Action, not words, required to take pressure off the EUR

An element of doubt came back into the mind of market participants Monday as (in particular, German) officials began to raise the possibility that the much vaunted ‘grand plan’ (which the rhetoric and inference by eurozone leaders commentary has been since the initial formulation by Merkel and Sarkozy on the 9^th October) may not be the all-encompassing solution to the woes of the eurozone.
German Government spokesman Seibert stated “Dreams of a swift Euro solution won’t materialise”. In conjunction with the German Finance Minister’s statement that the “upcoming EU summit will not present [a] final solution for [the] eurozone debt crisis.”  Both comments added to the weigh of an already seemingly faltering EUR.
Broader risk assets also struggled yesterday as concerns filtered through into the banking sector, despite the significantly better than expected Q3 earnings figures from Citigroup. With little in the way of top tier data this week, headlines will continue to dominate sentiment. A clear example of this was seen yesterday when a Der Spiegel online article suggested that “top German economists are warning that France’s AAA rating could be in danger should additional measures become necessary to prop up indebted eurozone members of to save ailing banks.” This is not a new concept and, indeed, it is one which I have discussed on this page a number of times. But the timing of the story into a market already feeling vulnerable top bad news exacerbated the impact.
This morning the spread between French and German 10 year yields has hit another new record at 100bps and despite Finance Minister Baroin’s protestations that France will do “everything” to maintain its debt ratings, we have reached a pinnacle. We have reached the point at which the rousing, determined words of officials are no longer enough; a point where action is needed.  Schaeuble’s words yesterday, that seem to have undone all the calming work of the G20, could well see the EUR decline back to the lows, seen before the irrationally exuberant, Merkozy-inspired rally, over the next week.
In China overnight data came in better than broad expectations as Industrial Production and Retail Sales data picked up again in September after a decline in August.  Fixed Asset investment was broadly stable yet GDP for Q3 slowed to 9.1% (its slowest pace since 2009). Whilst GDP growth is the envy of the developed world it is widely believed that the structure of the Chinese Economy requires it to maintain growth above 8% to maintain stable unemployment. The current easing of growth saw interest rate swaps fall as, in addition to a marked slowdown in money supply and an easing in inflation, the market has begun to price in a halt to monetary tightening in order to support growth.
In the UK today we get CPI data for September, where the market is expecting a print close to the 5%, up from 4.5% in August. In the eurozone we await the ZEW economic sentiment index but as I suggested yesterday the current market is not driven by the data but predominantly by the politics and that will continue until we get a resolution in the eurozone.

For the rest of the week I would anticipate that the EUR, in particular, but broad risk assets (including the AUD) will underperform, and after the capitulative deleveraging rally of last week, the support on the downside is likely more fragile than before. I still favour EURGBP throughout this week, but risk off sentiment is likely to pick up as we approach the weekend.

Storming Aussie Employment Data, but China trade Data Halts AUD

Asia saw a busier day on the macroeconomic front Thursday, and though there were arguments for both risk-on and risk-off, currencies remained at the top of their ranges.

For the pro-risk brigade, Australia’s employment data was a stormer with 20.4k jobs added in September, more than the 10.0k expected and more than compensating for the revised 10.5k jobs lost in August and halting a 2-month declining streak. Jobs gains were spread almost evenly between full-time and part-time workers and an unchanged participation rate of 65.6% was enough to tilt the unemployment rate a tad lower to 5.2% from 5.3%. Seen as a solid number, the AUD rocketed higher across the board with AUDUSD reaching 3-week highs.

After we had settled at higher levels, the China trade data was released and slightly disappointed. The trade surplus shrunk for the second successive month, declining to +$14.51 bln from +$17.76 bln with a drop in exports seen as the main culprit. Exports grew “only” 17.1% y/y and, perhaps more disappointingly, growth in imports fell to +20.9% y/y after recording 30.2% y/y in August. This took some of the shine off the AUD’s gains and AUDUSD retreated sub-1.02 again.

During the session we had additional dovish comments from BOE’s Bean who felt the outlook for the UK economy had worsened in the past 3-4 months which, if prolonged, would need an additional round of QE. He was of the opinion that inflation will cool in 2012, just in time for the Olympics! His comments on the economy echoed those we heard from BOE’s Dale who expressed concern about UK growth prospects for the rest of the year. GBP traded sidelined for most of the Asian session though.

The broader risk-on trade had extended overnight to the detriment of the greenback with a number of events forcing the EUR squeeze higher. Slovakian leaders said a second EFSF vote was likely by week-end and expected to pass while the EU Commission offered a framework for a European bank recapitalization plan. Euro-zone data was also impressive with industrial production up 1.2% m/m, 5.3% y/y, well above forecasts and higher than the previous month. EURUSD squeezed up to 1.3830+, one-month highs, before finding some resistance.

Economic Data Highlights

• CA Aug. New Housing Price Index out at +0.1% m/m, +2.3% y/y, both as expected and unchanged from prior
• US Aug. JOLTs Job Openings out at 3,056 vs. revised 3,213 prior
• NZ Sep. Business PMI out at 50.8 vs. revised 52.7 prior
• JP Sep. Bank Lending out at -0.3%y/y vs. -0.5% expected and -0.5% prior
• JP Aug. Tertiary Industry Index out at -0.2%m/m vs. -0.3% expected and revised -0.3% prior
• AU Oct. Consumer Inflation Expectation out at 3.1% vs. 2.8% prior
• AU Sep. Employment Change out at +20.4k vs. 10.0k expected and revised -10.5k prior
• AU Sep. Unemployment Rate out at 5.2% vs. 5.3% expected and 5.3% prior
• China Sep. Trade Balance out at +$14.51b vs. +$16.3b expected and +$17.76b prior
• China Sep. Exports out at +17.1% y/y vs. +20.5% expected and +24.5% prior
• China Sep. Imports out at +20.9% y/y vs. 24.2% expected and 30.2% prior

Upcoming Economic Calendar Highlights
(All Times GMT)

• GE CPI (0600)
• Swiss PPI (0715)
• Sweden Unemployment rate (0800)
• UK Trade Balance (0830)
• CA Int’l Merchandise Trade (1230)
• US Trade Balance (1230)
• US Initial Jobless Claims (1230)
• US Bloomberg Consumer Comfort (1345)
• US Fed’s Kocherlakota to speak (1830)

The Bullish Case for GBP?

"From the errors of others, a wise man corrects his own.” - Publilius Syrus

So European Central Bank President Trichet disappointed those looking for an interest rate cut but delivered just about everything else. The announcement of a reopening of covered bond purchases to the tune of EUR40 billion and the introduction of two one-year LTRO financing operations was a huge commitment to the ‘separation principle’ whereby the distinction between liquidity provision to the financial system is clearly ‘separated’ from the core function of interest rate, or monetary policy under the ECB's sole mandate of price stability. 

