The Euro today depreciated against the dollar, but gold held its ground, disrupting the strong correlation observed between the two over the past few weeks. Among other things such as the continuing rise in the Euribor rates, today's action in the FX market was influenced by PIMCO's Muhammad El-Erian, who stated that he expects Greece to default within three years . Although markets are for now rather bullish on the Eurozone, the PIMCO's chief's viewpoint makes sense not only because of the dire economic situation of the country, but also because the burden imposed on the voters is impractically and nonsensically harsh, in a way ensuring that the large amounts of aid so far bestowed on the Greek economy will go to waste sooner or later.

The Greeks naturally have a sense that they have been left to themselves by the rest of their European brothers. In spite of the large amount of aid that they have received and been pledged, the country is faced with rising unemployment, negative growth, and rising debt at the same time. A situation where debt is rising while GDP is contracting can never be the result of sound economic management, which should have been clear to the IMF, but now the task of demonstrating this viewpoint is a task for the Greek electorate, and the results cannot be very inspiring either for Europe or the rest of the world.

George Papandreou, the PM, for his part, has been trying to rally voters behind his intimidating program of tightening which will be going on for some years. In comments today, he stated that he expects the Greek people to support him in the local elections due November, adding however, that he will need the backing of the electorate in case that he finds in impossible to push his reforms through the parliament at some point, hinting that early elections are not inconceivable.

We quote some of the interesting statements of Mr. El-Erian here, via Bloomberg.

"It's in Greece's interest to default "as long as you can contain the contagion to other countries and it is done through orderly restructuring and repricing to retain competitiveness," El-Erian said at a conference sponsored by the Economist magazine in New York yesterday. Like Latin America's "lost decade" in the 1980s, "the alternative doesn't promise growth and employment generation," he said."

"I have never seen an 11 percent adjustment on the fiscal side being delivered" under the current program's assumptions, said El-Erian, who worked at the IMF for 15 years. "Eleven percent is heroic."

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European CDS and bonds have been reacting in an unsurprising manner to these comments, with the 10-year yield rising by 31 bp at one point, according to Bloomberg, reaching some of the highest levels of the past 20 days or so. The spread with German bunds also widened to more than 710 points during the day. Similar movements were observed in the bonds of the periphery, which in turn mirror the movements in the Euro.

Meanwhile, in other developments in the Eurozone, we saw 3-month Euribor rise again to 1.037% from 1.032%, continuing the trend of the past months, while the market is focused on tomorrow's 3-month LTRO from the ECB. As Divyang Shah of IFRMarkets comments, we would expect robust demand, since the fixed rate of the ECB's auction at 1% offers a significantly cheaper borrowing opportunity for the region's banks. the results of Today's weekly refinancing operation was mostly in line with the estimates of analysts, and in any case the EONIA rate is still at relatively acceptable levels, so tomorrow's results may give us some idea on the prospects from Eurozone interbank markets as we approach the year-end period.

Japan Thailand optimistic on FX, China keeps Yuan stable

In Asia, today's fixing of the USDCNY was at 6.6762 vs. 6.6729 on Monday. The Chinese are keeping their currency stable for now, but if the USD resumes its downward trend any time soon, it will be very hard to do so even for the stubborn Chinese government. In this context, the FOMC meeting of next week will be crucial.

In the rest of Asia, the central bank officials of Malaysia, Japan and Thailand were commenting on their confidence in the ability of the international community to avert currency wars, as they are called, while repeating their satisfaction in FX movements "so far". And we concur, it is of course too early to be so pleased with ourselves, especially as the market's mood remains as bipolar and volatile as ever.

Today's trade balance data released by the Philippines and India have shown once again that the current account situation of many Asian nations is deteriorating fast as a result of surging imports, which are, in turn driven by massive capital flows generated by the U.S., Europe, and Japan. The future of the region is going to be determined by the stance of China on currency policy, but even now, without further Chinese intransigence, the rest of the Asian region is being squeezed as the dollar depreciates vs. much of the rest of the world, diminishing competitiveness against China.

We could certainly make a case for the return of currency pegs. The return of protectionism is almost a mainstream idea at the moment, and as it is clear that floating, free FX regimes are essentially a product of free trade, it becomes harder and harder to maintain them in an environment where nations seek competitive advantage through manipulative practices. . The upcoming FOMC meeting attains an even higher significance if we consider the implications for Asian region, and we will make sure to follow the events here in order to keep you updated on all developments.