Currencies | Dec 15 2011
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
We are in full risk aversion mode. The euro is tumbling and EURUSD is now below 1.30 while the dollar is higher across the board. The dollar index is back above 80.50 and this is weighing heavily on European stocks and commodities. Meanwhile safe havens are soaring. The UK sold GBP3bn of 10-year debt for its lowest ever yield at 2.21%. Likewise, the 30-year German Bund yield also tumbled to its lowest ever euro-era level. US treasuries are also attracting significant flow. Yesterday it sold 4-week bills with a yield of a big fat zero.
The break below 1.30 in EURUSD highlights the escalation in the Eurozone debt crisis. But where it goes from here depends on how traders digest the vast amount of commentary coming from Europe’s political classes. On balance the most important comments (i.e., the ones that come from Germany) are negative. Firstly, Merkel ruled out a swift solution to the debt crisis when she addressed the Bundestag earlier. She said it will take years to solve, however she said it was possible to overcome, but it will take patience – which is something the markets have run out of.
Added to this, the head of the Bundesbank Jens Weidmann said that he wasn’t a fan of the ECB’s SMP programme and that the governing council is growing sceptical about the effectiveness of these bond purchases. However, the ECB has scaled back on purchases so no wonder its effects have been minimal. As we have said before, the ECB needs to be the lender of last resort for Europe’s peripheral nations to see their yields fall. Unless the central bank is there to back-stop members’ debts then these debts can never be considered risk free. This is a major concern for the markets, but Weidmann and co. seem to disagree, and have effectively laid to rest the prospect of the ECB printing money any time soon.
However, the Bank may have to reverse its position if we see 1, a failed Italian bond auction or 2, a bank collapse. The prospect of a Lehman-like event in Europe has definitely fallen since the coordinated central bank action from earlier this month, however banks are still nervous and are choosing to deposit funds with the ECB rather than lend to their peers in the industry. We mentioned earlier that not only are deposits at the EBC increasing but more banks are having to borrow from the ECB. This is acute for French banks who have seen their borrowing from the ECB jump to EUR87bn inn November from EUR37.4bn in October.
Although German banks have borrowed less from the ECB in recent weeks, Berlin still decided to re-activate its bank rescue fund today as the Eurozone crisis increasingly makes it less likely that banks in the currency bloc will be able to meet strict capital requirements set by the European Banking Authority for mid-2012. The German fund will be EU 360bn, and an official said that it currently remains un-tapped. This move comes after Commerzbank shares fell sharply yesterday after it said it may need national help to the tune of EUR 5.3bn.
So strains remain and as we head towards the end of the year there is a triple whammy of fears on investors’ mind: a failed Italian bond auction in Q1, a collapse of a bank and 3, sovereign downgrades.
Thus, comments from officials like Weidmann, who also added that some EU states can live with high yields and rising borrowing costs can bring greater fiscal discipline, are weakening the sentiment of the bulls, but are feeding bearish feeling in asset markets.
Debt auctions earlier saw Italy pay 6.57% for 5-year debt (unsustainable in the long-term). Tomorrow we have another Spanish auction to round off the week. Spain’s yields have come off today and the 10-year yield is currently around 5.65%, however this may be due to central bank buying – ironically.
The rot is spreading to Eastern Europe. Fitch said that downside risks are increasing for central Europe’s banking sector due to weak growth and worsening asset quality as bad debts start to rise.
In the UK it was the last Prime Minister’s questions of the year today. This time Nick Clegg was by the Prime Minister’s side. Cameron stood firm on criticism for using his veto in Europe saying that he “makes no apology for standing up for Britain” in Brussels last week. This hasn’t stopped safe haven flow into UK Gilts, and the pound remains strong against the euro.
We need a daily close sub 1.30 to see a sustained move lower to the 1.2860 support zone – the 100% retracement of the 1.4940 high from early May. The drop in the euro is also hurting the Aussie, considered the riskier end of the FX spectrum. It is sub- parity with the dollar and the next support level of note is 0.9870.
OPEC has also added to the political risk today. The oil producers’ cartel said that it would limit production in the first six months of next year to 30 million barrels per day. However, that hasn’t been enough to halt the decline in oil, Brent has fallen below $107 today as we await European economic data tomorrow, which is expected to show further decline in growth this month.
Overall, a pivotal day for the euro as political risk goes into overdrive.
This chart (from Bloomberg and the ECB) shows French banks’ borrowing from the ECB has risen sharply in recent weeks. (EUR billions).
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