Ultimately in expanding the separation principle and throwing all but the kitchen sink at liquidity in the financial system, Trichet has maintained both the credibility of the ECB and himself, giving some interim support to the EUR (at least until the focus comes back on the Eurozone political leadership’s efforts to contain the Sovereign Debt crisis). The surprise uptick in inflation in the Eurozone at the last time of asking (driven largely by 0.5 percentage points annualised increase in German inflation) highlights the fact that cutting rates clearly didn’t sit comfortably with what was a consensus (but not unanimous) view of the governing council.  

BOE's QE and Moody's downgrade of UK banks
Arguably though, the big news of the day was the surprise move to re-open the electronic printing presses in the UK. The Bank of England’s Quantitative Easing programme was increased by GBP75 billion to GBP275 billion in a move that Mervyn King described as “pre-emptive action to try and prevent the slowdown from becoming too serious”. 

This I feel is a very important nuance to the actions of the Central Bank. King was also specific in his rationale that loosening monetary policy further was necessary because “the impact of the rest of the world on the U.K. does threaten our recovery”. Banking liquidity has clearly become a significant issue and one which has driven the actions of messrs Trichet and King into further stimulative action (whilst taking different paths to achieve it). The downgrading of 12 U.K. banks by rating agency Moody’s this morning highlights the concerns, as does the growing amount of deposits from Eurozone banks placed at the ECB, when lending to other banks would earn significantly higher returns. 

GBP to outperform?
Whilst in the short term GBP has suffered on foreign exchange markets I feel that there is now a case for GBP to outperform. The pre-emptive action of the Bank of England in light of what is ultimately a global downturn in confidence and a result of significant risks in the global economy – primarily the Eurozone (as King clearly stated yesterday) – should underpin the U.K. economy and GBP going forward. Particularly against the EUR and in that sense I still see any rallies in EURGBP as offering value. 

US jobless data in focus
For the day however, the focus of market attention will likely be on the US employment report and with economists estimates of the headline payroll change at a low level (55k) the risks are that we get a slightly more positive number (although unlikely to be enough to warrant any serious comfort at the fed – above 200k is widely thought needed to stabilise the unemployment rate).  Ultimately that means that for the day, the USD will likely remain on the back foot and risk assets will continue to outperform. Next week however may be a different matter altogether!

ECB Likely Unch, but Raft of Other Measures Possible (Desired)

Despite the fact that Friday we will witness the US employment report, today is undoubtedly the most important day of the week and will likely shape the dynamic for EUR and GBP (in addition to UK and eurozone assets) over the coming weeks. The focal points obviously being the interest rate meeting decisions from the Bank of England and the ECB.
In the UK speculation will be on the initiation of a further tranche of quantitative easing.

Having seen a significant swing in the MPC last month towards the dovish end of the recent spectrum I still think that it is a little early for the MPC to embark on the next stage of QE. It is true the economic backdrop has deteriorated further yet the most recent activity surveys in both manufacturing and service sectors in the UK showed a modest improvement back into moderate expansion. Confidence data, and admittedly the consumer activity (as indicated in the Q2 GDP revision yesterday), has remained weak. But the predominant driver of global confidence remains at the hands of European policy makers and the implications for global confidence.

As I see it, expanding the money supply in the UK may be successful in pushing interest rates lower, but this impact will be minimal when you consider where they are already. Gilt yields are already trading around historic lows and whilst I understand the desire to give confidence a boost, QE (which is largely already priced in by the market) at this stage may be a waste of bullets – at least until there is a resolution to the eurozone crisis, of some form. Back revisions to the economic growth data by the ONS released yesterday showed that the peak to trough drop in UK output was 7.1% rather than 6.4%, but there were upward revisions to 2009 and 2010. Ultimately there is little in the data to impact on the current policy debate, as I see things.

In the eurozone the question mark will be on whether Trichet, in his final meeting as head of the ECB, sanctions an interest rate cut. Whilst the economists are estimating no change in rates, the interest rate market has priced in around a 50% probability of a 25bp cut in the benchmark rate.  Whilst I view a rate cut from the ECB as unlikely, a raft of further measures including a 1 year LTRO, a revival of covered bond buying and or further liquidity provision commitments are distinctly possible as the much more is still needed from Europe in terms of supporting, liquidity, European banks and, ultimately, global confidence.

Whatever the outcome of the two seminal meetings today, there is likely to be a sharp pick up in volatility as the market repositions. With the US employment report tomorrow and a US market holiday on Monday, liquidity will likely be reduced, which will likely add further to the volatility.
Elsewhere, EURCHF has traded above its 200 day moving average this morning for the first time in around 2 years, and with bounce being supported by official suggestion (not action at this stage) that the ‘peg’ may be moved up to 1.3000 or even 1.4000 in due course.

The other news of note overnight was the proposition of a second Homeland Investment Act in the US, or effective tax amnesty for USD repatriation. Whilst the announcement gave a short-lived bid to the USD, the likelihood of passing the bill is very remote in my view as the figures from the first act (2004) suggested that the 5.25% amnesty rate, reduced the effective tax intake over the following 10 years by around USD80 billion – not something that would be seen as prudent in the current fiscal deficit reduction debate.

Euro Squeeze Over With Ahead of Trichet’s Last Stand?

Tomorrow is Trichet’s last press conference as head of the ECB. While an interest rate cut is likely not in the cards and might be seen as a reason for a further squeeze on Euro bears, other factors may weigh more heavily.

UK Data and BoE pre-preview for tomorrow
The UK PMI Services data was rather strong today – at 52.0 vs. 50.5 estimated and an improvement from 51.1 in August. This did very little to help the sterling’s case, however, as the general focus on Euro-relief (or at least a Euro-squeeze) saw EURGBP remaining rather buoyant and GBPUSD was in no hurry to tack onto yesterday’s bounce. The GDP and consumption data from Q2 were a downer (increased government spending obviously accounting for all of the GDP growth), meanwhile, and confidence surveys have been very poor lately, so there may be little bearing on the timing of the BoE’s additional asset purchase expansion. Odds are perhaps 50/50 heading into tomorrow’s BoE meeting on an expansion of the target, with a consensus of 50B for those who think an expansion is on the way and a smattering looking for 100B.

Odds and ends
A fine example of how the AUD is more a product of volatility in risk in the shortest of short terms rather than from moves on fundamental indicators like rate expectation. Tuesday’s 17-tick jump in Sep 2012 STIRs saw the AUDUSD  fall a further 100 pips or so (to be fair, the pair had been selling off steeply), but then a sharp wall street rally late yesterday, and mixed Aussie data (great retail sales, weak services survey) saw the same STIR off about 3 ticks, but AUDUSD rallying as much as 200 pips.

