View: Draghi’s comments should draw EUR/USD back to selling levels, m/t trend bearish
Reading some amusing comments reacting to Draghi yesterday, the best so far being ‘there won’t be a Euro short left once the ECB has finished’ (to paraphrase) which we’ll have to put down to heatstroke. Fundamentally the best adjustment mechanism to help peripheral realignment is a weaker currency. The other ideas such as the confidence the economies will receive from effective fiscal consolidation and the structural reforms that sit alongside this prescription sound nice but are rather ineffective in the shorter-term and overlook the recessionary pressures that are resulting from them, most evident in the Greek death spiral. ECB medicine is likely to be equally ineffective as we know that the central bank itself is one of the key proponents of the austerity model and German opposition to bond buying will continue to obstruct. We don’t think another LTRO would be a game changer or for that matter another rate cut, already justified by the inflation outlook. Perhaps the aim is just to buy time over the summer. Furthermore the kind of firepower needed to really rebuild confidence will continue to lag what is needed, evident in the sums the EFSF has and ESM has to work with.
Full report below…
View: Selling rallies to remain the play, low 1.30’s ideally
Nothing moves in a straight line as they say and this afternoon’s EUR/USD squeeze is a case in point. Some confidence from the ECB helped, with Draghi placing a positive spin on recent efforts by the central bank to prevent a credit crunch while reaffirming that a further 3-year LTRO would be held in February (we knew this but it shows the bank remains committed to QE providing liquidity). Markets also seemed cheered by his observation that there had been some signs of stabilisation on the economic front. This allowed traders to place more weight on successful Spanish and Italian auctions we saw earlier in the morning. An added kicker came from weaker US figures which hit screens as Draghi began – particularly retail sales for December (0.1% m/m vs. 0.3% median) – which helped pull the rug from specs that had bought into the idea that every US number would continue to surprise on the upside (relative outperformance of America does not mean a boom)………..
Full Report attached:
View: Sometimes the market is right; EUR/USD has plenty of downside
As per our European update from earlier in the week, which merely brought up to date our long-term bearish view of the single currency, the technical picture for the euro is as equally troubling. The market has been in a downtrend since October’s blip – built around expectations that a breakthrough at the month’s Eurozone summit would actually be a watershed moment for the debt crisis – and while positioning (based on the CTFC non-commercials) is currently very short it still looks like price levels are lagging. Indeed, spot is still 9 big figures above the 1.1875 lows EUR/USD traded after the Greek problem first reared its head back in the spring of 2010.
There are a number of theories as to why the Euro held up so well despite relentless bad news since the Greece requested aid, the first being that the major alternatives were not too great either (the least bad currency view) and the smaller alternatives were at stretched levels, AUD probably being the most notable example, or protected – which sums up the Asia situation and latterly the CHF. Mistakes also played a role, by this we mean the ECB’s tightening cycle that ran until July last year which contrasted so markedly with the Fed’s ultra-accommodative stance which culminated in its pledge to hold rates until mid-2013 and the ‘twist’ launched in September. There is a good correlation between EUR/USD and 2-year swap spreads which reflect this dynamic and have supported the decline. More recently the very factors that should actually be euro negative have created a bid for the currency with cash starved bank’s from the region selling overseas assets to repatriate cash, needs that are clear to see looking at the demand for the various ECB borrowing facilities such as the €489bn lent in the first offering of 3-year loans before Christmas. Such flows, which we’ll likely see more of (bank solvency issues won’t go away), are a good opportunity to sell of course.
Many of the fundamental influences have been weakening, aiding the current leg lower. ECB President Draghi’s reversal of Trichet’s mistakes was the starting point to this with further rate cuts likely over Q1 and perhaps beyond as the central bank tries to steady the blocks stumbling economy (highlighted by contracting PMI’s). More importantly the US economy looks to have found a firmer footing which should continue to pare expectations of QE3 there – in contrast to the ECB’s actions which look like QE in all but name. In fact, it seems likely that Fed tone will turn more neutral in Q1 thanks to improved growth and possibly begin to exhibit a more hawkish lilt as the year progresses, all while the ECB digs. This is where our ideas on a cyclical dollar upswing find traction. The US will hardly boom, but on a relative basis the differences should look rather pronounced, and with rate differentials between the euro and dollar turning positive the path of least resistance too will shift.
Volatility is likely to remain elevated however as European leaders continue efforts to resolve the crisis. It is of course possible that they might come up with a credible plan before things really fall apart. Elections in France this year mean Sarkozy will be desperate to get things sorted out and Merkel with Federal elections next autumn (2013) will also want to rid herself of this headache.
This is where the charts should prove enlightening, as they proved in Q4, offering insight into timing and confidence to run with the trend. As can be seen on the chart below the long-term movement is clearly downward for EUR/USD but ranges can be wide as seen during October’s squeeze. The current band probably tops out at the 50% Fib line at 1.3407, an area which has proven to be something of a pivot area too, 1.3770 at a stretch. Those that remember our Nov 9th note (http://bit.ly/zJCxxy) recommending short Euro have more breathing space than more recent entrants of course but while the market remains under this area EUR/USD should be traded from a short base, using rallies back to 1.3045 and 1.3200/30 in the first instance while leaning on the 50% fib line.
