Morning Forex Review – 19 January
The Pan-European checkers game has transpired to chess since the growing complexity of the situation is outweighed by the simplicity of the core issues. As the ECB deposit facility staggers to all-time record highs over “502 billion, the question is not how rising systematic risk is factoring into bank’s decision-making, but rather what is the comprehensive solution to increasing both solvency and liquidity in the Euro-zone? The original intention of the Long-Term Refinancing Operation (LTRO) that doled out “489 billion to banks in December was increasing interbank liquidity as Euribor and Libor rates were shooting through the roof, but above all restoring confidence. As collateral requirements continue to be watered down, the borrowing constraints for the program included less than prime (read garbage) assets. This highlights that banks are running short on quality assets to borrow against (i.e. rehypothecate).
The ECB is not out of options and even though ECB President Mario Draghi has made his resistance to resorting to the printing press well known, he could still drop rates considerably. While there is a possibility of a rate cut in February, there is more likelihood that the ECB will cut during the March meeting because the end of February is marked by another round of LTRO coming soon to a bank near you. This will buy the ECB some time to measure the success (or utter failure) of another round of short term issuance. If indeed this money is parked right back at the ECB deposit facility and isn’t distributed by banks in the form of loans to stimulate growth it will be rather obvious that the velocity of money is slowing and highlights that banks are continuing to prepare for the worst. Regardless of the outcome, the ECB balance sheet will continue to explode as the LTRO operation isn’t forecast to decrease in size, but is estimated to possibly double to “1 trillion. That’s right, for those of you scratching your eyes; trillion, not billion. LTRO doesn’t do much to address insolvency and while the intention is to increase lending, the funds will instead be subsequently funneled back to the ECB deposit facility for the negative carry trade (borrowing at 1.00% to lend back at 0.25%).
Coming Up Today (All Times GMT)
• EUR – ECB Monthly Bulletin (9:00am)
• USD – Building Permits (1:30pm)
• USD – Core CPI m/m (1:30pm)
• USD – Unemployment Claims (1:30pm)
• USD – Philly Fed Manufacturing Index (3:00pm)
• USD – Natural Gas Storage (3:30pm)
Risk appetite is re-emerging in the markets as the dollar has been losing ground against the euro on signs the global economy is gaining momentum. On the other hand, demand for the euro was contained as Greece is trying to forge an agreement with private creditors – represented by the Institute of International Finance – and as France is scheduled to auction bonds today with maturity of more than a year for the first time since S&P stripped the nation of its AAA credit rating on January 13.
Euro found support around $1.2730, while resistance lies currently at $1.2870. Against the Yen the euro found support around 97.80 and at the moment EURJPY is trying to break a 2-week resistance level around 99 yen.
Today’s unemployment data will provide insight into US policy makers to evaluate their monetary policy, while additional monetary easing remains an open scenario. The next policy meeting will be held on Jan 24-25 and is expected to reveal the policy makers intentions for the near future.
EURUSD Support/Resistance: 1.2785/1.2925
GBPUSD Support/Resistance: 1.5365/1.5490
USDJPY Support/Resistance: 76.55/77.05
AUDUSD Support/Resistance: 1.0355/1.0475
EURGBP Support/Resistance: 0.8280/0.84
As inflation comes under control and approaches the 2% target rate, there is a definitely possibility of a 0.50% rate cut in the first half of the year. This will leave more room for Draghi’s backdoor easing. Not unlike his predecessor, Mario Draghi is a great liar. He will continue to say one thing and then do another in order to “protect” Europe from its worst enemy; itself. To give an example, the efficacy of his policies is paramount in the shorter-dated debt auctions. Why? Shorter-dated maturities, namely those of Spain, Italy, France, and Greece, are all showing better bids and lower yields as the ECB steps in as buyer of last resort in conjunction with the U.S. swaps agreement which was constructed to ease interbank lending. Longer-dated maturities however remain as a weak spot. Is this the work of the invisible hand, aka the ECB and its covert bond purchase program? Draghi has signaled his willingness to continue intervening in sovereign bond markets to limit yields to a palatable level, but has reiterated that he will not move to expand the asset purchase program. Is he indeed buying up debt on the primary market instead of the secondary market to hold down yields and give the illusion of demand to calm markets? If so, I think we’ve seen the outcome, mainly in longer-dated Portuguese debt which was hammered yesterday (yields rose from about 12.5% to 14.5%). The giant game of European “whack-a-mole” is certainly showing its cracks.
At the end of the day Draghi has shown more transparency than Jean Claude Trichet. But remember, he is still maneuvering in the shadows to fight the crisis, namely in bond purchases. His comments though have reflected his impression that European leaders are not doing enough to address fiscal policy. He went one step further to criticize the plan, stating the need for actions, not just commitments. Inherent in the newly proposed fiscal compact is further economic integration and less financial sovereignty for EU members.
When and how the market can start refocusing on economic data, instead of headline news?
This question deserves a noteworthy response as the last 6 months have been dominated by headlines that have a tendency to change every hour. The half-life of news trades used to be days. That has been shortened to maybe an hour. The old phrase, “buy the rumor, sell the news” has taken new meaning as economic data is dismissed as irrelevant to traders. Granted, for major news outlets, doom and gloom sells more advertising space than peace and love. But lately, it seems that news outlets have been on a witch-hunt to uncover darker truths than their competitors. Trading news is near impossible as it is bound to change within an hour of release. The transition necessary for traders to incorporate economic fundamentals hinges on our favorite insolvent sovereign; Greece.
The situation in Greece has been unfolding now for years, as the country enters its 5th year in recession. Major industry players, including Bill Gross, have announced that Greece is indeed doomed and will be forced into bankruptcy in March. Fitch also came out yesterday stating that missing the “14.5 billion repayment or restructuring existing debt would qualify as a credit event, thus triggering credit default swaps, tugging on the already fragile threads holding together the daisy-chained financial system. If the creditors and government should come to a resolution for the debt swap this week, the next bailout tranche will buy more time, but for what outcome? At the end of the day, the arguments over the new coupon and maturity are a joke because in the event that the sovereign entity goes bankrupt, the creditors could lose more than proposed swap.
It underscores the fact that Greece should declare bankruptcy sooner rather than later in order to usher a new chapter of growth. Once this situation is put to bed, markets can begin focusing on what matters which is economic fundamentals, not headlines breaking every half-hour.