EUR: Rumor vs. Reality

Keep your eyes on Europe. There is a lot going on in the Eurozone this week and based upon the urgency in the voices of policymakers over the weekend and the different European rescue plans being floated around the market today, we can feel the hope and energy on our fingertips. The reason why the rumor-mill is working overtime is because Greece is running of time. If Greece does not receive its next tranche of aid by mid October, they will be forced to default on part of their loans.   As a result, policymakers in Europe are rushing to find ways to shore up the European rescue fund to not only accommodate a Greek default but to also prevent contagion. We rarely like to discuss rumors but the amount of detail in the plans outlined by the U.K. Telegraph and CNBC suggests that there must be merit to the news. 

Option #1 – According to the U.K. Telegraph, a EUR2 trillion has been brokered by the G20, yielding support from Germany and France. This deal would involve a selective default by Greece and a bailout of European banks (mostly French) with the greatest exposure to Greek debt. Part of the funds will also go to purchasing Italian and Spanish bonds while a new bailout program would be created for Greece with funds from the IMF and EFSF. If such a plan becomes reality, the sheer size would be enough to send the euro soaring. The uncertainty created by a Greek default could temper the euro’s initial rise but once investors have a chance to digest the news and understand the aggressiveness of the EU’s efforts, we could see a sustainable broad based rally in the euro. 

Option #2 – According to CNBC who cites an unnamed European official, they plan to lever the European Financial Stability Facility (EFSF) and create a special purpose vehicle (SPV) that would be used to create a European Investment Bank collectively owned by the European Union. The SPV would issue bonds to investors and use the money raised from the bond auctions to purchase the debt of distressed European nations. The amount of detail provided by CNBC who cites an unnamed European official is impressive and leads us to believe that this could actually become reality even if it is another act in the Kabuki theatre that basically piles more debt onto existing debt. The SPV is a classic CDO (Collateralized Debt Obligation) and all of these 3 letter acronyms feels far too much like 2008. The key to making all of this work would be finding buyers of the repackaged debt offered by the SPV and combining options 1 and 2 could be the answer to the Eurozone problems because on the face it, the deal is aggressive and ambitious enough to lead investors to believe that it will work and buy the bonds of the new entity.

Although these rumors have helped to boost risk appetite, they are still nothing but rumors for the time being. Last night, U.K. Chancellor Osborne said no one has put forward a plan for Greece and aside from calling for collective action, government officials in other countries have provided little details. The reality of the matter is that the euro faces a number of challenges this week. The Greek Parliament is set to vote on a property tax increase that is seen as a test of the country’s resolve for austerity. The Germans will be voting on the previously proposed increase to the EFSF which the market has already declared to not be enough and Italy will be testing investor appetite post downgrade with bond auctions. These are all major hurdles for the euro that could erode confidence the longer European officials wait to announce a broad-based rescue plan for the region. 

USD: SAFE HAVEN FLOWS EASE, DATA DISAPPOINTS

The improvement in risk appetite drove the U.S. dollar lower against all of the major currencies. Although the pullback in the greenback is encouraging for risk, it is also worth noting that the decline only puts a small dent into the sharp gains in the dollar last week. European officials were not only policymakers to share their thoughts over the past 24 hours. Fed Presidents Raskin and Bullard both made the rounds today and their comments reflected the degree of pessimism within the central bank. Raskin supported the Fed’s decision to implement Operation Twist and urged policymakers to consider a wide variety of additional steps going forward. Bullard believes long term growth may be lower after the bubble and said that monetary policy is ultra-loose right now, and appropriately so. Based upon their comments, there is reason to believe that the Federal Reserve is considering more stimulus before the end of the year. Of course this will depend on Europe’s rescue plan – if the Europeans announce a deal that triggers a strong rally across the financial markets and a broad based improvement in risk appetite, there will be less pressure on the Federal Reserve to act. Consumer confidence numbers are scheduled for release tomorrow and there is a good chance sentiment increased based upon the upticks in the University of Michigan consumer sentiment survey and the Investor’s Business Daily Economic Optimism index. Meanwhile this morning’s new home sales report reminded everyone of the troubles in the U.S. economy.  New home sales fell 2.3 percent in the month of August. The larger than expected moderation in demand marked the fourth consecutive monthly decline in new home sales. The number of units sold dropped to 295k, a 6 month low. The details of the report showed particular weakness in the Northeast and West with prices falling an average of 8.6 percent across the nation in August. The decline in new home sales is at odds with the rise in existing homes which suggests homeowners may be more flexible with their terms than builders. Either way, the new home sales report reinforces the overall weakness in the U.S. housing market. With talk of the U.S. economy entering another recession, we do not expect any major improvement in demand for new or existing homes in the near future.  

