Jack Bouroudjian discusses the impact of three big potential market movers this week — the G8 summit, tomorrow’s Fed meeting and the quadruple expiration where hundreds of billions in positions will be rolled into the September contract. An especially good week to read the news and follow the markets.

All eyes are on the Federal Open Market Committee’s two-day policy meeting starting tomorrow, as investors anticipate the Fed’s decision to extend or taper their stimulus efforts. On top of that, the G8 meetings begin today in Northern Ireland, where world leaders will take on the recovery in the U.S., the fiscal challenges for the E.U. and Japan’s expanding role in the world economy. There’s a lot for markets to watch.

Economic Calendar:

Monday:

G-8 Meetings in Lough Erne, Northern Ireland

Tuesday:

U.S: FOMC Meeting Begins

U.S: Consumer Price Index- 8:30 AM ET

G-8 Meetings continue

Wednesday:

US: FOMC Meeting Announcement- 2:00 PM ET

Thursday:

US: Existing Home Sales- 10:00 AM ET, US: EIA Natural Gas Report- 10:30 AM ET

Links:

Was the biggest bilateral trade deal in history announced today? (CBS News)

Homebuilder confidence in the U.S. is at a seven-year high (Bloomberg)

An interview with financial news curator Tadas Viskanta (See It Market)

The biggest threat to the global economy could come from outer space (The Atlantic)

The USDA may wait until its June 28 report to give its true expectations for corn (Farmgate Blog)

A new oil production record in North Dakota (Mark Perry/AEI)

Fiscalists vs. Monetarists in the blogosphere (FT Alphaville)

Economists are getting more optimistic about the economy (New York Times)

Tweets of the Week:

Also hard to contain spending when population ageing. On net, monetary policy useful band-aid, but just that. Difficult policy decisions.

— Adolfo Laurenti (@AdolfoLaurenti) June 14, 2013

Increasing tension and complexity, requires careful, prudent and forward-looking approach / political decisions. #ert #Greece

— Manos Giakoumis (@ManosGiakoumis) June 17, 2013

this market so strong even the enron chart looking bullish.

— Phil Pearlman (@ppearlman) June 17, 2013

I think I can actually hear the corn growing today

— Mitch Zumbach (@mitchzum) June 17, 2013

#Lumber futures +.78%, trading higher after housing market index released better than expected. Live #grains audio http://t.co/L1JR75WmvN

— TradersAudio (@TradersAudio) June 17, 2013

The June World Agriculture Supply and Demand Estimate (WASDE) report from the USDA appeared to factor the unusually wet spring in the Midwest into its estimates. The expectation for corn was down 135 million bushels from May. Following the report, December corn futures dropped 3 percent to $5.32.

Preparing for the price swings such data releases can bring is one of the reasons CME Group introduced short-dated new crop options, which allow grain market participants to hedge short term events at a lower premium than a standard options contract. In his post in April about short-dated new crop options, Tim Andriesen wrote:

I recall hearing a prominent grain market analyst speak last winter. In his comments he suggested corn could be $4.00 this year or it could be $9.00 this year, depending on the growing season. Now, in late April, we don’t have a solid idea as to which of these prices will come to fruition.

That uncertainty of price appears to be in tact. But there is a case study for short-dated new crop options in Matt Burgener, a corn and soybean farmer from Moweaqua, Illinois featured in the video above. It’s the first in the new Inside Agribusiness series from CME Group.

Equities roll over to the September front month today, and the yen carry trade (short yen, long equities) appears to have been unwound. Jack explores what effect both of these might have on equity markets.

It can be said without doubt that short Yen, long Japanese equities has been one of the most popular and, many will argue, most crowded trades this year. The move higher in Japanese equities and the collapse of the Yen has been fueled by the unprecedented shift in monetary policy spurred on by Japan’s new Prime Minister Shinzo Abe.  Abe took office bent on stopping the stagnation of the economy that has been a constant over the past 20 years.

His plan involved the Bank of Japan (BoJ) deploying a bond-buying program on an unprecedented scale. The program is meant to devalue the Yen and forcefully put a stop to deflation while boosting the country’s exports. The program is part of Mr. Abe’s three-pronged approach to strengthening the Japanese economy in which radical change in monetary policy is combined with shifts in fiscal policy and a large-scale government investment program, the lattermost being focused primarily on infrastructure.

