German confidence is giddy as Ireland is slipping off into the Atlantic Ocean and a strong US Durable Goods Orders number gets risk excited once again ahead of the US open, restarting the USD/risk appetite three-ring circus.
Euro whiplash
Yesterday's ugly developments in Europe were tempered somewhat today with yet another super-strength Germany IFO survey reading for September, which was a three year high and near the highest levels in the almost 20-year history of the survey. The expectations part of the IFO number came off ever so slightly, but it is hard to put a negative spin on this data point. Germany has apparently hit a sweet spot as its exporters still enjoy strong demand from Asia and as the low rates of the last couple of years have sharply eased credit in a country that never experienced a housing bubble (even if its banks are mired in all of the sovereign debt mess) and whose exports are doing well, even if industrial production has only retraced about half of the levels from prior to the crisis as have factory orders - and both of these measures show signs of slowing. The difference the hangover from a housing bubble can make is most evident in Ireland at the moment, where spreads have headed to another record wide level despite active ECB intervention.
Yesterday's ugly developments in Europe were tempered somewhat today with yet another super-strength Germany IFO survey reading for September, which was a three year high and near the highest levels in the almost 20-year history of the survey. The expectations part of the IFO number came off ever so slightly, but it is hard to put a negative spin on this data point. Germany has apparently hit a sweet spot as its exporters still enjoy strong demand from Asia and as the low rates of the last couple of years have sharply eased credit in a country that never experienced a housing bubble (even if its banks are mired in all of the sovereign debt mess) and whose exports are doing well, even if industrial production has only retraced about half of the levels from prior to the crisis as have factory orders - and both of these measures show signs of slowing. The difference the hangover from a housing bubble can make is most evident in Ireland at the moment, where spreads have headed to another record wide level despite active ECB intervention.
Chart: No one hears the PIGS bleating?
The correlation of the EURUSD with PIGS sovereign default risk has become negative rather than positive lately - if there is any correlation, that is. As we have discussed quite a bit lately, the rise in rates at the short end of the curve in Europe could be at least partially due to poor Euro liquidity from the ECB's operations, in which it drains liquidity in order to support its sovereign bond buying operations. So somewhat counter-intuitively, the more distress and debt buying, the more liquidity must be drained, meaning that PIGS distress drives Euro short rates higher along with the Euro due to rate spread implications? Why is no one else talking about the enormous rise in Euro LIBOR rates? 3-month Euro LIBOR has stabilized at around 83 bps and at slightly over 50-bp spread to the US 3-month LIBOR in recent weeks after rising from about 10 bps in late May, but the 12-month LIBOR spread has continued to widen - to over 60 bps now from just a couple of bps in late May.
The correlation of the EURUSD with PIGS sovereign default risk has become negative rather than positive lately - if there is any correlation, that is. As we have discussed quite a bit lately, the rise in rates at the short end of the curve in Europe could be at least partially due to poor Euro liquidity from the ECB's operations, in which it drains liquidity in order to support its sovereign bond buying operations. So somewhat counter-intuitively, the more distress and debt buying, the more liquidity must be drained, meaning that PIGS distress drives Euro short rates higher along with the Euro due to rate spread implications? Why is no one else talking about the enormous rise in Euro LIBOR rates? 3-month Euro LIBOR has stabilized at around 83 bps and at slightly over 50-bp spread to the US 3-month LIBOR in recent weeks after rising from about 10 bps in late May, but the 12-month LIBOR spread has continued to widen - to over 60 bps now from just a couple of bps in late May.
This may be driving the Euro somewhat higher in the short term, but it is neither sustainable or Euro-beneficial for the right reasons. The chart below shows the CDS spreads of Germany vs. the rest of the PIGS (less Greece and Ireland, for that matter) and shows that how the correlation has either decoupled or ceased to exist. So what does it all mean? If the market is happy with the dynamic, one supposes that it can continue as long as any positioning squeeze can last or perhaps as long as risk appetite remains healthy, but one would expect that if this EUR rally is being driven for the wrong reasons (liquidity ones rather than more traditional "fundamental" ones) then the rally, when it unwinds, could come off very quickly and violently. Next week could be key for the shorter term liquidity situation in European banks as EUR 225 billion of 3-,6- and 12-month funds are set to mature. See more on this story from an article out yesterday from Reuters .