The US ADP employment change number was more or less in-line with expectations and with last month’s data (91k vs. 89k last month) and vs. last month’s Verizon strike-affected +17k US private payrolls number. In the meantime, some of the weekly jobless claims numbers ticked much higher before last week’s apparently calendar-affected low claims number. A bit more worrisome was the Challenger job cut survey that showed mass firing plans were the largest in more than two years, with Army and Bank of America cuts accounting for 70% of the total.  It all adds up to a yawn or slightly negative surprise this Friday, barring any dramatic evidence from the ISM non-manufacturing employment sub-index out a bit later today.

A great FTAlphaville article discusses the difficulties in addressing the Euro-debt situation, as it quickly becomes clear that anything short of a blanket guarantee will mean continued uncertainty, even if it is theoretically possibly to construct a credible haircut on Greece and some of the other peripheral countries and recapitalize banks. Meanwhile, Italy suffered the massive downgrade overnight and Merkel is not playing ball with the pro-EuroBond contingent, so the situation isn’t going much of anywhere at the moment as we await the ECB's next moves.

Chart: EURUSD
EURUSD reached its first major resistance area just below 1.3400 as we await tomorrow’s ECB outcome. (more on that below.) Above that, and we have 1.35 to contend with as the next resistance area of note.

Looking ahead – ECB pre-preview
Remember that tomorrow is Trichet’s last press conference at regular ECB meetings as Draghi is scheduled to take over at the end of this month. While many are predicting a rate cut from the ECB, it is hard to believe that Mr. Vigilance Trichet would want to leave the bank with a rate cut after having hiked as recently as July of this year. Leave it for the following meeting… More important will be further signals on the ECB’s plans to relieve the pressure on European bank funding as the general expectation is that Mr. Trichet will announce the reintroduction of unlimited 12-month funding but perhaps most importantly, will the ECB announce a new covered bond purchase program? Odds are perhaps even on the latter. And if it does launch such a program, will the move be seen as Euro positive because of the immediate relief. After all, is not a bond purchase program (despite vague possible claims that any purchases would somehow be sterilized) the same as the BoE expanding its asset purchase target. Very intriguing to see how the market will judge the ECB’s actions in addition to what the ECB does. Eventually, the only thing that keeps the banks liquid is effectively QE.

Economic Data Highlights

• Germany Sep. Final PMI Services survey lowered to 49.7 vs. original 50.3 estimate
• Euro Zone Sep. Final PMI Services survey lowered to 48.8 vs. original 49.2 estimate
• UK Sep. PMI Services survey out at 52.9 vs. 50.5 expected and 51.1 in Aug.
• UK Q2 GDP revised down to 0.1% QoQ and +0.6% YoY vs. +0.2%/+0.7% original estimates, respectively
• UK Q2 Private Consumption dropped -0.8% QoQ vs. -0.3% expected
• UK Q2 Government Spending rose +1.1% QoQ vs. -0.1% expected
• US Sep. Challenger Job Cuts out at +211.5% YoY vs. +47.0% in Aug.
• US Sep. ADP Employment Change out at +91k vs. +75k expected and +89k in Aug.

Upcoming Economic Calendar Highlights (all times GMT)

• US Sep. ISM Non-manufacturing (1400)
• US Weekly DoE Crude Oil and Product Inventories (1430)

Week, Month and Quarter End Flows Affect Markets

Germany successfully ratified the European Financial Stability Facility expansion yesterday with a very clear coalition majority for Merkel which gave the EUR and risk assets a brief bid initially.  Following on from the German parliamentary ratification of the expanded EFSF (as agreed on the 21 July across the Eurozone) the spread between 10yr Greek Bonds and German Bunds has come in from recent highs and the 2-year note yield found a bid in the improved sentiment, driving the yield as much as 500bps lower.

US Data Highlights
In addition to the relief of the German EFSF ratification the highlights of US data were a slightly better than expected Q2 GDP, which was revised slightly higher at the third time of calculating and a substantial improvement in the weekly jobless claims data (though there may be some seasonal anomalies that are likely see the improvement revised away - at least partially) gave risk assets and equities a boost and sentiment was generally improved.

That however appeared to be the top of the risk rally and the squeeze in positioning in short EUR positions that we were looking for at the start of this week that was supported by a sharp sell off in Euribor futures (or a rally in short end Eurozone rates). The revelation that Italy’s deficit rose to 3.2 percent of GDP in Q2 (up from 2.5 percent in Q2’10) just as Italy paid a high of 5.86 percent in its first long dated bond auction since its recent downgrade also helped take the shine off the EUR as the European Central Bank bond buying support seems to have waned or is having a smaller impact on lowering the yield on its debt.

Whilst for the most part of the week the headlines expounding concerns about and the flaws of the European Monetary (but not fiscal) Union have continued, their impact has been minimal.  Overnight S&P action to downgrade New Zealand’s Sovereign rating along with a more fragile start to the day for risk assets will likely bring Eurozone woes back to the fore today and I would expect to see the EUR underperform.

SNB action supports GBP
The announcement yesterday that the Swiss National Bank (SNB) “will likely raise the share of (their reserve) portfolio in GBP” should help GBP to outperform into the USD rally and EURGBP will start to look weak below the important 0.8660 level.  Whilst I have been emphasising the virtues of GBP for a while now I will stop short of suggesting that I was expecting the SNB action but I do strongly believe that GBP will continue to benefit on diversification and safe haven reserve allocation flows going forward. While Greece continues to remain the core focus of concern, the UK exposure to the troubled periphery nation, which is smaller than you might imagine should also be of some relief and despite the fact that everything is far from rosy in the UK economy (though UK consumer confidence rose for the first time in four months) at the moment I continue to be a GBP bull.

Today in the US sees month end index extensions, quarter end, and the twist to ‘operation twist’ as the long-end assets for purchase are announced by the Fed. The US curve is already markedly flatter with 10s 30s at a mere 105bps and I would expect this to remain a broad positive for risk assets and the US.

Data wise again there are no first tier releases today but confidence and activity data out of the US will be closely watched for sentiment into the close of the week month (and quarter).  On the day volatility is likely to pick up around the fixing times as rebalancing flows are potentially greater than usual following some relatively big moves this month, particularly in Emerging Markets and high yielders.

EURUSD in Temporary Limbo

Too early to tell whether that was it for the bear squeeze, but EURUSD failed to hold a minor new high today in the wake of the Barroso speech. 1.3550 is a tactical focus if the bears want to tactically regain the upper hand.

Odds and ends
Some ugly confidence numbers out of Sweden. While the manufacturing confidence was steady (though still at a negative level), consumer confidence plummeted and the economic tendency survey was also very weak, with both of the latter two at their worst levels since 2009. The Swedish krona is back in the range against the Euro after the recent risk meltdown saw It make and attempt at new 10-month high before the sell-off eased.

