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Telegraph Article Points to Fire that Der Spiegel Smoked

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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,

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9488698/Germany-backs-Draghi-bond-plan-against-Bundesbank.html

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”

http://online.wsj.com/article/SB10000872396390444375104577592850332409044.html?mod=ITP_opinion_0

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).”

http://www.newyorker.com/online/blogs/johncassidy/2012/08/niall-ferguson-vs-paul-krugman.html?mbid=social_mobile_tweet

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
Macro Analyst
MacroTack
646-236-2892

Written by MacroTack

August 21, 2012 at 8:31 am

Posted in EUR/USD

Der Spiegel Smells Smoke

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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
646-236-2892

Written by MacroTack

August 20, 2012 at 9:04 am

Posted in EUR/USD

CNY/JPY Continues to Move to Upside

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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
646-236-2892

Written by MacroTack

August 17, 2012 at 9:38 am

Posted in China, EUR/USD

The EU/US 2-Yr Basis Swap Continues to Narrow

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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.

Douglas

Written by MacroTack

July 27, 2012 at 12:22 pm

Posted in EUR/USD

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Is the ECB Ready to Make Olympian Decisions?

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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.

Douglas

Written by MacroTack

July 27, 2012 at 8:29 am

Posted in EUR/USD

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What if the ECB bought all Debt proportionally in the Euro-Zone?

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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.

Douglas

Written by MacroTack

July 26, 2012 at 3:14 pm

Posted in EUR/USD

DXY, USD/Index now sitting on Support

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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.

Douglas

Written by MacroTack

July 26, 2012 at 9:50 am

Posted in EUR/USD

Tagged with , ,

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