begun to show elevated levels of radioactive dust. Residents of the area surrounding the reactors have been advised to stay indoors, close the windows and wear masks when they have to go out. Those in the immediate vicinity are now being ordered to evacuate, in contrast to what was previously advice and recommendations to the same effect. Hoarding of foodstuff and necessities, energy and fuel shortages are being reported from around the country.

Japan`s natural disaster threatens to turn into a nuclear catastrophe, and the markets are not responding favorably. Commodities and stocks are selling off in a much anticipated phase of correction, while the the sharpest reactions continue to be experienced by Japanese markets. The Nikkei index has suffered its sharpest two-day fall since 1987, falling by 10% today alone, and Japan`s CDS yield has reached its highest ever level on record.

There are two major issues at the moment. How far reaching will the damage be on the Japanese psyche from the current crisis? And how much will the Japanese government borrow as it works to rebuild the economy? Will the world be willing to lend ever greater sums with the possibility that a significant proportion may not be paid back? Supply disruptions, the loss of Japanese demand, and market turmoil are serious issues, but their effects would be temporary if the Japanese people can get back to a degree of normalcy in a reasonable time. The nuclear crisis threatens to disrupt this process, and that is why the markets are reacting so nervously to the deteriorating situation.

Meanwhile, Bahrain in the Middle East has requested the deployment of foreign troops from the Gulf region yesterday in a bid to contain the unrest in the country as it threatens to transform into a shiite uprising. We are surprised to see a small Gulf nation call for the aid of its "brothers" so openly. The emirates and small kingdoms in the region are known to be highly suspicious of each other, and to prefer U.S. support over regional solidarity. So the common stance against a Shia minority may be regarded as a significant hint towards Iran that its intervention in the region is unwelcome, and may represent a hardening of attitudes in the Gulf Zone, with potential consequences for an eventual American-Israeli attack. It is interesting that the only regional power to condemn this action is Iran itself.

Libyan Rebels Approach Gaddafi Hometown, Portugal Remains in Crisis

The weekend has been heavy in terms of activity, and Monday 28^th is more active than a typical first day of the week would be.

In Portugal, it is expected that the President will meet with party leaders in order to determine the date of the oncoming early elections, which will end the current parliament`s tenure two year before the legal term. The outgoing PM Jose Socrates has been insisting that Portugal does not need a bailout yet, since it remains in possession of enough cash to meet redemptions of Eur 4.5 billion bonds due April 15th. There seems to be some agreement among Portuguese authorities that June redemptions of a similar size pose a different risk, and the next election will probably take place that month in order to face the turmoil with a strong and responsible government in place. Yet, whether it is a good idea to place these two events in such close succession is up for debate, and this is reflected in the market reaction as well, where traders demand a yield of 7.66%, or a spread of 260+ for funding the government`s 10 yr borrowing. Spain seems to have escaped similar treatment for now, perhaps due to the ruling government`s commitment to bring the deficit back to 6% of GDP from 9.2% in 2010.

In Syria, where demonstrations have caused deaths and a massive outpouring of anger in the south of the country, the Assad regime has adopted a very measured approach, no doubt sobered by what is happening to the Colonel in Libya. Promises of widespread reforms are flying in the air, but since similar promises were made in the past too, and never fulfilled, it remains to be seen how credible the latest pledges will seem to the people. Still, the Arab Revolution is a real and serious threat to the survival of these regimes, and as Basshar Assad has proven himself to be a reasonably flexible leader in the past, there is some hope that that bloodshed of the kind seen in Libya or Yemen recently can be averted. From a trader`s point of view, Syria is a tiny country with only a limited economic role in the region, but its pivotal situation and role in the Arab-Israeli conflict make it an important component from a strategical point of view. In Yemen, after yet more clashes and protests, the U.S. ally Ali Abdallah Saleh is reported to have agreed to leave the country, but not immediately. His ruling party has also declared its support for him.

Finally, in Japan, there is worrying evidence that the nuclear crisis is getting deeper and harder to control, as reports of radiation leakage into the sea, and radiativity levels reaching up to 100,000 times the natural norms frighten the Japanese people. Authorities have declared it likely that the resolution of the issues will last for months, and an influential advisor to the PM has suggested that Japan be decentralized in order to avoid similar events when Tokyo is hit by an expected earthquake-tsunami combination sometime in the future.

