Week in FX: Europe October 23-28

Has this weeks EUR “euphoria” been the product of a short squeeze? Positioning can be partially blamed for the currency marching towards last summers trading range. Price action is also telling us that investor’s perception of ‘tail risk’ in the economy has been somewhat reduced. However, with the execution obstacles still high for EU policy changes, the market is likely to price for more easing, making the EUR a tad rich.

The week has ended trading in a tight range, dictated more by fatigue than by increased nervousness. Next week will be no less eventful with the ECB and FOMC dominating rate and policy announcements (easing vs. QE3) and ending with NFP and G20. Will Capital Markets focus now swing to Italy’s debt now that Greece wins reprieve?

Below are some other highlights of the week:

EUROPE

• At the beginning of the week Policy Process got the benefit of the doubt, until the next negative headline. Markets responded well to the partial progress announced at last weekend’s summit and allowed “little” volume to push the EUR higher.
• Weaker Euro area PMI data killed off some of the first summit enthusiasm.
• Euro-zone October flash PMI surprised much weaker than expected. Manufacturing PMI fell to 47.3 from 48.5 in September, while services PMI fell to 47.2 from 48.8.
• German and French releases were less disappointing than the aggregate Euro print. French manufacturing PMI improved to 49 from 48.2, although services PMI fell substantially to 46 from 51.5.
• German services were more resilient than expected at 52.1 while manufacturing fell to 48.9 from 50.3.
• Italian government bonds continued to trade at odds to the broader risk environment.
• Econfin meeting was cancelled. Market seemed to have set low expectations for the policy outcome, reducing the potential for disappointment. Analysts expect US growth indicators and upbeat Chinese data to remain the key variables to drive risk appetite higher despite a less than perfect outcome from Euro area policy.
• UK: Current account deficit narrowed to £2b in Q2 from £4.1b in Q1. Importantly, Q1 was “substantial revised lower” from £9.4b previously estimated. The deficit amounts to +0.5% of GDP and is the lowest print in thirteen-years. Analysts note that this would suggest “lower financing requirements and less depreciation pressure from the new round of QE on the margin”.
• UK: CBI October industrial trends survey surprised weak. Total orders fell to -18 from -9 last month. Business optimism fell to -30, the lowest level in two-years and suggests continued weak sentiment. This should pressure sterling.
• TRY: The CBRT announced a plan to support their currency and centered around tighter lira liquidity for a temporary period of time. There is market uncertainty about the level of exchange rate they desires. In the summer, Governor Basci said that “the central bank would like to see BASKTRY between 1.95 and 2.05”.

   

  Second Summit Outcome

  • EUR: Leaders delivered a bit more clarity on Greek PSI, guidance on how the EFSF will be leveraged, and bank recapitalization plans. This has led to investors comfortably wanting to apply risk.
  • PSI: EU authorities and banks agreed on the nominal haircut for Greek debt to be 50%. This would allow Greek debt to be reduced to around +120% of GDP in 2020.
  • EFSF leverage: Authorities wish to leverage the EFSF by 4-5 times, increasing the firepower of the EFSF to around EUR $1.4t. It’s to be ready by end of Nov.
  • Bank recapitalization: EBA stress test results show a €106b capital shortfall. Banks were given to June 2012 to meet the capital requirement.
  • IMF: They confirmed its role in the EFSF leverage plan, and agreed to help seek other sources of financing. EU authorities will approach major developing economies including China to ask for investment in EFSF bonds. Policy makers believe they have averted a systemic crisis in the euro area.

   

• SEK: Riksbank left rates unchanged and followed with a more dovish statement. Policy makers will wait on rate increases until sometime in 2012. The repo rate path forecast was reduced to +2.3% for 2012 Q4, down from 2.6% previously. Forecasts for inflation and growth were also pared back. The market is focusing away from trades that remain EU growth dependant.
• EUR: Most confidence surveys printed above consensus this month. Economic confidence at 94.8 was a tad lower than the 95 of last month. Industrial confidence fell to -6.6 from -5.9, better than the -7 feared. Services confidence even improved slightly to +0.2 from 0.
• Fitch: Says a 50% Greek haircut would be a “default”.
• ITL: Their bonds end the week trading weaker following a less-than-impressive auction of medium-term paper. Market focus seems to be swinging towards Italy’s debt problems now that Greece has won a reprieve.
• FT: Reported China “might” contribute to funding the EFSF ($50-100b). This would suggest some sort of global coordinated action may be agreed at the upcoming G20 next week. Analysts expect funds to be channeled through the IMF.
• CHF: KoF leading indicator surprised to the downside (0.8 from 1.2 in September). It suggests that growth will slow markedly in the next few-months and this despite the additional liquidity and FX measures introduced in Q3. It seems that CHF overvaluation and Euro-zone growth slowdown now being passed through.
• SEK: Manufacturing confidence survey fell to -7 from -4 in September, below the consensus forecast for -5. Consumer confidence fell to -7.5. The market expects next week’s PMI to weaken further and remain in contraction territory for a third consecutive month.

Is EUR euphoria priced out?

What will the BoJ do?

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