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Friday was another eventful day in what has been a very dramatic month for both asset markets and currencies. Equities continued to plumb new depths as rumours spread that a major European bank had made use of the Fed’s emergency swap facility through the SNB. With the likes of Austria, the Netherlands and Slovakia joining Finland’s call for the Greeks to post collateral before the latest bailout is signed off, it was little wonder that the bears were out in force again. The FTSE dropped through the 5,000 level at one stage to a low of 4,929, while the DAX was down another 5% at one point after Thursday’s near 6% decline. Gold soared to new record highs, reaching $1,878 an ounce, the oil price fell to near $105 and the Swiss franc made strong gains.

Interestingly, in the light of the risk-repulsion that was again on full display, government bond yields actually rose after some dramatic falls in recent trading sessions. The mood shifted somewhat in the middle of the day, with shorts forced to cover as the market swirled with talk of an emergency Fed meeting. In addition, the Spanish government bravely announced new austerity measures, combined with pro-growth measures such as reductions in VAT on home purchases. Finally, Economics and Monetary Affairs Commissioner Olli Rehn provided the euro with a huge boost when he intimated that the EU may present draft legislation on the issuance of Eurobonds in an attempt to curtail the region’s sovereign debt crisis.

Guest post by FxPro

Commentary

Eurobonds get a push from the EU. Despite strong objections from Germany, it appears that EU regulators are now considering introducing the sale of Eurobonds after opposing such a course earlier this year. In response to a query in the European Parliament, Olli Rehn declared that the EU was looking into the feasibility of Eurobonds, which would be designed to “strengthen fiscal discipline and increase stability in the euro area”. German politicians remain generally opposed to the idea of Eurobonds as they believe it represents a form of fiscal transfer. On Thursday, Angela Merkel suggested that Eurobonds were “not the right answer”, although one suspects that in private she may hold a more nuanced view.    

UK public finances showing only slow improvement. The data on the UK public finances are going to be ever more important during the coming months, as the UK embarks on a fiscal consolidation exercise of a scale unprecedented in recent history. At the same time, there’s no doubt that the economy has slowed and will not be as strong as the Treasury envisaged in the budget presented in March.   Showing a repayment in July of GBP 5.6bln, the PSNCR (public sector net cash requirement) headline data were not as good as anticipated.   For the first four months of the financial year, the cumulative total is GBP 29bln, compared to GBP -11.74bln last year (i.e. a surplus). This does include the impact of financial interventions, which does make the data rather ‘lumpy’.   If we take the cumulative net borrowing (excluding financial interventions), then we are only marginally lower than this time last year (GBP 40.1bln vs. GBP 43.1bln). Central government receipts have generally been running higher but so has spending on interest payments and also social benefits, hence only a small improvement in the overall position. From this angle, we are seeing only a creeping improvement in the public finances and at a pace that is likely to struggle to achieve the targets laid out in the March budget. Furthermore, the recent data on the labour market – and also GDP – suggest that it will be a struggle to contain not only spending on social security but also to sustain the modest improvement in revenues. The pressure is likely to mount on the Chancellor to yield to at least some relaxation of the fiscal austerity, given domestic and also global developments.   The recent fall in gilt yields may help offer some scope to achieve this, but the question is whether the coalition is willing to break with its pledge to forge ahead, without a ‘Plan B’.   Sterling continues to believe that the UK government is on the right course, with backing from the OECD among others, but this belief could be strained in the coming months should growth numbers continue to disappoint.

Tokyo expresses increased alarm at yen strength. Japanese policy-makers expressed increased alarm at the continuing strength of their currency over the course of last week, raising the prospect that another round of intervention is under serious consideration. Just like their counterparts in Switzerland, policy-makers are struggling to respond to the currency’s ongoing appreciation, at a time when the economy is still really struggling to emerge from recession. Finance Minister Noda has been talking tougher, claiming that FX intervention needs to ‘surprise’ in order to be successful. Based on the fleeting success of the BoJ’s surprise intervention two weeks ago, unfortunately surprise is no guarantee of success given the strength of safe-haven demand. Noda also claimed that both monetary and fiscal policy could be wheeled out to try and weaken the currency. This claim also sounds hollow. With public debt already 200% of GDP and set to go still higher, fiscal policy desperately needs to be tightened, although it needs to be done very carefully given the fragility of the economy. Also, there is a limit to the contribution that monetary policy can make, as the central bank has been running a very large balance sheet for a very long time and excess reserves held by banks at the BoJ are already enormous. As such, a further injection of liquidity would be pointless. It may well be that Tokyo will need to live with a strong currency for a while longer.