ECB risks, more JPY jawboning, Asian FX supported

July 31, 2012 — Mitul Kotecha

Risk assets have given back some of their Draghi inspired gains but expectations of European Central Bank action on Thursday continues to provide a solid underpinning for markets. Although European equities closed higher US equities slipped while the VIX ‘fear gauge’ rose. Ahead of the ECB policy decision attention will be on whether German resistance to a more aggressive ECB stance eases. Given that markets have priced in a positive outcome the risks are asymmetric in the days ahead, with a bigger sell off in risk assets should policy makers disappoint.

One indicator worth highlighting is the Baltic Dry Index which has dropped by over 20% from its high on 9 July and continues to head south, indicating rising global growth risks. Economic data releases including the Eurozone ‘flash’ July Eurozone inflation data, and US July consumer confidence will offer some direction for markets but we suspect that a tone of consolidation will continue ahead of the ECB and Fed meetings and the July US jobs report at the end of the week.

Japan continues to jawbone about the strength of the JPY, with Finance Minister Azumi delivering a further threat of FX intervention. Azumi notes that the advance of the JPY has been one sided, does not reflect fundamentals and that no measures will be ruled out when it comes too FX action when needed. He also hints that any intervention may be supported by other countries. It is doubtful that Azumi is setting the scene for actual intervention although a sustained drop below 78.00 will sharply raise the odds of Japanese official JPY selling.

EUR/USD looks supported above 1.2118 but a drift lower is likely ahead of the ECB meeting. Reports in Der Spiegel that Draghi’s pledge of action has created discord within the ECB while Germany continues to resist action to restart the ECB’s securities market purchase programme. The risk is that Draghi has set the ECB and risk assets up for a fall if agreement cannot be reached ahead of the ECB policy meeting.

Asian currencies look supported going in the near term and its worth noting that equity portfolio flows to the region have pocked up over recent days led by South Korea. The USD will be restrained ahead of the Fed meeting allowing Asian currencies to grind higher. We favour KRW and IDR although gains are likely to be limited ahead of the key central bank policy decisions this week. On that note, a likely unchanged decision from the RBI in India today, may act as further disappointment for the INR.

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No respite for the Euro

July 11, 2012 — Mitul Kotecha

Following a relatively positive session for European stocks yesterday, the enthusiasm did not carry through to US markets which registered losses overnight. Commodity prices dropped led by gold while equity volatility rose.

Marginal progress at the meeting of European Finance officials, with the decision to furnish Spain with the first EUR 30 billion of funds for its banks, helped sentiment in Europe. Moreover, officials edged closer to purchasing bonds in the secondary market by agreeing a separate accord to use the European Central Bank (ECB) as a buying agent for bond purchases by the bailout funds.

However, questions such as how Greece would get through next month’s bond redemptions following a delay in a loan tranche for the country were left unanswered while the timing of setting up a single banking supervisor was also unclear. Meanwhile, the German constitutional court hearings on complaints about the ESM bailout fund mean that the ESM’s implementation continues to be delayed.

All-in-all, despite the marginal progress made yesterday there is a long climb ahead before markets can be appeased. Coupled with growing concerns about the US earnings outlook following several profit warnings by US companies market sentiment will remain fragile, with little headway likely for risk assets. Hopes of further Fed stimulus may offer some solace to markets but the reality is that the Fed is unlikely to be close to a further round of quantitative easing.

High beta / risk currencies remain pressured although it is notable that there is at least a little relative resistance from the likes of the AUD as indicated by the drop in EUR/AUD. European officials are doing just enough to prevent the EUR from gapping lower but not enough to enable the currency to rally. Having already dropped by around 3% against the USD since the start of the month EUR/USD looks set to test tech technical support around 1.2193 before next support around 1.2151.

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EUR slides as summit hopes fade

July 9, 2012 — Mitul Kotecha

Any boost to confidence following the recent EU Summit is fading fast. Policy easing from the European Central Bank, Bank of England, and PBoC in China, have done little to turn things around. Moreover, the weaker than expected US June jobs report has added to the calls for the Federal Reserve to inject more monetary stimulus via another round of quantitative easing but this is unlikely anytime soon.

Admittedly the jobs data which reported an 80k increase in payrolls and unemployment rate remaining at 8.2%, was disappointing but it was not weak enough to trigger imminent Fed action. Congressional testimony by Fed Chairman Bernanke on July 17 and 18 will provide the next key clues to whether the Fed is moving closer to more QE.

This leaves markets in a miserable state of being. It was hoped that the recent EU Summit would provide much needed breathing space and relief to Eurozone peripheral bond markets. However, renewed policy implementation doubts, concerns that the Summit did not go far enough and opposition from Finland and the Netherlands who appear to have taken an even tougher stance than Germany, have resulted in Spanish and Italian bonds facing significant pressure once again with yields higher than pre summit levels.

