Going nowhere fast

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Not for the first time, we’re left with the impression in Europe that policy-makers are running to stand still and failing to keep up with the pace of events.  On Monday, it was once again developments in the banks that were gaining the main attention.  The euro did manage to regain some of its poise after the initial selling pressure seen during the Asian session, but it was a token effort in light of the recent losses. 

Meanwhile, the ECB is looking more and more adrift after the resignation of its Chief Economist Juergen Stark, the second casualty from the German establishment due to the ECB’s foray into bond-buying. The phrase ‘end-game’ is cropping up more often with regard to the eurozone situation and understandably so.  Quite simply, the momentum in markets (Greek 2Y yield now 70%) is far outpacing the ingenuity of politicians.

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Commentary

ECB has nearly doubled bond holdings in five weeks. The latest weekly data from the ECB shows that it purchased just under EUR 14bln, up from EUR 13.3bln last week. Total holdings have increased 95% since the re-opening of the bond-buying program in early August.  This is shifting a considerable amount of credit risk onto the ECB’s books with total holdings now EUR 143bln.  This is nearly a third of the lending capacity of the expanded EFSF, once agreement is secured for its extension from EUR 220bln to EUR 440bln. In July, EU leaders were adamant that this would be sufficient, but the extent of the ECB-buying seen subsequently adds weight to the view that the newly expanded EFSF could struggle to cope with the demands being placed upon it.

Banks drag the euro lower.  There was a sense of déjà-vu as Monday started the same as the last, with the banks strongly in focus. Three French banks were in spotlight (Soc. Gen, BNP and Credit Agricole) as Moody’s review period on their credit rating (3 months) comes to an end. The fall in their share prices (around 50% over three months) suggests to some that markets are already well positioned for a downgrade, but nevertheless there’s a nervousness that this could be the start of many more downgrades to come. Meanwhile, in Germany, there was further talk of preparing for the consequences of a default should Greece not meet the requirements of its next tranche of the bail-out payment. Given the fact that the market now places a greater than 90% probability of a Greek default over the coming five years, it would be imprudent of the authorities not to consider such a scenario. However, this does involve doing one thing and saying another, which is not the best way to inspire confidence in financial markets. The euro is now better correlated vs. the credit quality of banks (looking at senior financials CDS index) rather than peripheral bond spreads, but inherently the two are very much inter-linked with the sovereign crisis squarely behind the current banking crisis. The euro’s Teflon coating, which protected it so well over the past year, appears to be flaking off rapidly.

Aussie suffers from that sinking feeling.  On the first trading day of the month, the Aussie was not far short of the 1.08 level and looking remarkably perky. However, risk repulsion has set in once again, with the MSCI World Free Index down 6% already this month and the AUD falling below 1.03 overnight. Growing concern that the major advanced economies are heading back into recession has also hurt commodity prices. Even the once-impregnable gold price is looking more circumspect these days, which is unusual as in previous episodes of risk avoidance it has tended to do well.  Apart from generalised risk avoidance and a renewed (perhaps somewhat begrudging) respect for the dollar, developments in the domestic economy have also weighed on the currency. As long as next month’s Q3 CPI outcome shows some moderation of inflationary pressures, then the marked slowing in growth down under should result in an easing of monetary policy quite soon thereafter (if not before). One look at the hugely inverse yield curve suggests that more than one rate cut is likely – the current 10yr bond yield of 4.1% is 65bp below the cash rate.  Worth noting is the overnight release of the NAB business confidence survey, showing a sharp fall from 2.0 to -8.0 in August, this being the lowest level since May-09.

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