The easy policies adapted by the BoJ made shorting the Yen and buying Japanese equities one of the most popular trades among investors this year. The Yen has tumbled over 12 percent in 2013 and the Nikkei 225 has rallied over 28 percent. However, increased volatility in the Yen and in Japanese equities is signaling that this trade may be in correction and investors could continue to unwind.

We saw Nikkei futures tumble more than 2,500 points from the highs made in late May amidst concerns over the future of easing policies here in the U.S. ahead of the May unemployment number. The day before the unemployment announcement Yen futures saw the largest single-day rally in this particular derivative of the past three years during which the Yen showed gains of over 3 percent at the highs. This recent action has many investors asking if the unwind of this trade will continue or if the BoJ’s efforts can keep pressure on the Yen.

The Bank of Japan Response

Current market conditions suggest that there will be much more whipsawing to come as 30 day implied volatility in the Yen has reached a 12 month high. Increased volatility in Japanese bonds also threatens the BoJ’s longer-term goals. Markets expected the BoJ to address this increased volatility in bond markets through further open-market actions, but the BoJ stunned investors by choosing to take no further action to reign in volatility during a meeting held on Tuesday. While the lack of further action by the BoJ came as a surprise, the expectation is for them to continue their easing program at its current pace, which should continue to pressure Yen futures to the downside.

Markets reacted sharply to the decision to do nothing in the short term. Nikkei 225 futures fell during Asian trading and through the extended session fell over 3 percent at the lows. Japanese Yen futures rose over 2 percent as the Abenomics trade continues to unwind. The expectation that the U.S. Fed will begin tapering its own easing programs has brought new strength to the dollar, increasing volatility in the Yen.  While the BoJ seems determined to stay the course, an exponential acceleration of the correction in the Yen trade could pressure them to take further action in the bond market.

The uncertainty over easing in the U.S. could also put pressure on the BoJ as increased volatility in U.S. markets could destabilize markets abroad. Price action over the next few months will prove if recent action is a temporary correction or a complete breakdown of the overall trend.  The coming months will show markets if the BoJ has the resources to keep the Yen under control or if the unwind will accelerate and force the BoJ to take extreme actions.  However, with the scope of easing in Japan already at unprecedented levels the BoJ may not have many options left.

Read More:

The Yen and Japan’s Fast Start to the Year

Next week is expiration for the S&P Futures. Jack talks about why that makes this week a critical one for equities, and visits how the Japanese Yen continues to influence the market.

Each month ahead of the USDA crop production and supply and demand reports, CME Group hosts analysts on the trading floor to discuss their expectations for the report. Ahead of the June 12 report, Terry Roggensack of The Hightower Report and Greg Wagner of GWX Ag Advisorsspoke today on what they expect from the USDA release. Not surprisingly, weather and late plantings were a major focus of discussion:

Terry Roggensack:

Rarely does a wet spring result in poor crop conditions. The crop which has emerged should likely see some very good improvement in crop conditions over the next two weeks. We’re 95 percent planted as of the weekly update from USDA. That leaves 4.75 million acres left to plant. In 1995 we were only 88 percent planted by this date, and we ended up losing a total of 3.9 million acres to the weather that year. So estimates that go much above the 3 million acre loss look a little bit far fetched.

Greg Wagner:

Statistically, you get an early planted crop, you have the potential for higher yields. Obviously, that’s not the case this year. However, as far as the production potential for corn right now, it’s a coin toss. Because you could go back 14 years where we were in a similar situation as we are now with delayed plantings… if you go back and take a look at the yields, it really is a tossup.

CME Group received the Inside Market Data Award for Best Data Provider of 2013 among global exchanges this May. Having now won the award for the second consecutive year, our market data team has established CME Group as a top place among global exchanges in this category.  The award carries special meaning because it comes at a time of growing demand for market data analysis within the financial information industry.

We have more than 500,000 instances of real-time market data in 150 countries, with nearly half the data usage coming from international customers. The number of accounts with a direct market data relationships has tripled in the last few years and we have met this increased global demand with the creation of a market data team in the UK within the past year.  Also, we’ve provided new products such as block futures data, equity execution statistics, and quick strike analytics for FX options.

We’ve really focused on applying the company’s core business principles to our department by adopting a leadership role within the industry, and representing CME Group as a proactive member in the Financial Information Services Division (FISD). The organization consists of a number of data providers and consumers, which allows us to collaborate with other organizations and systems to support the global financial information industry.

