FYI | Dec 20 2011
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
Price action may feel like the markets have ground to a halt as we wait for the Christmas break; however headline risk is as strong as ever as we get close to the end of the year.
The main points to note today were a strong French bond auction and testimony from ECB President Mario Draghi on Economic and Monetary Affairs to the European Parliament. Looking at the debt auction first, it appears that bond investors aren’t put off by the prospect of a French credit rating downgrade. Expectations are building that France could be downgraded sometime this week; however at its debt auction earlier yields were incredibly low for 12-month, 6-month and 3-month debt. The 3-month yield was a mere 0.005% for EUR3.05 billion of debt. This could certainly make Paris smile.
However, the risk is that today’s bond auction success is all down to investors wanting to buy French debt before it loses its triple A rating, and if it does get the chop then there won’t be as much demand waiting in the wings. France next sells bills on 27th December, which will be one to watch if the credit rating agencies act before Christmas.
Some in the markets think that the prospect of a French downgrade is already priced in. The market has certainly been prepped for it by European governments who have essentially said that another downgrade would mean that double A becomes the new triple A. However, while the euro remains precariously above 1.30, a French downgrade could be the trigger that sees it slips to the mid-1.20’s.
The next major event today was the Draghi speech. He stuck to his script as is expected during these testimonies. He told the European Parliament what the Bank was doing to help banks and prevent a liquidity crunch in the currency bloc. He reiterated the Bank’s stance that it is there to protect the banks NOT sovereign governments and that the ECB Treaty forbids monetary financing for the ECB. He also praised efforts to enforce stricter fiscal governance in a nod to the Germans. However, the struggling peripherals would like the ECB to do more, and new Spanish Prime Minister Rajoy said today that he would like a “different kind of ECB” and would like the ECB to be the lender of last resort.
But does anyone believe the ECB’s Treaty won’t be changed if we have a major event like a failed Italian bond auction? Would a French downgrade be enough to trigger some real action from the EU’s leaders? So far in 2011 there has been a lot of hype but no actual solutions. This situation isn’t sustainable, so expect more volatility to continue.
It seems like the market is done with the single currency and it would fall further if the market wasn’t so short of it already. The latest speculative positioning data from the CFTC shows that short EURUSD positions are now at their lowest ever euro-era level, having fallen deeper into negative territory in recent weeks. This could keep the euro range-bound for now, but as bond investors continue to re-balance their portfolios out of Europe and elsewhere then the selling pressures in the Eurozone debt markets could weigh on the euro into year-end.
Added to that, once investors are back from the New Year further selling pressures could emerge. So the euro is still a sell on rallies in our view.
It’s not just the Eurozone that has problems there remains rot at the heart of Bank of America. BOA shares hit a fresh 2009 low of $5.01 per share earlier, below the $5.03 reached on November 29. Stricter regulation, fines, an era of de-leveraging and a sluggish US economy are all likely to continue to weigh on the US’s largest lender for the foreseeable future. Some have argued that today’s decline, which happened during trading hours, could cause a wave of algo-related selling as the $5 level is a key support. So the market is on the lookout for further downside momentum to come.
Tomorrow watch out for the Spanish 3 and 6-month debt auction at 0930 GMT.
The views expressed are the author's, not FNArena's (see our disclaimer).
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