On the first day of the new week it was the dollar that was in retreat as investors shed some of their pessimism and risk appetite returned. Bolstered by Google’s announcement that it was buying Motorola, and Warren Buffet’s admission that Berkshire Hathaway had jumped back into equities in a big way last week, the S&P closed up more than 2% at just above 1,200. The single currency was a major beneficiary of the dollar’s decline – at one stage, the euro was up more than two big figures and looked poised to penetrate 1.45 as shorts were forced to cover, but it has since drifted back and in early London trading is just below 1.44.
Rumours that the issue of Eurobonds might just feature in today’s discussions between French PM Sarkozy and German Chancellor Merkel also triggered some euro short-covering yesterday. Against high-beta currencies such as the Aussie and the Norwegian krone, the dollar also fell back sharply, with losses of around 1.5% at one stage. Indeed, the Aussie threatened 1.05 in the London afternoon – just a week ago, it had fallen back briefly below parity. Another major currency to benefit from the dollar’s latest wobble was the Swiss franc – early in the day it was close to 0.80, but as the dollar lost ground the Swissie came back strongly and in early London is back under 0.78 again.
Guest post by FxPro
Commentary
Eurobonds: a step too far. In the ebb and flow of European crisis management, the issue of whether to issue common eurozone bonds comes and goes and right now it’s coming back. By common bonds, we mean debt securities issued for the benefit of all nations, rather than a single nation. But to achieve this, one inevitably needs a degree of political and also fiscal union, something which up to now has been fiercely resisted in most quarters. Would this be a step too far? For the peripheral nations, the answer is probably not. If it amounts to a choice between facing likely default – and the prospect of a disorderly exit from the eurozone – and giving up a degree of political authority – the latter route may be perceived as the price to be paid for avoiding years of pain and a greatly devalued domestic currency. Naturally, the bigger question is how this will fit with the top investment-grade nations, principally Germany, which will undoubtedly face the more substantial near-term costs from any such steps in terms of higher funding costs for a large proportion of its debts. Whichever way you slice it, eurozone bonds would be a very hard sell electorally. In principle, eurozone bonds are the most likely route via which the single currency will gain long-term sustainability. The issue we have is that the authorities are trying to keep together a political and economic system which is not designed to cope with what we are seeing now or able to secure the euro’s longer-term future. Fundamental changes are required, but it’s a question of how we get from here to there. Taking the Eurobond route, one of the key issues would be the credit rating of Germany (and France) and how this is maintained. Losing this status would have implications for the cost of funding for the EFSF and, by design the ESM, which is due to take over in mid-2013. The EFSF is triple-A rated, owing to the funding provided by France and Germany, so the cost of this could well increase if there is a move to common bonds and a more broadly denominated credit rating as a result. It is no doubt a complex issue and there are many obstacles, but we are now at the stage where such moves have to be given serious consideration rather than doggedly sticking to the current structures, putting on the sticking plasters and hoping for the best.
ECB buys more bonds than expected. The ECB’s weekly announcement of its Securities and Markets Program (bond-buying to you and me) was the most watched figure yesterday, in contrast to the previous nearly four months. The ECB spent EUR 22bln last week in trades that were settled, so this includes the initial buying that started on the day of the Governing Council Meeting of August 5th. There were some wide variations in terms of what the market was thinking with some thoughts of up to EUR 30bln being mooted. Nevertheless, this is still the biggest weekly level of purchases since the start of the initiative in the first week of May 2010 when we saw EUR 16.5bln of purchases. Yields on both Italy and Spain narrowed by 100bp to 125bp over the period in question. From this respect, the ECB has achieved decent results, but it was very much ‘shock and awe’ tactics. The question is, what is left after this initial shock and does the ECB (which entered into this reluctantly) have the stomach to continue purchasing? The answer is probably not quite at this pace, but still at a fairly decent pace.
Talk better than action for Swissie. It’s ironic, but so far at least, the mere threat of pinning itself to the single currency has done more to soften the Swiss franc than the vast interventions of 2009 and 2010 as well as the substantial expansion of the monetary base seen over the past two weeks. The issue was first raised in comments from the SNB’s Jordan last week, but according to the Swiss press there have been some advanced discussions between the government and SNB on the issue. In response, the Swissie fell more than 2% at one stage yesterday representing a loss of more than 10% since the middle of last week. For all the talk though, currency pegs only work when the policies of the respective countries are in general alignment so as to achieve an underlying equilibrium. Otherwise, the pressure on the respective central banks to intervene to support the peg becomes too intense and too costly, as was the case with the exchange rate mechanism in the early ’90s when sterling was eventually ejected (and others were forced to devalue). There is also the issue that the pressure on CHF would be to the upside and therefore whether the ECB would be a willing participant in wanting to defend any Swiss currency peg to the euro. In all likelihood, the answer would be no, unless such a peg could somehow be formalised in the interests of the eurozone. Right now, the ECB does and should have bigger problems to be dealing with. We still feel a peg is unlikely, but it’s not that surprising it’s being talked about, given that the options for the SNB are limited and the pain is intense from this year’s peak rise of 22% on a trade-weighted basis versus last year’s closing level (the current level is 15% appreciation). The best thing for now is for the Swiss authorities to keep talking about it.
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