GBP: BOE TALKS MORE QE

The British pound strengthened against the U.S. dollar and euro despite the talk of more stimulus by a member of the Bank of England’s Monetary Policy Committee. Ben Broadbent who replaced Sentance had nothing hawkish to say about the outlook for the U.K. economy and monetary policy. One of the biggest challenges for the Bank of England has been high inflation but according to Broadbent, there are no signs of second round inflation effects and if anything, the global environment is in a disinflationary mode. He believes that a weak currency is needed for some time to aid in the rebalancing of the country and for this reason he supports the idea of more Quantitative Easing which would help growth and the banking system. Broadbent even went on to say that the central bank prefers buying government bonds for more QE and hinted that they are “reasonably close to voting for more QE.” Based upon these comments, it is quite clear the U.K. central bank is at the cusp of increasing stimulus. They have an active interest in keeping the pound weak and one way to do so would be through another round of QE. Normally, comments such as these would be very bearish for sterling but after having fallen more than 1000 pips over the past month, the improvement in risk appetite has overshadowed the growing possibility of more stimulus for the time being. Adam Posen will be speaking tomorrow and given that he has voted for a GBP50 billion increase in the bond purchase program since October of last year, we do not expect any positive comments from him. The only piece of U.K. economic data scheduled for release tomorrow is the Confederation of British Industry’s retail sales report. Demand is expected to weaken further in the month of September, after having fallen to the lowest level since May 2010 in August.  

NZD: FIRST MONTHLY TRADE DEFICIT FOR 2011

Having fallen to fresh lows against the greenback during the early European trading session, the Canadian, Australian and New Zealand dollars recovered strongly, ending the day in positive territory against the U.S. dollar. The reversal in the commodity currencies can be attributed entirely to the improvement in risk appetite because comments from central bank officials and economic data were bearish and not bullish for the currencies.&nbsp Gold prices ended deep in negative territory but oil prices rebounded by 1.87 percent, driving the price of oil back above $80 a barrel. The turnaround in crude helped to boost the Canadian dollar which had fallen to an 11 month low against the greenback intraday. Over the weekend, Bank of Canada Governor Carney talked extensively about how Canada is not immune to the slowdown in the U.S. and global economy. This leads us to believe that the BoC is moving towards a more dovish stance and could even be preparing the market for a rate cut. The New Zealand dollar also rallied despite weaker trade numbers. Not only did the country report its first trade deficit of the year but the August deficit was also the largest in 2 years. Considering that the New Zealand dollar climbed to a record high on August 1 ^st , the decline in exports and rise in imports is not surprising. With no economic data scheduled for release from the commodity producing countries over the next 24 hours, risk appetite will determine the price action of the comm. dollars. 

JPY: EFFECTS OF A STRONG YEN

Unlike the U.S. dollar, the Japanese Yen gave back its gains only against some currencies. The Yen weakened against the British pound, Swiss Franc, Australian and New Zealand dollars but strengthened against the euro, U.S. and Canadian dollars.  To the dismay of Japanese policymakers, milestones continue to be made the Yen. On an intraday basis, EUR/JPY fell to a 10 year low, CAD/JPY fell to a 2 year low while AUD/JPY fell to a one year low. All three currency pairs have rebounded significantly since reaching those levels, but the fact that these levels were reached at all will keep pressure on the Bank of Japan to intervene. No comments were made overnight by Japanese policymakers but that does not mean that they are not actively considering intervention. The 76 level is the line in the sand for USD/JPY and we expect to see the BoJ in the market if the Yen revisits that level.  Small business confidence and the Corporate Service Price index are scheduled for release this evening and both reports will show how a strong Yen can erode sentiment and lower inflationary pressures. 

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be our currency pair in play over the next 24 hours. The Japanese Corporate Service Price Index is scheduled for release at 7:50 pm ET or 23:50 GMT. This will be followed by the U.S. Consumer Confidence report at 10:00 am ET or 14:00 GMT.

Although our Bollinger Bands show USD/JPY in a downtrend, the narrow width of the BB indicates that range trading is still the dominant theme in the currency pair. The August and record low of 76 is key support in the currency pair and we expect this level to hold. On the upside, the 50-day SMA and first standard deviation Bollinger Band create resistance for USD/JPY at 77.20.

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