Payrolls sour mood, Eurozone concerns intensify

September 5, 2011 — Mitul Kotecha

The market mood has soured further and risk aversion has increased following disappointing August US jobs report in which the change in payrolls was zero and downward revisions to previous months has reinforced the negative mood on the US and global economy while raising expectations of more Federal Reserve action. Moreover, the report has put additional pressure on US President Obama to deliver fresh jobs measures in his speech on Thursday though Republican opposition may leave Obama with little actual leeway for further stimulus.

There is plenty of event risk over coming days, with a heavy slate central bank meetings including in Europe, UK, Japan, Australia, Canada and Sweden. The European Central Bank will offer no support to a EUR that is coming under growing pressure, with the Bank set to take a more neutral tone to policy compared its previously hawkish stance. In the UK, GBP could also trade cautiously given recent comments by Bank of England Monetary Policy Committee members about potential for more UK quantitative easing.

The EUR has been unable to capitalise on the bad economic news in the US as news there has been even worse. The negative news includes the weekend defeat of German Chancellor Merkel’s centre-right bloc in regional elections, which comes ahead of a vote in Germany’s constitutional court on changes to the EFSF bailout fund.

The withdrawal of the Troika (ECB, IMF and EU) from Greece has also put renewed emphasis on the country at a time when protests are escalating. If all of this is not enough there is growing concern about Italy’s apparent backtracking on austerity measures, with the Italian parliament set to discuss measures this week. Separately Germany, Holland and Finland will hold a meeting tomorrow on the Greek collateral issue. On top of all of this is the growing evidence of deteriorating growth in the euro area.

Data releases are unlikely to garner a great deal of attention amidst the events noted above, with mainly service sector purchasing managers indices on tap and at least threw will look somewhat better than their manufacturing counterparts. In the US the Beige Book and trade data will be in focus but all eyes will be on Obama’s speech later in the week. The USD has maintained a firm tone despite the jobs report but its resilience may be better explained by eurozone negativity rather than US positivity. Even so, the USD is looking less uglier than the EUR in the current environment.

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Will the ECB intervene to support the Euro? (Part 2)

May 23, 2010 — Mitul Kotecha

Click here to read Part 1

The last official intervention by the European Central Bank (ECB) in the currency markets took place in November 2000 and at the time the Bank stated that “the external value of the EUR does not reflect the favourable conditions of the euro area”. The ECB also noted the impact of a weaker EUR on price stability, with inflation at the time running above the ECB’s 2% threshold. This followed intervention a couple of months earlier in September 2000 when the ECB jointly intervened with the US Federal Reserve, Bank of Japan and other central banks in a concerted manner due to “shared concerns about the potential implications of recent movements in the euro exchange rate for the world economy”.

Conditions in the euro area could hardly be described as favourable at present, suggesting that this rationale would be very unlikely to be used to justify intervention. Conversely, a weaker EUR may actually contribute to making conditions in the eurozone more favourable. The rationale used for the September 2000 intervention holds more sway in the current environment. Nonetheless, the move in the EUR is very unlikely to do any serious damage to the world economy even if some Japanese exporters are suffering.

In the past the ECB has given various verbal warnings about the volatility of the EUR being too high, and this could potentially be utilized as rationale for FX intervention. However, implied volatility in EUR/USD is not particularly high when compared to the levels it reached during the recent financial crisis. Currently 3-month implied volatility is at its highest level since June 2009 but well below the peak in volatility recorded in December 2008. Clearly if EUR/USD volatility continues to rise there will be a greater cause for concern but at current levels the ECB is unlikely to even crank up verbal intervention let alone actual FX intervention.

One of the main benefits of the decline in the EUR is the support that it will provide to the eurozone economy. At a time when growth in Europe is slowing EUR weakness will be particularly welcome. Germany and other countries in Northern Europe will be major beneficiaries of EUR weakness given their export dependence. Given such benefits and the currently limited risks to inflation, the ECB is highly unlikely to intervene to strengthen the EUR.

Given the current very negative mood in the market, officials in Europe would do better to rectify some of the structural issues that markets are concerned about. This may provoke a more sustainable rally in the EUR but until there are concrete signs of progress on the fiscal front sentiment towards the EUR will remain negative. Against this background FX intervention to prop up the EUR would face more of a risk of failure, and in turn damage to the credibility of the ECB. This is perhaps as good a reason as any not to expect intervention.

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