Archive for August 2012
While many in the market saw bluster in yesterday’s Der Spiegel article, I smelled smoke. The article written by Ambrose Evans-Pritchard in the Telegraph,
shows there is indeed fire behind the smoke.
AEP asserts that Jorg Asmussen, Germany’s member of the ECB’s executive council, fully backs ECB President Draghi. AEP also confirmed that ‘ECB technicians are examining plans to cap Spanish and Italian bond yields,’ with the analysis on how this can be done lead by Ulrich Bindseil, the ECB’s Director-General of Market Operations.
The ECB’s meeting in September will be the time and place when this plan is presented to the ECB members. Up to this meeting the ECB will draft the model for action.
The market consistently calls for action from the ECB. Unlike the US FED, the ECB is treading through unfamiliar ground. It takes time to draft consensus and agreement, it also takes time to make sure that any action falls within the bounds of the ECB’s mandate.
AEP points out that, “Mr. Asmussen told the Frankfurter Rundschau that the surge in Club Med bond yields over recent months “reflects fear about the reversibility of the euro, ad thus a currency exchange risk” rather than bad economic policies in struggling states.” He points out that the wording is important. “If it can be shown that the ECB is acting to avert EMU break-up – known as “convertibility risk” – bond purchases would no longer be deemed a bail-out for Italy and Spain.”
Now there are some that have been saying any move by the ECB to cap yield differentials between Spain/Italy and Germany would be terrible news for Germany as it would push up German borrowing costs. These detractors fail to understand the liquidity differentials between the ‘Club-Med’ countries fixed income markets and Germany’s. It doesn’t take much to move Spain and Italy yields lower. It would take much more to push German yields higher.
French economist Guy Sorman had an excellent piece in the weekend’s Wall Street Journal, “Guy Sorman: Why Europe Will Rise Again”
I think this piece is excellent reading as it goes into depth on how much EUR detractors underestimate the political will European leaders have for the EUR to stay together.
I fully believe the ECB will give the green light to yield manipulation. It is not a new concept, after all, the US Federal Reserve keeps US yields low in the face of fiscal difficulties, as do many countries that have embarked on quantitative easing. It has become so prevalent that many commentators in the US use the low US yields as a reason for US fiscal health. A case in point would be John Cassidy’s piece in the New Yorker, where he states: “(If people in the markets truly believed Ferguson’s analysis, the U.S. government would never be able to issue ten-year bonds with a yield of well under two per cent).”
Mr. Cassidy fails to mention yields are where they are because the US Fed is buying that paper.
As of writing, the EUR/USD is trading at 1.2420. Should the ECB follow along the lines of that suggested by Der Spiegel and the Telegraph, which I think it will, then there could be a significant squeeze higher in the EUR/USD, especially considering the technical breakout of the downtrend witnessed last night. I continue to be a EUR/USD bull. I do not see myself as a contrarian, but rather as someone who is convinced of strong EU political support, and ECB action.
Douglas C. Borthwick
Over the weekend German Newspaper Der Spiegel http://www.spiegel.de/international/europe/european-central-bank-may-set-yield-targets-for-bond-purchases-a-850979.html suggested the ECB was nearing a decision to cap yield differentials between German and peripheral counterparts. Earlier today the ECB stated “it is wrong to speculate on the shape of future ECB interventions,” adding “it is misleading to report on decisions which have not yet been taken.” While I believe that such action has not yet been delivered to the desks of the ECB Governing Council it does seem likely that the ECB has been studying ways to give action to ECB President Draghi’s words from August 2nd, where he alluded to the ECB intervening in the secondary market. Any such decision and action is likely to be proposed on September 6th.
It should come as no surprise that the Head of the Bundesbank, Jens Weidmann, is not in favor of such action, however it should also be noted that as long as the ECB sees this as being within their mandate to ensure price stability; then Weidmann’s lone voice may be drowned out by his ECB Governing Council counterparts.
Douglas C. Borthwick
CNY/JPY has continued its move to the upside, as USD/JPY leads the charge.
Last month I noted the support at 12.20 in CNY/JPY and suggested that this pair would experience a short-covering rally. Since then it has rallied to 12.49, just shy of the 200-Day Moving Average at 12.50.
Japan has very little interest in having a strong Yen against its Chinese trade competitor, and is generally quite vocal whenever the cross nears the 12.20 area. While many argue that the reason for the short covering is the higher yields in the US, I would argue that this is a by-product. The real reason is that June and July 2012 saw significant risk moving into safe-havens. These would include both US treasuries and the Japanese Yen.
The safe-haven move came as the market worried about a collapse in the Euro-zone. This is a worry that has been with the market for the past few years, reaching a high-point in early summer. The odds of Eurogeddon have diminished significantly since then as the summer has continued on. While Europe has been largely on vacation, the ECB and the EU have been hard at work shoring up the legal end of their Summit promises.
The market now waits for German and European courts to validate the ESM, while the ECB waits for a formal aid request from Spain. Yields in the periphery have decreased dramatically from their highs, and the EU/US 2 year basis swap is trading close to its narrowest in 12 months. The EU has consistently noted that it works on its own timetable, and not the market’s. This summer and its lack of volatility has played into their hand. September and October should be interesting, but for now it looks like August will see continued short covering of risk-on positions. The market isn’t covering short positions because things are better in Europe. Rather it is covering risk-off positions because Eurogeddon has failed to come to fruition.
Douglas C. Borthwick
No matter how you parse it, today’s Philadelphia Fed number disappoints. It is hard for US consumers and companies to step up demand in an economy that continues to let them down, while offering little in terms of stability for the future. I expect US data will continue to be weak through the end of this year; in part due to the election cycle, but also due to the uncertainty surrounding both the US Congress’ and the US Fed’s ability to confront the looming US Fiscal Cliff.
While it is true that the backdrop of European uncertainty continues to weigh on the US economy’s shoulders, it is not the main cause of uncertainty, nor should it be made the scapegoat. US consumers and Corporate CFOs share a common anxiety over a number of issues in the US. Be it uncertainty over the safety of their financial institutions following MF Global, Lehman Brothers and Knight Trading news; uncertainty over the reliability of their financial institutions following the LIBOR fixing scandal and apparent lack of Federal/Regulatory oversight; and finally uncertainty over the willingness of the US Congress to confront the US Fiscal cliff coupled with the US Fed’s ability to do much more given the increasingly diminishing returns of QE.
All of these uncertainties cast a shadow over confidence and spending. Only with confidence will we see an uptick in the economy, and with that an increase in equity volumes.
An Op-Ed by Lee Il Houng, The author is the senior resident representative of the IMF in China.