In consequence of these developments, global stocks showed a mixed performance, while the USDJPY and AUDJPY pairs appreciated, and the Euro fell in reaction to Portugal concerns. Gold and oil were lower. This is probably due to the rapid advance of rebel forces in Libya this weekend, which brought them close to the Colonel`s birthtown, raising hopes that the crisis and the war may reach a conclusion earlier than expected. There is not much that can be said on this matter, since conditions are volatile, and it is difficult to predict what kind of surprises may be awaiting both sides.

Irish Crisis Domino Effect Concerns Increase Risk Aversion

The Greenback's notable strength last week against the other major currencies was due in large part to the European financial crisis that was dealt yet another blow by the most recent Irish bailout request from the IMF and European Union.

Nevertheless, the financial markets cannot seem to stop themselves from worrying about yet another potential financial crisis, with the focus now shifting toward either Portugal or Spain to be the next financially troubled European country humbled into accepting bailout money.

Nevertheless, each successive bailout seems harder to get the approval of the more fiscally responsible Germans, who seem to feel that the bond holders should pay the price for buying high yield debt from the more financially troubled EU members.

Irish Financial Crisis Prompts Risk Aversion

The financial troubles in Europe added substantially to the U.S. Dollar's dramatic rise last week. The concerns initially solidified with the Irish financial crisis and then started spreading into worries over the financial situation of other European member states like Spain and Portugal.

The financial crisis in Ireland began causing concerns the previous week when a London clearing house - LCH.Clearnet - raised margins on Irish bonds to between 15 and 30 percent. By the end of the week, the Irish government had agreed to a joint EU/IMF bailout program, which is currently estimated to be between 80 and 100 Billion Euros.

Last Monday, Moody's Investor Services warned the markets that it might have to make a multiple notch downgrade for Irish debt. The rating agency noted that the rescue package from the EU and the IMF would, "crystallize more bank-contingent liabilities on the government balance sheet, and increase the Irish sovereign's debt burden."

The currency market basically interpreted this as a signal to buy U.S. Dollars against the other major currencies, especially other European currencies. As a result, the Euro declined by -3.3 percent last week, while the British Pounds lost -2.5 percent on the week.

The commodity currencies were also lower, with the New Zealand Dollar dropping a whopping -3.6 percent, while the Australian Dollar shed -2.2 percent. The Canadian Dollar - last week's best performer against the Greenback - dropped a mere -0.2 percent and was least affected by the financial crisis in Europe.

Domino Effect May See Portugal and Spain Next in Line

In addition to the Irish financial crisis, concerns arose over the financial position of other troubled members of the European Union such as Portugal - who is rumored to be the next troubled economy in line for a rescue package from the EU and IMF.

Earlier in the week, Portuguese Prime Minister José Sócrates stated that

"Portugal doesn't need anyone's help and will solve its own problems."

Sócrates also stated that Portugal had a clear strategy to bring down its massive deficit and that the Irish rescue had "no connection" to the situation in Portugal.

Spain was also mentioned as a bailout candidate, but it managed to sell 3.26B Euros in Treasury bills last week, although this was on the lower end of the estimated 3-4B Euros that the debt auction was expected to raise.

In Spain, Spanish Finance Minister Elena Salgado stated that,

"Spain is doing everything it has promised to do, with tangible results"

When asked whether Spain would need a bailout from the European Union, Salgado answered, "Absolutely not".

Despite the relatively optimistic comments made by Salgado and Socrates, Portuguese bonds surged last week to 6.9 percent. This pretty much mirrored the sharp yield rise that Greek and Irish bonds demonstrated just before going to the EU to request a bailout.

In addition, the spread between 10 year Spanish bonds and German Bunds hit a post EMU record of 233 basis points over the Bunds, achieving a yield of 4.87 percent on the Spanish bonds.

Nevertheless, according to some analysts, Spain is too big to bail out. They argue that the size of any meaningful rescue package for Spain is likely to use up all of the available EU funds.

Such a situation could seriously destabilize the European Union during this crisis period since Germany seems increasingly less supportive when it comes to bailing out less fiscally responsible EU countries.