At a time when a weather forecast or Federal Reserve meeting can spike data usage in an instant, we see this as an opportunity to contribute to the stability of our markets by constantly enhancing our market data infrastructure and providing the tools and content to make more confident trades. This benefits the market as a whole, and encourages growth by allowing market participants to get the best information faster.

Jack looks at whether there might be any traction after the S&P snapback from its 5 percent correction. Also, the yen/dollar relationship has played a large role in driving trading the last few weeks. Will tonight’s policy statement from the Bank of Japan help continue the trend?

For most of 2013, some of the most active days in foreign exchange trading have been driven by the Japanese Yen/U.S. Dollar (JPY/USD) futures and options contracts. That has largely been a result of the Bank of Japan’s asset purchases.

FX market participants have had to simultaneously watch the actions of the BOJ’s American cousin, the Fed, and when it plans to scale back its own policy of continued stimulus. It was this anticipation that served as one of the major drivers of the record volume and open interest we saw across our FX complex on June 6, which saw a total of $239 billion in notional value traded in FX futures and options

But this wasn’t just the result of QE watch either. The market experienced something of a perfect storm of news and data releases that led to an all-time record in trading of Japanese yen futures and options, among other records. The results of the May U.S. jobs report were to be a tell-tale sign for the fate of QE in the United States. Former Fed chairman Alan Greenspan also commented that the U.S. should scale back QE regardless of the jobs data. The combined effect seemed to be a broad dollar selloff, which could again be seen most notably in JPY/USD.

In all, yen futures and options traded a record 503,232 contracts with record yen futures contracts of 454,554 on June 6. The previous records for combined futures and options contracts were on May 23, 2013, and the previous record for futures contracts for U.S. dollar notional was on August 16, 2007.

When the market experiences moves in currencies based on uncertainty (in this case JPY/USD), a lot of risk is managed in the form of options. And on top of the look ahead to U.S. jobs data, June 6 was also the expiration for options contracts. So it’s maybe not too much of a surprise that the market experienced a record in electronic options trading as well. The conditions were certainly right for a big day in options, but it should be stated that this is the continuation of what has been a big year in FX options trading. We’ve seen healthy participation in FX markets all year, but this is especially true in options, which are up 55 percent over a year ago in terms of total volume, and up 68 percent in electronically traded volume (which makes up 85 percent of all volume).

The full details of our recent records are here, where one of the most important bullet points you will read states a significant reason for the high trading volumes on June 6 and throughout 2013: the record number of large open interest holders. More participants in the market mean more risk is being held. And when you have a big day, as we did last week, you have incrementally bigger days. Banks, hedge funds, CTAs, proprietary trading firms, multinational companies and active individual traders are all contributing to the growth in FX markets. We believe that’s primarily the result of a continued expansion of our offerings, which now total 60 futures and 31 options products.

The jobs numbers for May likely didn’t settle the QE question. There will be more employment reports and more Fed meetings, and that will again make trading levels by both hedgers and speculators in FX markets something to watch this year.

The shift to mandatory clearing for over-the-counter  transactions has included several significant dates on the way to full compliance for buyside customers in swaps markets. Today is one of the most important dates yet. Mandatory clearing for category 2 firms begins today. Category 2 includes private funds, non-swap dealer banks and commodity pools. The mandate for swap dealers began on March 11, and the mandate for pension funds and any other firm not fitting in the first two categories begins September 9. According to the Financial Times, about 500 firms qualify as category 2, though many of them have already begun clearing, as our head of OTC told Bloomberg.

Here’s our look at the economic week ahead, and some other stories you may have missed…

Economic Calendar:

Tuesday

U.S. Wholesale Trade Report
10:00 AM ET

CME Group Ask the Analysts Panel: USDA Crop Reports

3:30 PM ET

Wednesday

USDA Crop Production Report
11:00 AM CT

USDA Supply/Demand Report
11:00 AM CT

Thursday

Fed Balance Sheet
4:30 PM ET

Bank of Japan Minutes
7:50 PM ET

Friday

US:Industrial Production
9:15 AM ET

See our full economic release calendar here.

