The euro’s break below the 1.30 level has been sustained overnight and it’s notable that the dollar has risen in all but two of the past nine sessions, looking at the dollar index chart. The political events in Europe, both in France and Greece, have served to enhance the more risk-averse trend that was already in place last week.
Furthermore, in Europe we are seeing fresh signs of stress in the banking sector. The amount banks are borrowing from the ECB overnight (at penal rates) has jumped, and we’re seeing a widening in other measures of stress, such as cross-currency basis swaps and also Libor-OIS spreads.
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These both reflect greater concerns with regards to the fragility of the European banking sector, but at present there are few signs that the ECB is keen to get stuck in, already having undertaken two 3Y injections of liquidity. We’ve also seen disappointing trade data from China overnight (a bigger balance but also a slowdown in both exports and imports). Meanwhile, Asian equities are declining for a sixth consecutive session, the MSCI Asia (ex-Japan) index is now around 7% up on the year, having stood 16% higher at the end of February. Reality is biting hard and not only in Europe.
Commentary
The golden question. This week has been pretty key in the gold market. Spot fell over 2% on Tuesday and, as well as moving below the USD 1,600 level, it also fell through key trendline support just above that level, drawn from the late-2008 lows. Technically, this puts the gold bulls in a more difficult position, arguing that what we are seeing is just a temporary pull-back from a longer-term uptrend. As always, some of this recent activity can be put down to the movements in the dollar, with the dollar index rising against the backdrop of greater political uncertainty within Europe. The 1mth inverse correlation between gold is nearly at its strongest for the year. What’s more interesting however is the way gold has now diverged from what’s happening in global real interest rates. The negative correlation between the two has been quite strong for most of the past four years. As real interest rates have fallen (and indeed are negative on our measure), investors have diversified into risk assets, including gold, as a way of seeking higher risk and also return. This relationship appears to have broken down of late, with the 6mth (weekly) correlation currently at zero, having averaged -0.60 since mid-2007. This suggests that the risk appetite of investors is waning, even with near-zero funding costs and low or negative real-returns elsewhere. The gold bulls need some new ammunition to justify fresh record highs because the rules of the past few years are changing.
Moody’s bank downgrades looming. Back in February, Moody’s intimated that it was reviewing the credit ratings of more than 100 banks, with the results expected to be announced in the near term. For many, a single notch downgrade looks unavoidable; moreover it will raise funding costs and limit access to the wholesale market, reduce profitability and result in margin calls. This in turn will further constrain the availability of credit, at a time when the ECB has already provided bountiful liquidity to banks through the LTRO. On the positive side, some of the earnings results of some of the banking majors (JPMorgan, Deutsche Bank, Goldman Sachs and RBA) have been better than expected. At a time of renewed and heightened uncertainty, a cacophony of bank downgrades is the last thing an already skittish market needs.
Bonds bite back. As expected, the bond vigilantes are punishing those sovereign markets in which the political will to implement fiscal austerity is in doubt. In Italy, where Silvio Berlusconi’s People of Liberty Party is backsliding on the ratification of the fiscal treaty, and in the north where there was a surge in support for anti-euro candidates in last weekend’s elections, the 10yr yield was up to above 5.50% yesterday. Meanwhile, German bonds themselves were in uncharted territory, with the 10yr yield down to just 1.53%, and the 3yr yield just 0.2%. Gilt yields are also attracting a safe-haven bid, the 10yr yield (now 1.93%) closing in on a multi-decade low.
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