FxPro Daily Forex Brief - Safe-haven stress
Thursday, 02 February 2012 | 11:00
One of the more remarkable developments during January was the relatively strong performance of the traditional safe-haven currencies, principally the yen and Swiss franc. We wrote about this during the course of last month, but the Swissie is particularly under the spotlight, given the proximity of EUR/CHF to the 1.20 floor imposed by the SNB last September. The Swissie only needs to appreciate another 0.5% vs. the euro to reach the 1.20 level, so the market is becoming increasingly nervous of further intervention by the central bank. The remarkable thing is that this has come at a time when the euro has been subject to some fairly severe short-squeezes, a function of the stretched short positions which lie beneath (see comments below). Once positioning becomes more neutral on the euro the SNB is likely to have an even tougher time defending the line in the sand it has drawn. Bear in mind also that creating so much liquidity is not a costless exercise in terms of its impact on the domestic economy. At some point in the not too distant future things could get rather messy for the Swissie and for the SNB in particular.
The ECB pressure on peripherals. As Greece continues to hammer out details with private sector creditors, the story is already moving on to Portugal and more specifically, the pressure the ECB’s stance is putting on the bond market there. Having touched 15% over Germany, spreads are now at the level of those of Greece when the first private sector involvement was announced in July of last year. Back at that time, Greek CDS prices were near to 2,500, whilst in Portugal they are currently 1,500. Some of this can be put down to the fact that Portugal’s public debt burden is a lot less excessive than that of Greece, still under 100% of GDP according to the latest Eurostat numbers. Politicians have been adamant that what they are asking of Greece (a voluntary private sector write-down) is a one-off. The initial suggestion by Germany’s Chancellor Merkel was seen as a key driver of the widening in peripheral spreads as other countries feared they would be next. Even if off the table, the new issue is the ECB’s assumed position as a preferred creditor over ordinary bond-holders. This underscores its insistence on not participating in any write-down of Greek debt, arguing that doing so would in effect breach the ‘no bailout clause’ enshrined in EU treaties. However, if the ECB continues to buy Portuguese bonds (as it was reportedly doing in January) then a greater proportion of Portuguese debt will be held by this new assumed preferred creditor. This being the case, then the private bond-holders will become more suspicious that they will be the ones being asked to take the pain again despite official assurances to the contrary. As such, there could be a fight going on and, regardless of all the bonds the ECB buys, the upward pressure on yields could continue and even be enhanced by the ECB’s firm stance.
Seeking data justification. Markets started the new year on an optimistic footing, of that there can be little doubt. We’ve seen some double-digit gains in equity markets during January, most notably Germany (up nearly 10%) and several emerging market indices (Russia, Peru and Argentina all double-digit gains). The question now is whether the economic data is going to do its part to offer substance to such gains. The tentative answer yesterday morning was ‘Yes’, with modestly better than expected PMI readings both in China (manufacturing holding above 50) and also in Europe, with a marginal improvement from the provisional readings in manufacturing PMI data. The biggest standout was the UK release, showing a rebound in the headline index from 49.7 to 52.1. There have been some suggestions that we will see the UK escape a second quarter of negative growth, but it’s far too early to be taking a punt on that, especially with the balance of growth in the fourth quarter yet to be fully revealed. We’ve pointed out before that both 2010 and 2011 started with economic data (primarily in the US) surprising to the upside, only to see a sharp turn thereafter towards disappointing releases come late February and into March. What is also noticeable is the Fed’s willingness to retain an accommodative stance on policy and keep the door open to QE3 despite better numbers of late. This all relates back to the fact that balance-sheet recessions invariably tend to be longer than others and also vs. nearly all expectations. This underpins the Fed’s actions and also recent comments last week on the matter from BoE governor King. As such, even if the mildly better tone to data continues, central bankers will be the last to get excited by it.
A merciless euro short-squeeze. Wednesday saw another impressive display by the beleaguered single currency. After looking decidedly vulnerable at close to 1.30 early in the London session, it subsequently bounced to above 1.32 at one point. Bolstering the recovery were higher than expected January PMIs throughout Europe, optimism that a Greek debt deal might now be very close, lower sovereign debt yields in both Italy and Spain and stronger risk appetite across the board. A 170K increase in US private sector payrolls during January (as reported by ADP Employer Services) also helped the mood. There were reports of sovereign wealth funds again on the bid – in contrast to the last few months of 2011. In the first weeks of 2012 they have mainly been buyers on weakness. In terms of pure price action, this yesterday’s rebound yet again provided plenty of encouragement for the bulls. Short-covering was once again a feature as those negative on the euro start to throw in the towel in despair. The bulls have the euro-bears on the run. Moreover, this painful short squeeze probably has a lot further to go. As is invariably the case, the most profitable trade is the one that inflicts the most pain.
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