US durable goods orders data out of the US were subdued. There have been very few swings in the ex Transportation data series for several months now, an usual state of affairs for this normally volatile data series. On the bright side, the core “Capital goods non-defense ex Aircraft” measure saw a strong rebound, even from heavily upward revised July data. The question going forward is the degree to which durable goods orders will slow after the end of the year due to the hefty writedown incentives provided by the Obama administration that expire at the end of this year.

Dovish utterances from the BoE’s Miles today in an interview with The Times newspaper as he indicated he was leaning more toward voting in favor of more asset purchases today, though his mind was still “finely balanced”. This and Barroso’s speech to help drive EURGBP higher, but the pair then moved back just below the 200-day moving average (around 0.8710) again by the time of this writing. 0.8650 looks like an important level if the pair heads lower.

Chart: EURGBP
Interesting to see EURGBP so rangebound when we have such important outstanding questions about the Euro. But both currencies are quite weak as the BoE is clearly leaning toward more quantitative easing. The pair are in the vice grip of a range at the moment, with 0.8650 the first interesting are of support to the downside, followed by the recent 0.8530 area low.

Looking ahead
The Euro rally on the “strength” of EU commission president Barroso has so proved choppy, as we suggested this morning it might not last long, though it is too early to tell as of this writing, as 1.3595 minor support and bigger support down at 1.3550 are still in place after we surprisingly rallied all the way to new local highs earlier in the day.  The risk appetite side of the equation is an important one from hour to hour as well. Regarding Barroso’s speech: again, the assumption is that it will be very difficult to get Germany on board Barroso’s “stability bond” train and that yet another chapter of the extend-and-pretend saga is a more likely route to be taken. On that note, the SPV solution appears more likely, the question being whether the EU’s shenanigans have become so desperate that the market refuses to play ball without a better quality solution. 

As for the financial transaction tax – Britain will never go for it and large European banks would look to start pulling up as many stakes as they can in order to take their operations abroad before the eventual implementation date, assuming legislation is ever passed. There’s something not right about Barroso upbraiding the banks for bad behavior when a significant reason EU banks are in trouble is due to their massive sovereign debt holdings – which under strain because of poor political leadership.

Watch out for the SNB’s Jordan set to speak in basel at 1615 GMT today – this could get CHF crosses to sit up and pay attention. Less importantly, watch out for Bernanke out enlightening a Cleveland, Ohio audience on “Lessons from emerging market economies on the sources of sustained growth”. Hmmm.

Economic Data Highlights

• Australia Aug. New Home Sales rose +1.1% MoM vs. -8.0% in Jul.
• Germany Aug. Import Price Index fell -0.7% MoM and rose +6.6% YoY vs. -0.3%/+6.7% expected, respectively and vs. +7.5% YoY in Jul.
• Sweden Sep. Consumer Confidence out at -5.8 vs. +1.2 expected and +4.3 in Aug.
• Sweden Sep. Manufacturing Confidence out at -3 vs. -6 expected and -3 in Aug.
• Sweden Sep. Economic Tendency Survey out at 96.9 vs. 97.3 expected and 100.3 in Aug.
• Germany Sep. CPI out at +0.1% MoM and +2.6% YoY vs. -0.1%/+2.4% expected, respectively and vs. +2.4% YoY in Aug.
• US Aug. Durable Goods Orders out at -0.1% MoM and ex Transportation out at -0.1% MoM, vs. -0.2%/-0.2% expected respectively.
• US Aug. Capital Goods Orders – non defense and ex Airplanes out at +1.1% MoM vs. +0.4% expected
• Canada Jul. Teranet/National Bank Home Price Index rose +1.3% MoM and +5.3% YoY vs. +1.7%/+4.5% in Jun., respectively

Upcoming Economic Calendar Highlights (all times GMT)

• US Weekly DoE Crude Oil and Product Inventories (1430)
• Switzerland SNB’s Jordan to Speak (1615)
• US Fed’s Bernanke to Speak (2100)
• Japan Aug. Retail Trade (2350)

A Break of the 50% fib Could see EURUSD Reach 1.3500

The EUR/USD has continued its rise today and could still have much further to go. Choosing where to move the stop to is always difficult and never an exact science. As this trade is based on Fib levels, the 1.3610 area may be a good place as it is 50 percent of today's highs and lows. If we get a break of that level we might see a return towards the 1.3500 area where we could still look for further long entries.

Market Pondering Whether to Pump or Dump Ahead of Weekend

Market can’t decide whether to dump risk ahead of the weekend or dump it as the interventionist spirit has clearly been moved by the latest round of market turmoil.


The G-20 communiqué issued late yesterday promising a “strong and coordinated response” provoked a shoulder shrug in Asia, followed by a swoon for much of the European day before a tentative stabilization ahead of the US session. It is clear that the ponderous international organizations, the G20 and the IMF, who are continuing to meet this weekend in Washington, will kick the jawboning on Euro Zone stability into high gear.But it’s also clear the market is very nervous about how much confidence can come from pronouncements after the painful post-FOMC disaster this week. That and the very weak recent record of any kind of sign that even Europe itself is “all-in” on the EuroZone project, much less the rest of the world. Still, as we have discussed before, we are heading into Maximum Intervention, a theme we have discussed extensively of late.

As for other developments during the day, the Finnish parliament’s finance committee did recommend to parliament to pass the new ESFS measures. The vote by all of parliament on the plan is to take place next Wednesday. Our quote of the day has to go to the ECB’s Coene who said that the ECB may act as soon as October “if the crisis deepens”. Shouldn’t it be something like: the crisis will continue to deepen until we act enough – and even then it will only re-deepen until we do the right thing?

Sarcasm aside, there were only incremental moves in the usual measures of EU sovereign debt worries. As for the EURUSD interest rate spread equation: Operation Twist is so far not doing much to the short end of the US yield curve (2-year rates barely budged a half basis point higher today, while the ECB comments did provoke a 6-tick rally in the June ’12 Euribor futures.

Chart: EURUSD
EURUSD fiddling and hesitating as new lows traded in the last 24 hours, but didn’t see follow through. Many of the coincident measures (basis swaps, forwards and interest rate spreads, etc…)suggest that fear levels are not worse than they were at recent lows, though French and Italian CDS prices closed at the high for the cycle yesterday. Next week will be pivotal for the pair.

Looking ahead
The rest of the day and the opening Monday are not likely to see any reduction in volatility after a tumultuous week, regardless of the direction markets decide to move over the next couple of trading sessions.. The emerging market currencies are seeing an enormous relief rally as we are writing this – are we about to see a more two way market? Or is the market merely unwinding its latest anti-risk positions ahead of the uncertainty of the weekend? 