Links:

Deutsche Bank is opening a 200 ton gold storage facility in Singapore (Reuters)

Emerging market currencies weakened on anticipation of the Fed’s QE tapering (Futures)

Why the Fed doesn’t like the word “tapering.” (Real Time Economics)

Fed tapering concern has hit the Indian Rupee (Financial Times)

A map of the history of the Fed’s balance sheet (Sober Look)

The IMF details how its Greek bailout could have been better (Bloomberg, Economist Meg)

The Japan national soccer team qualified for the World Cup, and gave business a boost. (Bloomberg)

The latest farm economy observations from the Federal Reserve (Farm Policy)

Which country’s stock market leads the way in growth this year? (Bespoke)

Tweets of the Week

Core inflation was 1.05% in April. That was a 50-year low.

— Matt O'Brien (@ObsoleteDogma) June 10, 2013

No contra-indicator like a rating agency: Treasuries sell off after @standardpoors raises outlook on U.S. credit rating

— Pedro da Costa (@pdacosta) June 10, 2013

U.S. dollar hits session high against Japanese yen, trading 1.5% higher at 99 yen

— MacroScope (@MacroScope) June 10, 2013

The world's 2,170 billionaires have an average of $31 million each of art. (via @WealthX)

— CNBC (@CNBC) June 6, 2013

Late planting means signif gap between old crop running low and new crop corn+beans coming in. Potential for squeeze: Steve Meyer

— Ed White (@EdWhiteMarkets) June 6, 2013

In this review, I present an eclectic set of proposals and analyses that have been put forward by economic historians to reform the functioning of the eurozone in a big way. The first category of proposals discuss ways through which monetary policy could be differentiated across different countries within the monetary union. The second category of analyses challenges the now conventional view that a monetary union necessarily requires some form of fiscal, banking and/or political union.

Making monetary policy more flexible

Markus Brunnermeier writes that the ECB could optimize its currency area by using “regional tools” that affect the regional credit and term spreads. Unconventional monetary policy allows central banks to influence term and credit spreads directly by buying or selling long-term risky assets. But the ECB could also use its haircut policy to lean against regional imbalances. Using haircuts to lean against regional imbalances is in sharp contrast to the ECB’s current policy. Currently, the ECB uses collateral and haircut policy purely as a risk management tool, i.e., to minimize potential losses from lending against certain assets. Furthermore, there is a tendency to treat all member countries the same and avoid any differentiation. This makes all spreads more uniform across the membership countries – the opposite effect of what a targeted active policy that leans against regional imbalances would prescribe.

Harold James also argues that different interest rates in different countries might open the door to a more stable eurozone, but notes that different policy rates might even be possible. When the EC Committee of Central Bank Governors began to draft the ECB statute, it took the indivisibility and centralization of monetary policy as given. But it was not really justified either historically or in terms of economic fundamentals. The history of the gold standard, and of other large common-currency areas show that despite the theoretical possibility of capital being sent over vast distances to other parts of the world, much capital remained local, making the differentiation of interest rates possible. In the early history of the Federal Reserve System, individual Reserve Banks set their own discount rates. In smooth or normal times, the rates tended to converge. But in times of shocks, they could move apart. The Eurozone is now moving to a modern equivalent as bank collateral requirements are being differentiated in different areas. This represents a remarkable incipient innovation.

Source: Harold James

A common currency does not mean a single currency

Harold James notes that was one of the possibilities that was raised in the discussions on monetary union in the early 1990s was that there might be a common currency but not necessarily a single currency. Keeping the Euro for all members of the Eurozone but also allowing some of them (in principle all of them) to issue national currencies would be the modern equivalent to the band widening of 1993. The countries that do that would find that their new currencies immediately trading at what would probably be a heavy discount. California recently adopted a similar approach, issuing IOUs when faced by the impossibility of access to funding. Such a course would not require the redenomination of bank assets or liabilities, and hence would not be subject to the multiple legal challenges that a more radical alternative would encounter.

Harold James writes that such a state of affairs is not just a theoretical construct in fringe debates in the early 1990s, but a real historical alternative. There is in fact a rather surprising parallel for such a stable coexistence of two currencies over a surprisingly long period of time. Before the victory of the gold standard in the 1870s, Europe operated with a bimetallic standard for centuries, not only gold but also silver. One trick that made this regime so successful was that the coins were used for different purposes. High value gold coins were used as a reference for large value transactions and for international business. Low value silver coins were used for small day to day transactions, for the payment of modest wages and rents. A depreciation of silver relative to gold in this system would bring down real wages and improve competitiveness. In the modern setting, the equivalent of the adjustment mechanism in the early modern world of bimetallism would be a fall in Greek (or other crisis country) wage costs as the wages were paid in the national currency, as long as it was traded at a discount. These would be the equivalent of silver currencies. Meanwhile, the Euro would be the equivalent of the gold standard. It would be kept stable by the institutions which already exist today, the ECB and the ECSB of those national central banks who have no new alternative.

