The political theatricals in Washington have captivated markets for the past few weeks, but now the show is over, there’s a feeling that the crowd is hungry for more. For Tuesday, there was a quick shift back to Europe to see what the supporting cast was up to. The spread of Belgian bonds over Germany’s pushed out above 200bp for the first time since the start of monetary union, whilst France was also pushing higher (out to 75bp over Germany). Two of the past four trading sessions we have seen true de-coupling of Germany and France, so German yields moving lower as French yields move higher.
The price action on the Swiss franc is also indicative of investors becoming more concerned with sovereign balance sheets, with yesterday’s down-move on EUR/CHF the biggest one seen since the start of EMU back in 1999. The other thing we are seeing is banks hoarding cash, especially in the eurozone money market. All this is telling us that, despite the deals cobbled together on both sides of the Atlantic, the show is far from over.
Guest post by FxPro
Commentary
Moody’s relatively relaxed on US ratings outlook. The first assessments from Ratings agencies since the US debt deal was agreed saw both Moody’s and Fitch put the US on watch for a possible downgrade, the same as S&P instigated last month. That said, Moody’s says that the risks of a downgrade in the near-term “are not high”. There’s little in these reports to provide relief, not least given that the deal is seen just as a ‘first step’ along the road. If both sides fail to reach an agreement later this year, based on the outcome of the grand committee being put together, then downgrade risks are likely to increase once again.
Global growth concerns dominating Tuesday. In the wake of the weak US ISM data on Monday, concerns as to the strength of the US economy were again to the fore Tuesday, with the latest personal income and spending data showing that consumer spending had virtually ground to a halt in the second quarter, spending falling 0.2%. This weighed on equities, both in the US and Asia, with the S&P500 down more than 2.5% on the day. The focus today will be on ADP’s steer on US jobs data this Friday, together with the non-manufacturing ISM data.
Why the Swissie stands out. The most interesting currency reaction so far this week has been on the Swiss franc, not least given the record 1-day down move on EUR/CHF on Tuesday. Even before the disappointing ISM data on Monday afternoon, the Swissie was pulling ahead, especially vs. the yen, as investors shed their initial relief to focus on the shortcomings of the deal. The US ISM data pushed EUR/CHF near to the 1.10 level, with yesterday’s further weak US data leading to a sustained push below. Speculation of yen intervention has also served to push the Swiss franc higher, with the finance minister Noda saying that the yen is overvalued and stating that they are watching markets closely. This remark is not necessarily a precursor to intervention, but should be interpreted as a warning shot across the bows of the market that this is not a one-way street for JPY/USD. For the Swissie, the domestic economy is doing reasonably well. But the currency has been surging ahead, outpacing the yen for most of the past year and also this week by over 3%. In a world where investors are becoming more focused on sovereign risks, there is a gaping chasm between Switzerland and Japan, with Switzerland having run budget surpluses throughout the financial crisis. Of course, Japan is the dog that has yet to bark in terms of sovereign risks. That said, in the new investment environment that is emerging, markets are going ask a lot of questions of a country where gross debt to GDP is seen rising to 250% in five years time (IMF forecasts).
Funding markets becoming more tense. The other means by which the focus was switching back to Europe on Tuesday was via money markets. Euro-basis swaps and Libor-OIS swaps were both reflecting tighter funding conditions in euro money markets. Both highlight the preference for USD liquidity in the interbank funding markets. Three-month Libor-OIS spreads moved out to near 40bp, a level not seen for nearly two years. Furthermore, there have been signs that banks are hoarding cash, taking liquidity from the ECB and then putting it back on deposit there. All of this creates an uncomfortable backdrop for the ECB meeting tomorrow, given that over the past two years, the ECB has been stepping back from ‘temporary’ facilities introduced in 2007 to provide sufficient liquidity to eurozone money markets. There will be mounting pressure for the ECB to somehow extend the duration of unlimited funding (beyond the current 3-mth maturity), but the trouble is that the ECB balance sheet is already overloaded with collateral of deteriorating credit quality and there is a great reluctance to open the floodgates to more.
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