Watch for Trichet and Stark out speaking this weekend and for the Fed’s Dudley later today – he of the important New York Fed. Will Stark be a bit more stark in his commentary now that he has essentially resigned in protest over ECB policies?

The latest Hilsenrath piece from the WSJ suggests that Bernanke is not about to give up and that the Fed chairman will want to continue to tinker with policy until (reading between the lines) he is dragged kicking and screaming from the Eccles Building. The next logical step could see the Fed quickly move toward declaring targets for inflation and unemployment, but it appears that the Fed is finally being seen more universally by market observers as inept and unable to provide what the economy needs. After all the idea is ludicrous that, as Hilsenrath puts it, “clarity” is what is causing the market and economy to hold back because e of “lingering fears in financial markets that the bank might prematurely tighten monetary policy”. The lingering fears are about what we are going to do with all of the debt!

Have a wonderful weekend and stay careful out there


Economic Data Highlights

• UK Aug. BBA Loans for House Purchase rose to 33.5k vs. 33.3k expected and 33.7k in Jul.

Upcoming Economic Data Highlights

• US Fed’s Dudley to Speak (1730)
• US Fed’s Williams to Speak in Zurich (1730)
• Euro Zone ECB’s Trichet to Speak (2030)
• Euro Zone ECB’s Stark to Speak in Washington (Sat 1540)
• New Zealand Aug. Trade Balance (Sun 2245)

EURUSD - Bearish on Rallies Below 1.3602

For the second day in a row EURUSD remained broadly within Monday’s range during the European time frame. But late selling pressure renewed the underlying negative tone highlighted in this week’s view. Selling has continued in Asia taking EURUSD to the lowest levels since February.

Intraday signals for sentiment are at oversold extremes and a growing concern regarding profit taking. Therefore today’s call is Bearish on rallies below 1.3602. The immediate objective is 1.3523 with a move below that point targeting 1.3497, this month’s base, or even towards 1.3410.

GBP and NOK in Focus Ahead of FOMC

Today’s obvious focus is the US FOMC meeting much later today, but in the meantime, we’ve got a couple of important event risks for GBP and NOK in the form of BoE minutes and the Norges Bank rate decision.

Hard to believe that it isn’t topping all of the new services today, but we’ve got a massive news item out of the US the bears directly on today’s FOMC meeting and all future Fed activities: here we’re talking about the news that Boehner and the House Republican leadership have penned a missive to Fed Chairman Bernanke that asks the Fed to “refrain from further stimulus” as this Bloomberg article puts it, in order to avoid “further harm” to the economy. This is a tremendous development – a drawing of a line in the sand. How will the Fed respond, not so much today, but in the weeks and months to come?

BoE Minutes
The BoE minutes are squarely in focus for the UK today (to be published at 0830 GMT), as continued relatively weak data combined with still uncomfortably high inflation levels paint an ugly picture for sterling, which has fallen precipitously versus the greenback and the yen of late on the expectation that the next round of QE is nigh. Looking at the status in the charts, one wonders how much more the market is willing to punish the currency even assuming the BoE September meeting minutes show the MPC gearing up for another round of asset purchases. Certainly from a rate differential perspective, the GBPUSD move appears overdone, though that pair may move more on tonight’s FOMC meeting than . EURGBP may be a better indicator on the market’s sentiment toward sterling.

Norges Bank
As we have previously discussed, the Scandies received some degree of interest as safe haven currencies in the wake of the SNB’s declared war on the strengthening franc earlier this month, but EURNOK quickly righted itself after a brief swoon. Norges Bank will be out declaring its interest rate policy today at 1200 GMT. The increasing dovishness of the central bank has seen the forward expectations fall from +60 bps in July to about -60 bps at present. EURNOK is not priced fairly according to that movement, obviously as the market is also pricing Euro according to the latest sovereign debt woes. But further reminders from the Norges Bank that it doesn’t like NOK appreciating too much or that its stance is relatively dovish could see the NOK  lose some more of its shine. Our position is that viewing the NOK as a safe haven currency is a difficult proposition – the attraction of the impeccable sovereign balance sheet is undeniable, but the currency has a more compelling history as a petro-currency and its relatively thin liquidity more or less disqualifies it for true safe haven status.

It will be interesting to see how the Norges Bank discusses the housing bubble, which is the only factor that has kept rates as high as they are. The job of suppressing further bubble risks, however, may fall more toward the Financial Supervisory Authority with possible new tougher rules, rather than to the Norges Bank.

Chart: EURNOK
EURNOK rebounded from new multi-year lows recently, as the market shied back from the break lower, a reversal that has somewhat neutralized the downtrend. Does today’s Norges Bank finally see the pair pull back higher through the 200-day moving average? (black line)

Chart: EURNOK vs. interest rate spreads
The NOK has already been outperforming the indications from interest rate spreads due to the Euro’s unique sovereign debt situation, but the premium for NOK has been particularly large of late as rate expectations for the Norges Bank have crumbled.

Daily Report: Euro Soft after Italy Downgrade, Greece Talk Continues

Euro remains generally weak after S&P downgraded Italy's credit rating. Also there are rumors that a major China bank has stopped foreign exchange swaps with several European banks in response to recent downgrades. Though, there was some relief as Greece said the country is close to getting the next tranche of bailout funds after a conference call with the international lenders. Dollar is steady on risk aversion and as FOMC will start its two days meeting today. Yen is also firm on news that the Japanese government is going to unveil some measures to cushion the image of its strength. Australia dollar stabilizes a bit as RBA minutes signals that the bank is in no hurry to cut rates.

S&P's cut the credit rating of Italy to A from A+, with a negative outlook, amid concern that deteriorating growth and a 'fragile' government would make the country unable to reduce its deficits. S&P's currently forecasts Italy's GDP to grow +0.7% this year, down from previous estimate of +1.3%. According to the agency, 'the reduced pace of Italy's economic activity to date will make the government's revised fiscal targets difficult to achieve'. Moreover, the 'fragile governing coalition and policy differences within parliament will continue to limit the government's ability to respond decisively to domestic and external macroeconomic challenges'.

There rumors that Bank of China, a major market-maker in China, stopped forwards and swaps trading with some European banks. Those banks include Societe Generale, Credit Agricole and BNP Paribas and recent downgrade by Moody's was cited as one of the major reasons. The bank declined to comment so far. It's believed that another China bank has followed and stopped trading yuan interest rates swaps with European banks too.

Greece Finance Minister Venizelos said that "substantive" discussion was held with EU and IMF officials on securing the EUR 8b installment of the first bailout. While the troika stressed the country should speed up activities in trimming spending and raising taxes, . Bob Traa, the IMF's resident representative in Greece, stated that 'impressive fiscal consolidation has happened' in Greece. The discussion will follow with another conference call today.