A delay in the ESM permanent bailout fund, timing of the setting up of a banking supervisory authority and doubts about the size of the bailout fund given that the ECB appears to have ruled out a banking license as a means of leveraging up the ESM, are just a few of the concerns afflicting markets. Meanwhile, added to this list is the fact that Greece’s next bailout tranche has been delayed to mid September. Many of these issues as well as the bailout of Spanish banks will be discussed at today’s Ecofin meeting but the chances of much progress remain limited.

The EUR which is of course not uncrorrelated with peripheral bond yields has itself fallen sharply. Thin trading conditions have helped to exacerbate the drop in the EUR while the realisation that the EU summit has been no game changer is increasingly weighing on the currency. I had thought that the Summit may have helped to at least provide a floor under the EUR but this now looks like a case of misplaced optimism.

The only supportive factor for the currency is that it looks heavily oversold, with market positioning extremely short. However, if a break below the 2012 EUR/USD low around 1.2288 can be sustained markets will quickly latch onto 1.20 as the next target. Given the lack of major events or data releases over coming days there looks like little to offer the EUR any support.

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Central banks fail to impress

July 6, 2012 — Mitul Kotecha

Three central banks acted within a short time of each other to provide yet more monetary stimulus. However, the European Central Bank’s (ECB) 25 bps cut in its refi rate and deposit rate, China’s central bank, PBoC’s cut in interest rates and an additional GBP 50 billion of asset purchases by the Bank of England have failed to stimulate markets. This is a worrying development for policy makers especially as the drug of monetary stimulus has been a major factor spurring equity markets and risk assets since the global financial crisis began in 2008.

The lack of positive momentum emanating from the policy easing by central banks yesterday reflects the reality that the efficacy of further easing has now become very limited. Will a quarter percent rate cut from the ECB or yet another round of asset purchases from the BoE really make a difference at a time when core bond yields are already at extremely low levels and the demand for credit globally is very weak? Moreover, are policy makers really addressing the underlying problems in the Eurozone or elsewhere? I think the answers are obvious.

The same argument applies to the Fed if it was to embark on a third round of quantitative easing. Admittedly more Fed QE could weaken the USD and boost equities but would it really have a lasting impact? In any case I don’t think the Fed is on the verge of more QE following the recent extension of ‘Operation Twist’ which itself will do little more than have a psychological impact on markets. Today’s release of the June jobs report could give some further impetus to QE expectations if it comes in weak but I doubt this will occur.

One casualty of the cut in ECB rates was the EUR which dropped sharply, having not only given up its post EU Summit gains over recent days but extending its losses even further. This is perhaps an odd reaction considering that a rate cut was widely expected. ECB President Draghi’s warnings about the path ahead will have played negatively on the currency as well expectations of more stronger easing in the months ahead perhaps involving ECB QE.

I still stick to the view that European policy makers have at least put a short term floor under the EUR in the wake of the decisions at the EU Summit suggesting that further downside will be limited, with the 2012 low around 1.2288 likely to act as a short term floor for EUR/USD. Nonetheless, with many details of the plans announced in the Summit yet to be ironed out and implementation risks running very high a degree of market caution should be expected.

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Progress at last in Europe

June 30, 2012 — Mitul Kotecha

As last week progressed markets had been increasingly poised for disappointment at the EU Summit at the end of the week. Given such low expectations it was probably not so difficult to exceed them. In the event there was progress towards breaking the vicious cycle between banks and sovereigns. The immediate reaction to the announcements from the EU President was clearly positive, with risk assets rallying sharply. EUR/USD had rallied by over 2 big figures from a low just above 1.24 as a massive short squeeze helped propel it higher.

With their backs against the wall EU leaders finally agreed upon short term stabilisation measures as well as long term measures towards closer European integration. Under pressure from other leaders including French President Hollande, German leader Merkel obviously softened her stance to agree on some of these measures. The deal goes to show that leaders in Europe can act when needed or at least when desperate which is how they were after 13 hours of talks and the reality that bond yields in Spain and Portugal were at unsustainable levels.

Short term measures in particular utilising the EFSF / ESM bailout fund to recapitalize banks directly and the creation of a European banking supervisory body was a shot in the arm for Italian and Spanish bonds and the EUR. The dropping of the condition that EU governments be given preferred creditor status for loans to Spanish banks bodes well for peripheral Eurozone sovereign debt markets as it means that private investors will not be put at the back of the que in any debt restructuring.

While the measures mark an important step in the direction of providing clear resolutions to the Eurozone crisis there is a very long way to go. Admitedly the use of the bailout funds is positive but at some point markets will ponder the fact that while they could handle a bailout of Spain the funds are clearly insufficient to cope with a bailout of Italy should it be needed. If the steps announced at the EU summit lead to a sustained drop in peripheral country bond yields then the prospects of more bailouts will be limited but this is by no means guaranteed.

Whether the risk rally is sustained into next week depends in part on whether the European Central Bank responds with actions of its own by cutting interest rates or by indicating the use of other measures such as restarting its securities markets purchases program. The risk remains that the rally will likely fade as skepticism sets in again once again and more details are sought.

Posted in Bond markets, ECB, eurozone, Italy, Spain. Tags: , , , , . Leave a Comment »
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