The dollar sell-off late into the NY session saw the euro one of the main beneficiaries, with EUR/JPY pushing higher for the 7th consecutive session. Indeed, it’s EUR/JPY that best illustrates the change in FX dynamics we’ve seen over the past week or so.
On the yen, only some movement can be attributed to the change in policy from the BoJ, with the widening of interest rates spreads in favour of the US being a better explanatory factor of the move we’ve seen on USD/JPY.
As for the single currency, it is once again notable for its resilience, undeterred by the 38-point plan that Greece has to implement to secure its bailout funds, together with the bond-swap which is due to start today. The euro stands out as one of the strongest performers of the majors so far this week, despite the negativity surrounding the Greek deal and the road ahead.
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One has to acknowledge its resilience, helped by firm data from Germany yesterday, but also be aware that we have a critical four weeks ahead for Greece, during which there are numerous hurdles to negotiate.
Commentary
German Ifo and internal competitiveness. The firmer than expected Ifo figures (and rumours of a strong number beforehand) proved to be the catalyst for the break above 1.33 on EUR/USD yesterday, with the ground set during the Asia session by a marginally weaker tone to the dollar. The jump in the expectations balance of the business survey (from 100.9 to 102.3) is the more notable aspect, having the better leading properties to GDP vs. the current conditions element. This suggests that Germany may be able to escape a technical recession after the decline seen in Q4, but on present readings it’s going to be a close-run thing. For the currency markets, there is something of a dichotomy. Whilst better than expected strength in Germany is a positive in isolation, it also serves to widen the gap between Germany’s performance and that of peripheral eurozone nations. Although the talk earlier in the week from the EU and IMF was geared towards making Greece more competitive once again, the road to achieving this is going to take many years to travel, if not a decade or more. Naturally the main focus is on internal competitiveness, as this is where the greater deviations have occurred. If Germany’s prowess leads to greater inflation – at a time of slower or no inflation in the periphery – then Germany could play its part in closing this gap. But so far, all the signs have been that Germany wants to place the onus on other nations, rather than be ‘punished’ for its own success. That said, for now at least, having been overwhelmed by negativity in recent weeks, the single currency is content to jump on some rare good news to come out of the eurozone.
The ECB’s LTRO dilemma. Next week the ECB will undertake the second 3Y auction, but does this mean more of the same if take-up is high? In all likelihood, probably not. With regards to the EUR 489bln that was taken up in December, there are a few things that we do know and a few we should. Firstly, it is sometimes forgotten that the net increase in liquidity was EUR 193bln because a lot of funds matured around this time and banks switched to borrowing longer-term rather than refinancing through shorter-term repos with the ECB. Secondly, the ECB’s own analysis showed that there was a strong correlation between bank refinancing requirements in the coming year and take-up in the 3Y refi. This adds weight to the view that the auction did play a key role in reducing refinancing risks in the banking sector, with banks in the Eurostoxx 600 outperforming the main index by nearly 6% over this period. Whether the carry trade has been more internal (investing in EUR-denominated assets) or external (non-EUR) is more difficult to ascertain. Certainly, the data from the ECB showed banks to have turned net-buyers of government paper in the last two months of 2011, but the data for the early part of 2012 is not yet available. Given the ECB’s sense that bidding was more linked to refinancing needs, then the rally in external assets appears to have been an indirect rather than direct consequence of the auction of funds. This brings us to next week’s offer of funds at which the market will be in something of a no-win situation. If take-up is large (over EUR 500bln, some talk of up to EUR 1trn), then this takes us towards a situation where the banking system and asset markets are ever more reliant on central bank money, which makes the road to the exits (the ECB stresses that these are temporary facilities) that much longer. This may prompt further gains in risk asset and peripheral bond markets but, for the former especially, it will be an even weaker basis for gains. Conversely, if take-up is low, whilst this could be taken as a sign of an improved balance sheet situation for European banks, there is a reasonable case for suspecting that markets will fear the rally in peripheral bonds is over. The route to the exits will be shorter, but the fact that this is a 3Y funding auction underlines that we are in this for the long haul. Overall, markets will struggle to be clear-cut on the implications, whichever way the results go.
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