The RBA minutes of its September 6 meeting showed that bank is still confident that the boom engulfing the mining sector will continue to support the economy and gave little hints of rate cuts in near term. The minutes noted that "the international outlook had become significantly more clouded since the previous board meeting." But, "members considered that the current setting of monetary policy left the board well placed to respond to evolving global and domestic economic conditions."

It's reported that Japan is going to unveil a string of measures to cushion the impact of yen strength on domestic economy. The measures would likely include subsidies for companies to establish facilities in Japan. Also there will be measures for job creation and support to finances of SMEs. Economy Minister Furukawa said Japan needs to "establish a strong economic structure that won’t be affected by movements in currency markets, whether it’s a strengthening or a weakening in the yen."

The Fed will begin its FOMC meeting today. It's widely expected policymakers will announce something called 'operation twist' -increasing the average maturity of securities holdings by swapping holdings of lower maturities Treasuries with longer ones, after the 2-day meeting. Compared with outright bond purchases (QE3), one advantage of operation twist is that the size of the Fed's balance sheet would remain unchanged and is less unlikely to invoke inflation.

EUR/JPY Daily Outlook

Daily Pivots: (S1) 104.01; (P) 104.75; (R1) 105.55; 

Intraday bias in EUR/JPY remains on the downside with focus on 103.88 support. Break there will confirm resumption of whole fall from 123.31 and should target medium term projection level at 103.42 first. On the upside, above 105.27 minor resistance will turn bias neutral and extend the consolidation pattern from 103.88. Nevertheless, even in case of another recovery, we'd continue to expect upside to be limited by 108.01 support turned resistance and bring fall resumption eventually.

In the bigger picture, the break of 105.42 support indicates that whole down trend from 169.96 has resumed. As noted before, the up trend in weekly MACD is broken and EUR/JPY is possibly building up downside momentum again. Next target will be 61.8% projection of 139.21 to 105.42 from 123.31 at 102.42. And sustained break there will pave the way to 100% projection at 89.52, which is close to 88.96 all time low. On the upside, break of 123.31 resistance is needed to signal trend reversal or we'll stay bearish. 

EUR/CHF  Daily Outlook

EUR/CHF spikes higher to 1.2213 today on rumor that SNB could raise the floor from 1.2 to 1.22, or even 1.25 tomorrow. The break of 1.2190 resistance argue that rise from 1.0061 might be resuming. But we'd prefer to see sustained trading above 1.22 level to confirm. In that case, EUR/CHF should head towards 1.2399 support turned resistance. Meanwhile, if SNB disappoints tomorrow, EUR/CHF could dropped back to prior range but again, SNB has made it clear about their intention to keep a floor at 1.2 and any decline attempt should be contained by this level.

Economic Indicators Update

GMT	Ccy	Events	Actual	Consensus	Previous	Revised
1:30	AUD	RBA Minutes
5:45	CHF	SECO Economic Forecasts Sep
6:00	EUR	German PPI M/M Aug	-0.30%	0.10%	0.70%
6:00	EUR	German PPI Y/Y Aug	5.50%	5.80%	5.80%
6:00	CHF	Trade Balance (CHF) Aug	0.81B	1.97B	2.83B
9:00	EUR	German ZEW Survey (Economic Sentiment) Sep		-45	-37.6
9:00	EUR	German ZEW Survey (Current Situation) Sep		40	53.5
9:00	EUR	Eurozone ZEW Survey (Economic Sentiment) Sep		-42.3	-40
12:30	CAD	Leading Indicators M/M Aug		0.20%	0.20%
12:30	CAD	Wholesale Sales M/M Jul		0.30%	0.20%
12:30	USD	Housing Starts Aug		590K	604K
12:30	USD	Building Permits Aug		590K	597K

Italy Downgraded as Troika Call Proves Fruitless

Not only did the Troika conference call yesterday not result in any concrete initiatives, but not long afterwards S&P, the ratings agency, went ahead and downgraded Italy in line with what it had earlier indicated was likely to occur. The calendar does have a few interesting numbers, but the Eurozone's struggles will be the agenda today before we gear up for the FOMC tomorrow.

Italy downgraded: One of the three big rating companies, S&P, went ahead and lowered Italy's sovereign debt rating by one notch to A from A+ previously and also slapped a negative outlook on the sovereign. The move surprised the markets with the EURUSD giving back all of the hardfought gains yesterday evening, but S&P actually had warned that such a move might take place stating in July that there is a "one-in-three likelihood that the ratings could be lowered within the next" two years. The rating agency expects Italy's economic activity wlil grow 0.7 percent annually over the coming three years which seems very low only until you consider that 1) Italy's GDP has only grown 0.2 percent annually from 2001 to 2010 and 2) that the country faces adverse effects from its coming austerity programme, which will further inhibit growth... Not exactly the perfect starting point of an attempt to lower the debt-to-GDP ratio of 119 percent and public deficit-to-GDP of 4.6 percent (December 2010 numbers).

Greece-Troika conference call proves fruitless: Despite the insistence of Greek Finance Minister Venizelos that the conference was "productive" the end result was weak by any standards with an agreement to schedule another conference call today in which further talks about the data will take place. The announcement afterwards said that a deal is close by, only to be followed up by the statement that some work is still needed to quantify measures. With the markets pricing in a near perfect probability of default let us see how long the charade will continue before the inevitable happens and Greece defaults, in an orderly or inorderly manner.

Building permits to decline in the U.S.: Yesterday's weak NAHB Housing Market Index printing 14 in September down from 15 last month did nothing to change the dismal outlook for the U.S. housing market. Today's Housing Starts and Building Permits report is expected to show declines in both to 590,000. The latter is part of the Conference Board's Leading Indicators Index.

(Note the disruptions in permits in 2010 caused by the First Time Homebuyer Tax Credit programme)

FOMC meeting commences today: The expanded two-day FOMC meeting commences today at 13:00 GMT with the (unchanged) rate decision tomorrow at 18:15. Will the committee announce QE3, Operation Twist or a third monetary policy tool? We will have much more on this in tomorrow's piece.

US Dollar Outlook Remains Highly Constructive in Current Enviornment

• EconFin meeting disappoints; Euro back under pressure
• Strauss Kahn intimates that Greek default is inevitable
• French banks could be exposed to UBS rogue trading incident
• WSJ article talk of a more balanced Federal Reserve than markets are looking for
• Yen at risk for depreciation as government set to unveil plan to deal with strong currency

Any hopes for some form of a constructive resolution to the Eurozone and Greek debt crisis over the weekend, were sorely disappointed after the EconFin meeting failed to produce any significant results. The expectation that things need to get done, and fast, is incredibly high and so long as these expectations are let down, we should see a quick deterioration in sentiment. It is therefore no surprise to see the Euro and risk correlated currencies tracking lower into early Monday. Adding insult to injury have been comments from ex-IMF Director, Dominique Strauss Kahn who basically concedes that Greece will default on its debt obligations. Additional factors seen weighing on the markets have been UBS raised estimates of losses from unauthorized trades executed by rogue trader Kweku Adoboli. A WSJ article cites someone close to the story who says that French banks may be among the counterparties to the fake trades.