Hugh Rockoff argues that the case of the West in the 19^th century suggests that dividing the Eurozone in two currency zones is possible. From the outbreak of the war until 1879 the West remained on the gold standard while the East was on the greenback standard. National banks in the West issued “goldbacks” redeemable in gold. The exchange rate between greenbacks and goldbacks fluctuated. A curiosum, but perhaps one that suggests that dividing the Eurozone in two currency zones is possible.

A monetary union without a fiscal/political union

Simon Wren-Lewis writes that the view that the Eurozone will have to move to fiscal union, which implies some form of political union, seems to be a very common view at the moment. Those working in the political unions that are the U.S. or the U.K., know combined monetary and fiscal unions can work. From this perspective, the monetary only union of the Eurozone was a largely untried experiment, and it appears to be failing. Within the Eurozone itself, there has always been a powerful lobby for further integration. It is therefore not surprising that actors like the Commission see further integration as the longer-term solution to the Eurozone’s problems.

Harold James writes that the idea that Europeans simply need a country because they happen to have a currency reflects a misunderstanding about the reasons politicians embarked on the economic and monetary union of Europe.

Simon Wren-Lewis writes that we should be very cautious about making generalizations from a single observation. The Eurozone has not been a fair test of monetary union without fiscal union since poor policies were also put in place at the same time. 1) No attempt was made to use fiscal policy to offset overheating in periphery countries. 2) Instead of recognizing the need for default early on, the union made a futile attempt to avoid it by replacing private debt with intergovernmental lending. 3) The fiscal position of Eurozone economies became critical because the ECB refused to act as a lender of last resort. 4) The current double dip recession in the Eurozone is largely about a collective failure of fiscal and monetary policy.

Benjamin Cohen writes that history suggests that political union is not necessary for the longevity of the euro area. In the modern era (19^th century onward), there are at least seven notable examples – other than EMU – of formal monetary unions without political union: The Latin Monetary Union, the Scandinavian Monetary Union, the Belgium-Luxembourg Economic Union, the CFA Franc Zone, the East African Community, the East Caribbean Currency, and the West African Monetary Area. Two of the seven (CFA, ECCA) remain in existence to the present day; a third (BLEU) existed for 3/4 century until incorporated into the larger EMU; and two other (LMU, SMU) managed to survive for more than a half century until brought to an end by World War I.

Randall Henning writes that a couple of observations emerge from the history of the US fiscal rulemaking that seem especially relevant to the E.U. now.

1.      Even though the debt brakes of the fiscal compact are introduced into national constitutions and framework laws, the process has been initiated by the center and in some cases under duress. In the United States, rules were adopted autonomously by the states. This has implications for domestic political “ownership”.

2.      Community institutions play a leading role in enforcing the rules, whereas the U.S. federal government has no such role. In fact, the U.S. federal government in fact cannot legislate fiscal rules for the states; this would be an unconstitutional infringement on “state sovereignty.” The U.S. model of fiscal rectitude for the states rests on multiple layers of rules combined with the no bailout norm.

Germany: the missing hegemon

Benjamin Cohen writes that experience suggests that in the absence of political union, a local hegemony or solidarity are necessary to keep a monetary union functioning reasonably well; where both conditions are present, they are sufficient. The importance of a local hegemon was well demonstrated by BLEU (Belgium, twenty times the size of Luxembourg, called the shots). The importance of solidarity is evident in the longevity of SMU, BLEU, ECCA. All three involved groups of partners with a strong sense of common identity, grounded in a shared cultural and political background and institutionalized in a broad network of related economic and political agreements.

Brad DeLong writes that the Kindlebergian perspective would lead one to think that the problem of Europe today is that Germany does not want to assume the burden, or assume the role, or is not wanted by the rest of Europe to assume the explicit role on terms that Germany wishes to exercise it. Brad DeLong and Barry Eichengreen write the German federal government has room for countercyclical fiscal policy. It could encourage the ECB to make more active use of monetary policy. It could fund a Marshall Plan for Greece and signal a willingness to assume joint responsibility, along with its E.U. partners, for some fraction of their collective debt. But Germany still thinks of itself as the steward in a small open economy.

This post originally appeared on the Breugel blog. It is republished here with permission.