Good US data = better risk appetite and weaker USD
The USD/ risk appetite three-ring circus continues today as a much stronger than expected US durable goods orders number (less Autos) showed a 2% bounce after last month's horrific 4.8% drop. This has equity traders chomping at the bit ahead of the US open and pushed the USD weaker on the risk appetite implications. A further digging into the internals suggests even better news, as non-defense, non-air new capital orders bounced very strongly from the previous month's cratering. Still, don't we want to pay more attention to the September ISM and other data rather than this rather oild and always volatile report? Judging from the scale of the market's reaction to this report, volatility is on the rise.
The USD/ risk appetite three-ring circus continues today as a much stronger than expected US durable goods orders number (less Autos) showed a 2% bounce after last month's horrific 4.8% drop. This has equity traders chomping at the bit ahead of the US open and pushed the USD weaker on the risk appetite implications. A further digging into the internals suggests even better news, as non-defense, non-air new capital orders bounced very strongly from the previous month's cratering. Still, don't we want to pay more attention to the September ISM and other data rather than this rather oild and always volatile report? Judging from the scale of the market's reaction to this report, volatility is on the rise.
Bank of Japan
The Bank of Japan may or may not have been out overnight intervening. If it was, the effects certainly didn't last very long as the pair swooned back lower as interest rates fell again in Europe, though the good US durable goods orders numbers helped take the pressure off the yen.
The Bank of Japan may or may not have been out overnight intervening. If it was, the effects certainly didn't last very long as the pair swooned back lower as interest rates fell again in Europe, though the good US durable goods orders numbers helped take the pressure off the yen.
AUDUSD parity talk begins
We noticed the first headline crossing our screen suggesting that parity in AUDUSD is on the way (BNP Paribas is out with the call due to the usual suspects of QE from the Fed, decoupling, risk appetite, China yada yada), which is certainly possible at the rate things are going lately and if the paradigm doesn't change - and assuming no hiccup in China's commodities imports, since mining is the only sector driving Australia economic strength, dominant as that sector is. It also might require quite a move in interest rate expectations higher in Australia and a move in the S&P500 of another 50 points or so (though latetly AUDUSD has been tracking the trajectory of EM equities more closely as these are challenging the highs from April while the US market lags). The market is pricing in about a 5% rate for the RBA a year from now vs. 4.50% currently. It needs to price in another 50 bps or so beyond the current Australia/US spread of 462 bps in the 2-year rate if interest rate spreads track spot and vice versa.
We noticed the first headline crossing our screen suggesting that parity in AUDUSD is on the way (BNP Paribas is out with the call due to the usual suspects of QE from the Fed, decoupling, risk appetite, China yada yada), which is certainly possible at the rate things are going lately and if the paradigm doesn't change - and assuming no hiccup in China's commodities imports, since mining is the only sector driving Australia economic strength, dominant as that sector is. It also might require quite a move in interest rate expectations higher in Australia and a move in the S&P500 of another 50 points or so (though latetly AUDUSD has been tracking the trajectory of EM equities more closely as these are challenging the highs from April while the US market lags). The market is pricing in about a 5% rate for the RBA a year from now vs. 4.50% currently. It needs to price in another 50 bps or so beyond the current Australia/US spread of 462 bps in the 2-year rate if interest rate spreads track spot and vice versa.
Looking ahead
Watch out for US New Home Sales out shortly - judging from recent reaction patterns, a strong data point would be met with further risk appetite and more USD weakness, though it feels like this market is more about gaming the overall themes and increasing boldness on leveraging up positions rather than a careful consideration of where these themes will take us eventually. With volatility expanding, we all need to stay careful out there.
Watch out for US New Home Sales out shortly - judging from recent reaction patterns, a strong data point would be met with further risk appetite and more USD weakness, though it feels like this market is more about gaming the overall themes and increasing boldness on leveraging up positions rather than a careful consideration of where these themes will take us eventually. With volatility expanding, we all need to stay careful out there.
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