Relative performance versus the USD on Monday (as of 10:00GMT)

1. JPY +0.01%
2. CAD -0.39%
3. GBP -0.41%
4. NZD -0.89%
5. CHF -0.91%
6. EUR -0.99%
7. AUD -1.19%

On the other side of the ocean, yet another WSJ article is gaining some traction early Monday after Jon Hilsenrath talks about the on goings at the Fed and future policy considerations. The article suggests that the Fed is more reticent than many might have thought towards its ultra accommodative bias, and failure to discuss QE3 or other radical stimulus measures should be all the more concerning to those in the dovish camp. At the end of the day it is very difficult to determine just where the chips will fall at the next meeting, but this article certainly does a good job of painting a picture which potentially could open the door for repositioning back in favor of the USD on a less aggressive accommodative central bank outlook.

Elsewhere, despite the uptick in risk aversion and flow of funds back into safe haven bids, the Yen tracks lower against even the buck, with market participants perhaps less inclined to be buying Yen on the news that the Japanese government is expected to unveil its interim plan to deal with the strong Yen early this week. It looks as though the government is now trying to consider the implementation of softer and less aggressive measures to weaken the local currency rather than resorting to aggressive intervention tactics. In our commentary from the previous week, we continue to like the idea of selling Yen aggressively at current levels, with the currency trading by record highs against the buck and due for a major cyclical reversal over the coming weeks and months. We do not see the lure of the Yen as a safe haven currency and anticipate that any additional flows into the currency from the recent measures taken by the SNB will be highly unwelcome.

All of this continues to translate into a highly favorable outlook for the US Dollar, which we expect will be the primary beneficiary from safe haven flows going forward. The Franc and Yen are no longer viable options and the ongoing deterioration within the broader global macro economy demands a flight to safety back into the highly liquid US Dollar. While the following argument isn’t necessarily relevant right now, we also see the US Dollar in a position to benefit on any upside reversal to global growth prospects, with the rebound in the global economy to likely force a material narrowing in yield differentials back in favor of the buck as the Fed looks to reverse its ultra accommodative policy.

Looking ahead, the calendar is exceptionally light in North America, with the only release coming in the form of NAHB housing due at 14:00GMT. US equity futures are tracking a good deal lower and point to an open of some 1.50% in the red. Commodity market price action is jiving well with familiar correlations and market themes with oil a good deal softer and gold managing to find some renewed safe-haven bids.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The sharp pullback below the July lows and establishment below the 200-Day SMA solidifies the prospects for the carving of a major lower top on the monthly chart which now ultimately projects additional declines down towards the 1.2000 area over the coming weeks and months. The latest inter-day rally off of the 1.3500 area lows has stalled out within our projected lower top region between 1.3835 and 1.4055 and a break back below 1.3500 will confirm the lower top at 1.3940 and accelerate declines down towards 1.3000. Ultimately, only back above 1.3940 delays outlook and gives reason for pause. 

USD/JPY:This is a market that looks like it trying very hard to establish some form of a base after recently setting fresh record lows just under 76.00. Although the downtrend remains intact and has been fairly intense, longer-term studies welcome the prospects of the formation of a material base and shift in the overall structure. Price action over the past several days has been confirming, with the market very well supported in the 76.00’s and unable to extend the downtrend to fresh record lows. Instead, the break back above 77.00 is looking more and more constructive, with the weekly chart also showing bullish tendencies after quietly putting in three consecutive positive closes. From here, we look for the establishment back above the 50-Day SMA at 77.90 to reaffirm our recovery outlook and accelerate gains towards next key resistance by 80.25 further up. Ultimately, only a daily close back below 76.50 would give reason for concern.

GBP/USD: Overall price action seems to suggest that this market could once again be looking to roll over in favor of some fresh medium-term declines. Any gains in recent months have proven to be very well capped above 1.6500, and this latest break back below 1.5780 opens the door for a pick-up in bearish momentum towards key support by 1.5345 further down. Any interday rallies are expected to be well capped below 1.6000, while ultimately, only back above 1.6500 would give reason for concern. 

USD/CHF: A recent acceleration of gains beyond critical resistance and a previous lower top at 0.8550 confirms bullish bias and from here, we see room for fresh upside above 0.9000 and towards 0.9500 over the coming days. Look for any setbacks to be well supported above previous resistance now tuned support at 0.8550 on a daily close basis, while ultimately, only back under 0.8200 would delay. A break and close back above the 200-Day SMA for the first time in several months will provide more ammunition for our highly constructive outlook.

 

Written by Joel Kruger, Technical Currency Strategist

 

If you wish to receive Joel’s reports in a more timely fashion, email jskruger@dailyfx.com and you will be added to the distribution list.

        

Nothing New from EU meeting - Stocks and Risk Thumped in Asia

Negative EU weekend headlines add to the gloom
The markets headed into the weekend meeting of EU finance ministers with high hopes of some more concrete developments regarding the European financial crisis, European bailout fund and Greek funding. The fact that U.S. Treasury Secretary Geithner would be in attendance gave the meeting some additional spice. The final outcome however was outright disappointment.

Not only did the meeting fail to deliver anything new/concrete, but other weekend headlines/commentaries combined to have this week starting off in a definite risk-off mood. No progress was made on either the EFSF ratification or expansion), nor leveraging on the EFSF (a programme suggested by Geithner) while a decision on the release of the next tranche of Greek bailout funds was delayed until October. In the meantime, Greece was urged to come up with additional savings resulting in PM Papandreou being forced to cancel a planned visit to the U.S. to attend the UN General Assembly and IMF meetings.

Outside of the EU meeting, weekend press also had negative implications for risk at this morning’s open. Former British Prime Minister Gordon Brown commented at the World Economic Forum that European banks were “grossly under-capitalised” and warned that, while in 2008 governments were able to step in to sort out banks’ problems, in 2011 they have problems of their own. Elsewhere BIS chief economist warned that additional monetary stimulus would not solve the current crisis with governments needing to urgently fix the debt problem as financial market conditions worsen significantly. Former IMF chief Strauss-Kahn was also in the headlines, suggesting that Greece will be unable to pay its debt and that a haircut was likely inevitable. The final piece in the risk-off jigsaw came when Angela Merkel’s party lost a regional vote in Berlin to the Social Democrats on Sunday, a matter of weeks before the key Euro-zone vote in parliament.
In all the focus on the weekend EU finance ministers’ meeting, US data was by-and-large ignored. The Michigan confidence index was a touch above consensus, rising to 57.8 from 55.7 (57.0 expected) but is still the second worst reading since March 2009. The current conditions turned out higher but, more worrying, the expectations index slid 0.4 points to 47.0 which is even below recession/downturn times and at its lowest since May 1980. Despite this, Wall St made it five days in a row in the black.

