The positive reaction to yesterday’s ECB decisions was a step too far for the EUR/USD rate, with the yen (weaker), Aussie (stronger) and stocks (Spain up over 3%) all better indicators of the positive reaction. The reaction on EUR/USD was contained by the stronger dollar tone on better labour market indicators (ADP and initial claims data) ahead of today’s employment report.
Short-term, there is a positive glow about the single currency, because after more than two years of sovereign crisis-management, the ECB has formally come out in favour of moving beyond a strict interpretation of its mandate to keep inflation stable just below 2% and taking on a wider and more formalised role in supporting the single currency. The wider issue is how we get to there, given that the ECB’s new tools will only be activated once a country has formally applied for assistance from the rescue fund(s).
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So beyond the initial glow, there is a sense that things have to get worse (i.e. Spain and/or Italy ask for assistance) before they get better (the ECB comes out with guns blazing). The outside hope is that the mere presence of this new regime will mitigate the chance of it ever being activated. For now, that’s probably a hope too far.
Commentary
Positive payroll prospects. The tentative signs for today’s non-farm payrolls look positive, based on some of the partial indicators released over recent days. According to ADP Employer Services, private payrolls jumped by 201K last month, with July being revised higher to a 173K rise. Separately, initial unemployment claims fell by 12K in the most recent week to 365K. Average claims for the month of August were broadly unchanged from the previous month. Finally, the employment component of the latest ISM survey remained above 50, suggesting some jobs growth (albeit modest). The central expectation for non-farm payrolls tomorrow is an increase of 127K – based on the preliminary evidence there is a decent prospect that the outcome will be on the higher side of this expectation.
The franc party. The Swiss franc celebrated its one year ‘cap’ anniversary with a party. EUR/CHF has been bordering on comatose for over three months now, but the past two sessions have seen the CHF depreciate by around 0.4% at the lows, which may not sound a lot but is significant when compared to the normal daily range of around 0.05%. It seems that nerves are entering the market ahead of next week’s quarterly policy assessment by the SNB. The domestic economic outlook remains weak, deflation persists and for all of the past year the SNB has maintained that the franc remains overvalued, even at EUR/CHF 1.20. On this basis, there seems to be some position adjustment and hedging on the basis of expectations of a modest upward adjustment to the floor on EUR/CHF. On balance, this appears unlikely in our view, with the SNB likely to be more focused on mitigating the effects of the franc liquidity injections on the banking sector, which has spilled through into the property market. The other point to note is that the latest GDP data showed the external sector holding up to the stronger franc relatively well. It’s not easy, but Swiss exporters are pretty resilient and used to dealing with a strong currency.
Acronym arbitrage at the ECB. The much awaited presentation from the head of the ECB was largely as expected, given the leaks that were seeping out ahead of the event. The old bond-buying vehicle (SMP), which has in effect been “on ice”, has been shut. The bonds will just mature over time. A new acronym has arrived in the form of outright monetary transactions. This is where the ECB buys the bonds of countries either receiving help from the rescue vehicles, or a precautionary program (Enhanced Conditions Credit Line). Even if a country (read Spain, less so Italy) applied for such assistance, it would be some time before the ECB would be able to start buying bonds. It appears that the IMF will be brought in to design the country-specific conditionality and this in itself would take some time. Finally, not a great surprise to see that all bond purchases will be sterilised, so the ECB will ‘mop-up’ the additional liquidity created via such purchases, nor that it will rank equal to private sector holdings in the event of any subsequent debt-restructuring. The market reaction is a classic case of the euro pushing up in anticipation of today’s announcement, together with the rumours and leaks, then selling off as if nothing over and above this was delivered. As a result, upside resistance on EUR/USD around the 1.2655 has remained intact.
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