FxPro Daily Forex Brief-The euro as a funding currency
Tuesday, 24 January 2012 | 09:03
Has the euro become the new carry currency of choice? That’s the suggestion being thrown around on the back of the
performance seen so far this year, together with the injection of 3-yr funds last month and the talk of anything up to EUR 1trln or more at the next 3-yr tender in February. We will have to wait a month or two for official data to fill in some of the gaps, so it is really only the market action that we have to go on at present. When the ECB first started injecting long-term funds in 2009, it was the internal carry trade that was more prevalent - banks using money from the ECB’s longer-term tenders to invest in the euro-denominated bond market. That is where around half of the cash went. This time around, bond auctions have gone well but the ECB’s own analysis (January Monthly Bulletin) showed a strong correlation between banks’ funding needs and the level of participation in the 3-yr auction. This suggests that funding carry trades is not currently the primary motivation for taking cash. Indeed, banks should and do have more pressing matters on their minds, such as meeting new capital requirements by mid-year. There’s certainly evidence that the euro is trading as less of a risk asset so far this year. The breakout on EUR/AUD (3% lower) illustrates this well, as does the breakdown in the correlation between EUR/USD and equities (S&P). But even beyond the euro moves, the dollar has been playing its part, USD having held its ground vs. some of the less high-beta currencies such as sterling, at least to a greater degree than past correlations vs. equities suggest should be the case. In sum, whilst it’s likely that there is some downward pressure on the single currency from carry, it is unlikely to prove substantive not least because, as 2008 showed all too clearly, the rush for the exits on a turn can be highly costly.
Lagarde wants a much larger bailout fund. Repeating previous appeals, IMF Managing Director Lagarde extolled European leaders yesterday to combine the EFSF with the ESM and to raise the size of the latter. Of interest in the lead-up to Monday’s meeting of finance ministers were the impassioned pleas from the likes of Lagarde, Monti, Barthle and Venezelos to substantially increase the firepower of the ESM. As expected, German Chancellor Merkel has expressed her opposition to this proposal. Moreover, and not surprisingly, she is not minded to provide Greece with any form of bridging loan should the debt-restructuring talks break down. Lagarde also stressed the need to raise the IMF’s resources by USD 500bln, although initial approaches to the United States have been met with only a lukewarm response at best.
Pound suffers as QE speculation intensifies. Despite the euro successfully penetrating 1.30 yesterday morning, the pound has again failed to keep pace with the single currency. Most telling is that cable was essentially unchanged, despite widespread losses by the dollar against other major currencies. Weighing on the currency is increased speculation that the MPC minutes to be released tomorrow will reveal that the committee is minded to engage in a further round of asset purchases before too long. The way the economy is performing, implementation of more QE is likely sooner rather than later. Q4 GDP, also set to be released on Wednesday, could well show that the economy contracted; it is perfectly possible that the economy has lapsed back into recession. Helping the doves on the MPC would be growing evidence that inflationary pressures are moderating; last month’s retail sales figures showed that prices (ex fuel) have barely changed over recent months. Also, a survey conducted by Ernst & Young showed that profit warnings in the final quarter of 2011 jumped by over 70%. EUR/GBP has been edging higher over the past two weeks, to 0.8375 currently from a low of 0.8245. Euro shorts are still very considerable, although the direction of travel is towards closing them out, while GBP shorts are increasing. If the MPC gives the green light to further asset purchases, then the currency may not respond very positively.
Spain must push EU to adjust 2012 deficit target. According to an interview in a Barcelona newspaper over the weekend, Budget Minister Montoro has urged the EU to give Spain some breathing room with respect to the achievement of its fiscal targets. Yesterday’s Q4 GDP figures confirm that such a reappraisal is urgent. The economy contracted by 0.3% in the final quarter of 2011 and the Bank of Spain expects that GDP will decline by 1.5% this year. This is in contrast to the 2.3% growth assumption that was embedded in the previous fiscal deficit target for 2012 of 4.4%. With the deficit last year well above target at 8% of GDP, there is very little realistic prospect of the government meeting this 4.4% objective. The new government of Prime Minister Rajoy has already announced a package of fiscal measures worth EUR 15bln, although the full budget will not be revealed until March. There is also the question of how the critical Andalusian regional election in March will affect Rajoy’s appetite for further fiscal austerity. Europe will need to cut Spain some additional slack, because to chop the fiscal deficit so savagely in a recession is extremely dangerous and risks condemning the country to depression-like conditions.
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