Archive for July 2012
The excitement over this week’s ECB comments has seen the EU/US 2-Year Basis Swap narrow to below 50bps. This was last seen on June 15th, when the EUR/USD was around 1.2700, and on May 7th, when the EUR/USD was above 1.3000. This tells me that while the inter-bank market is finding comfort in the ECB and EU message, the currency market as reflected by the EUR/USD rate at 1.2370 remains behind the curve.
Discussions continue to grow within the ECB regarding Greece and Spain. Over the past week we have heard from Draghi, Nowotny, Noyer et al. The 200 Month-Moving-Average in the EUR/USD has been a line in the sand going back to 2004. It was the US FED and China who formed the bottom in June 2010, and now the torch has been passed to the ECB.
The ECB is holding Greek debt on its balance sheet at par following the last Greek restructuring. While the media indicates they may take a ‘loss’ on their position to help alleviate Greece’s debt-load, they may simply re-mark the position at cost. This would not be a ‘loss’ to the ECB, but rather the ‘fair’ thing to do. It would help Greece get from under its ominous debt load, and create a turning point for its future.
The ECB should buy debt in the secondary market in times of stress and later sell it back to nations they help. When a US bank sees its debt drop in value and CDS blow out, the US bank reports a ‘profit’ based on the cost it would take for them to retire their debt at lower levels. If Greece and Spain were US banks, they would be reporting significant earnings.
The market continues to believe this is a short-covering rally that should be sold into. I believe Draghi et al believe this may be the turning point.
If the ECB bought debt across the board in the Euro-zone in proportion to ECB membership, it is doubtful that Germany could complain, given all countries would be treated equally. Whats more; given the liquidity in peripheral debt versus core debt, proportionate purchases of EZ debt would have a much greater effect on the peripherals. It could serve to cap yields, and establish a floor on the current situation. Something to think about.
CNY/JPY has yet to take part in today’s risk-rally, though it does look poised to do so. 12.20 showed good support in early June. Japan has made it clear they do not want a stronger JPY, and consistent voices in the Diet are anxious about Japanese exporters moving to China. The RSI’s are turning higher off the lows much as they did in June. Tonight’s USD/CNY should fix lower given EUR/USD strength. Something to watch in coming sessions.
The USD/Index has slipped to its support line on the back of ECB Draghi’s favorable comments. The EUBS2 EU/US Basis swap has tightened and Spanish 10-yr yields are back below 7%. The 10-yr Spain market is illiquid; what is seen today is an amplification of liquidity. While yields can quickly move higher, they can move lower with similar speed.
The market now waits to see whether recent ECB rhetoric can proceed towards action.
Overnight, Mario Draghi once again stressed the ECB’s Mandate limitations. He said;
“To the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate… We have to cope with the financial fragmentation, address these issues… Within our mandate, the ECB is ready to do whatever it takes to preserve the euro, and believe me, it will be enough.”
Earlier in the week I noted that the ECB was likely to step up rhetoric given the EUR/USD’s proximity to the 200 Month-Moving-Average. This is a prime example, as were Nowotny’s comments yesterday. The ECB is not asleep at the wheel. Rather it is working within the confines of its mandate. I am certain Spanish yields above 7.5% do not show ‘price stability’ to the ECB. They will likely buy time through rhetoric, and then use a form of leverage on the ESM in September.
Monti once suggested using the ESM to guarantee first loss to the ECB on any secondary market purchases. This would add considerably to ESM firepower. Also note that the ECB continues to hold Greek paper at par, despite its cost being much lower. It would be interesting to see the ECB re-mark this paper at cost; giving debt relief to the Greek people. There would be no material loss to the ECB, yet would denote remarkable goodwill to Greece. Sometimes the carrot is needed along with the stick.
This 200-Month-Moving-Average has held since 2004, after being tested in 2005 and 2010. The US FED seems to be trying to protect the downside through threats of QE3; while the ECB ponders allowing the ESM to have a banking license.
In 2010, when this moving average was last tested; the USD came under severe pressure from FED QE decided at Jackson Hole, coupled with a change in Chinese rhetoric regarding the Yuan, where they decided to allow it to become more ‘flexible.’ This allowed China to be more aggressive in their reallocation of FX reserves from the USD into the EUR. The latest statements from China and the IMF lead me to believe they are happy with the current USD/CNY rate, and see it at equilibrium. That being the case, all eyes on the US FED and the ECB.
Any significant move through this support line will likely generate a reaction from various Central Banks.