The Asian session was focused on the downside for risk from the get-go. EURUSD gapped lower, trading back down to 1.3650 from a 1.38 close in NY on Friday. We saw more of USD/Asia-Ex-Japan liquidation with USDKRW leading the way to near six-month highs. Asian equities took their cue from S&P futures which slide over 1.5 percent though a Tokyo holiday perhaps kept some players sidelined. After the initial flurry, currencies traded in tight (lower) ranges with traders sitting back and likely humming “Let’s twist again” ahead of this week’s FOMC meeting.

On the data front, New Zealand consumer confidence was unchanged in Q3 while the service industry continued to see a slowing amid cautious consumers with the PMI services sliding to 53.9 from 54.5, the second straight month of declines. UK house prices nudged higher in September, according to Rightmove, but the 0.7 percent m/m increase was not enough to wipe out the hefty 2.1 percent decline the previous month yet, year-on-year, prices are indicated 1.5 percent higher.

There was further indication that China’s inflation battle is not yet over as new home price data showed prices rising in all 70 cities monitored by policymakers. With Premier Wen saying on 1 September that China needs to focus on curbing price rises in less-affluent cities, the data questions whether specific efforts are working and may call into question growing market talk recently that the next move in interest rates will be down rather than up. The central city of Nanchang posted the biggest increase among the 70 cities with a 9.1 percent y/y while Beijing rose 1.9 percent and shanghai 2.8 percent.

A Look at How the Market is Pricing EURUSD

Ahead of the outcome of the Eurogroup meeting this weekend, we thought we'd take a look at the EURUSD from a number of different angles to see where things stand and hopefully provide some perspective ahead of Monday’s open.

Remember the post-kneejerk implications if EU officialdom/the ECB manage to pull together and salvage the the critically wounded EU ship because any viable solution has to involve de facto large scale QE. So at what point would a relief rally based on eased pressured on sovereign debt/banking system transition to mulling the competitive devaluation angle of yet another currency joining the "QE crowd"? For now, it appears the market either wants to party, or that the risk/Euro shorts are running for the hills.

Chart: EURUSD vs. CB Expectations

Here we use the two year swap spread to represent CB expectations, as 2-years out is about the maximum influence traditional monetary policy can have. With the US rate expectations essentially at nil for the next two years because of recent FOMC promises to keep the rates low until mid-2013, this is effectively all about the signals from the ECB and whether it unwinds its (vigilant?) two rate hikes from this year and then some going forward. It also becomes a question of “relative QE” – and in that instance, would be interesting to see if an Operation Twist from the Fed is supportive for the USD if it raises rates at the front end of the curve while the world recognizes an EU “solution” for the effective massive QE that would be required to implement it. By a pure rates measure and from past history, EURUSD looks like “fair value” at around 1.35 or a bit lower. Data source: Bloomberg

Chart: EURUSD vs. Basis swaps

This is the measure that shows the degree of the USD funding strain on EU banks – note how yesterday’s coordinated intervention move has helped encourage the recent bounce in this measure. Data source: Bloomberg

Chart: EURUSD vs. Germany/US CDS spread

This is a simple spread on the CDS spreads of Germany vs. the US. Interesting that the spread hasn’t improved much in Germany’s favor as EURUSD has bounced. (NOTE: price data only updated through yesterday’ close on the CDS prices).  Data source: Bloomberg.

A Critical Weekend for the Euro

Yesterday we got coordinated central bank action to ease USD funding pressures in Europe. Now we have “informal” (read: extremely urgent emergency) two-day meeting of the Eurogroup finance ministers with US Treasury’s Geithner in attendance.

All eyes on Eurogroup meeting

Today and tomorrow, an “informal” Eurogroup meeting of all EU finance ministers is meeting in Wroclaw, Poland to discuss the next steps in addressing the EU’s ongoing financial crisis. Informal is hardly the word – the politicians and ECB will need to act now and in a big way as it is crunch time for the EU and its financial system. US Treasury Secretary Geithner will also be in attendance.

Yesterday, an article from Reuters made the rounds that suggested Geithner was recommending to his European colleagues that they “leverage up” the EFSF to sufficient size to get ahead of the pressures of the sovereign debt debacle, similar to the way the TALF program was employed to leverage public sector funds in the US. The challenges is that the EU governments have yet to ratify the new intervention powers of the EFSF that were agreed upon at the last Greek bailout round 2.0 meetings. The stakes of this meeting are rather clear after a rather breathtaking couple of weeks for the single currency, which saw a 1000-pip drop in EURUSD and the need for a coordinated central bank intervention to dig EU banks out of trouble from USD funding pressures.

But this “bailout” by liquidity yesterday is merely another stopgap measure – like throwing up a dam in front of a raging torrent that will eventually dissolve it only to continue raging until something  more permanent is crafted. To keep markets orderly and banks from failing across the EU, we’ll eventually need to see a sufficiently large package/commitment to stop the chronic return of funding difficulties, default risks, defunct regional  bond markets (the EU effectively ceases to function if Italy can’t sell/roll its debt). The “best” solution of course is a single EU finance ministry and the ability for it to issue EuroBonds – but that too big a step, at least for this weekend’s meeting. But this weekend could give us an indication whether the EU leadership is going to retrench and put more effort in moving in this direction, or whether we get more of the same (an alphabet soup of kick the can liquidity measures or simply the hope that the EFSF can be inflated to sufficient size to suffice).Remember my basic tenet that either it is Lehmanesque crisis time, or we get the Eureka moment that the solution is a de facto QE that continues to weigh heavily on the EURUSD.

Elsewhere, there is little to discuss, because there is no elsewhere at the moment. The US calendar only features the preliminary University of Michigan Confidence reading for September. But looking ahead, next week’s open will be very interesting in the wake of this Eurogroup meeting and we have to anticipate the coming FOMC meeting on Wednesday. In that light, an article title on the Bloomberg this morning trumpeted “Yen rally seen ending on Operation Twist” with the idea that the Fed’s interest in raising the yields slightly at the front end of the yield curve could relieve the pressure on the JPY to strengthen. Worth consideration.

Economic Data Highlights

• New Zealand Sep. ANZ Consumer Confidence out at 112.6 vs. 113.3 in Aug.

Upcoming Economic Calendar Highlights (all times GMT)

• EuroZone Jul. Trade Balance (0800)
• Canada International Security Transactions (1230)
• US Jul. Total Net Long-term TIC Flows (1300)
• US Sep. Preliminary University of Michigan Confidence (1355)