Looking at things shorter-term momentum still favours downside with the immediate draw being the 1.2570/1.2600 area where we might see accounts begin to cover some shorts, especially if news flow turns more neutral which it has shown a tendency to do for (short) periods. There are some signs of divergence on the daily technical indicators too, RSI for example, although not yet confirmed by price action. We also like the MACD but it isn’t offering a clear signal here which might also warrant more immediate caution too. Spec accounts will be looking at the 1.2930’s in the first instance for stops but for those with deeper pockets it’s a close above 1.3080 that should be watched. If the market can stretch back through here it would be a signal the immediate bearish bias has shifted and we’d begin to think we might get a chance to sell into those higher resistance levels.
This is the preferred strategy longer-term (3-months plus), working a book built around a core short, using volatility and periods of calm to cover shorts and sell out again at richer levels. Ultimately we’re still of the view that this is the early stages of a pronounced euro decline and with the US looking fundamentally stronger (in relative terms) the best way to play euro stresses should be via this cross. Ultimately the chart suggests a run towards the low 1.17’s is the objective, a sustained flip through here would open even lower targets sub 1.000.
Spot Ref: EUR/USD 1.2783
- Dollar vs. euro: Battle of currency chumps (money.cnn.com)
- Euro architect: ECB knew of tensions (cnn.com)
- ECB QE through the back door Euro 489 billion Sell Euro (greatlakesforex.wordpress.com)
View: Mario can’t stave of recession, austerity drive flawed, markets to remain tough
It was a good start to what should be an 8-year Presidency for Mario Draghi, the 25bps rate cut showing some degree of pragmatism from the ECB and the press conference was well conducted, indicating a smooth transition from Trichet – not that we expected otherwise. Of course Super Mario is well versed in the routines of the central bank, stepping up from his existing seat on the governing council, and was unlikely to fall into any traps even in these testing times. While median expectations were for unchanged rates, expecting Draghi to wait until December before delivering the much needed rate cut (the perception being he won’t want to upset the German’s), a good chunk of the market was still calling for a cut and given the extreme uncertainty surrounding not just Greece but also Italy and the block as a whole the decision is not really surprising even if Euribor traders thought so. Something needed to be done and in these times the only body with any firepower is the ECB.
Unfortunately expecting the central bank to take more aggressive steps under Draghi’s helm might be wishful thinking, it seems unlikely we’ll see any imminent U-turn in the bank’s policy towards Securities Market Programme through which it has been purchasing peripheral debt – namely that it is temporary – and even then there is a clear carrot and stick with purchases conditional on meeting required reforms to aid policy transmission, i.e. fiscal consolidation. Liquidity will continue to be provided as necessary to the regions banking sector although we’re not quite sure how this will fit with the counter-weight of banks increasing tier one capital, which can only restrict credit availability going forward. There was nothing in the recent EU-17 agreement to suggest any formal help to banks raise capital (EUR106bn needed) which we think would have been sensible, after all the prospects of bank raising such sums in private markets is not much better than fiction showing once again a high degree of ignorance from the EU17 leadership.
It is this leadership vacuum that is really at the heart of the crisis, the risk of a Greek default hogs the headlines but really it’s as much a symptom of poorly directed policies to deal with the sovereign debt crisis which began nearly two years ago. Perhaps the biggest irony of the current flare up is that even if Greece manages to escape from the clutches of the current Papandreou induced crisis another one is just around the corner. The medicine Sarkozy et al. are advocating can only add to the problems Greece faces. Austerity will fail as a policy, simply because the results of that pain are insufficient to bring the country back to a position of fiscal sustainability (120% of GDP based on the latest projections). It is another futile can kicking exercise.
We would have hoped the economic landscape was warning enough. But no. Prescribed fiscal tightening will merely magnify what looks to be an inevitable Eurozone recession. Draghi may have described his expectations of “a mild recession” this afternoon but given how little focus there has been on growth throughout this entire process risks are skewed to the downside. A recession also raises the spectre of a French downgrade which would pull the rug from the EFSF’s so called AAA rating (spreads already telling us this). On the positive side inflation should moderate leaving room for the ECB to take a more proactive stance on rates in 2012 but the poor health of the banking sector means the transmission mechanism won’t improve.
This has interesting implications for markets. It doesn’t bode well for equities in the region over the coming months so selling rallies looks sensible. DAX 6,000 is not a level we’d associate with a real crisis. It should also exacerbate the need for a weaker euro over the medium-term (no matter what the Fed might think). Despite the current mess the single currency is still 3.3% stronger against the dollar than at the start of the year and comfortably above (11.0%) its average since launch which sits around EUR/USD1.21. But even a move back to here would be insufficient to help restore some of the periphery’s lost competitiveness, closer to parity might. The (German) yield curve has steepened since the start of October and may have room to move out a little further if this week’s Greek fears can be put back into the bottle, but looking at the 5/10’s spread levels above 90bps looks too steep to us, even if you buy into the idea that German credit quality will be compromised by bailout costs. This is perhaps the trade where we closest too in terms of timing based on the current story.
- Five Highlights of Mario Draghi’s First Press Conference (blogs.wsj.com)
- Economists’ Early Reactions: ‘Decisive Move’ in Draghi Debut (blogs.wsj.com)
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