Week in FX: Europe Nov 27-Dec 2

Markets have been trying to add risk as the hangover effect from central bank actions earlier in the week remains. However, it’s a rather tenuous relationship with next weeks Euro-event risk on everyone’s radar and Friday’s NFP labor participation rate been scrutinized. Germany’s Merkel says the EU is in a marathon, stating “the lessons are very simple: Rules must be adhered to, adherence must be monitored, non-adherence must have consequences. (Leaders have to) overcome fundamental flaws in the construction of the euro area.”   These fundamental flaws, if addressed and changed, will take years. Next week we get to see how serious Euro members are about been on the same ‘playing field’.  

Below are some other highlights of the week:

EUROPE

• Last weekend press rumors were fast and furious: The free press was reporting positive EUR actions. Germany’s finance minister suggested that the Euro-zone could rapidly implement changes to the Lisbon Treaty, allowing for significantly greater EC fiscal oversight of Euro area member countries. In theory, this would create a “Stability Union” before a deeper treaty change in the future.
• Italy: La Stampa, suggested that that the IMF would provide a €600b financing facility for Italy, however, this was denied, deemed not credible and that there are no discussions within the G7 of a large IMF package for Italy.
• Germany: Die Welt reported that the German government and five other EZ members, with triple “A” credit ratings, are considering issuing bonds. Part of the money raised would be used to provide financial assistance, under strict conditions, for Italy and Spain.
• The EFSF issued a new issuance strategy that would have it increase precautionary funding. All the reports stop well clear of promising immediate relief.
• Moody’s: Warned that Euro area sovereign ratings are increasingly under threat. They noted that risk of multiple defaults by Euro area countries is “no longer negligible”.
• EUR: EZ M3 growth slowed to +2.6%, y/y, in October from +3% in September, weaker than the +3.4% forecasted. The market expects that signs of monetary contraction suggest a strong need for further monetary stimulus from the ECB. FI traders are pricing in a -25bp ease next week, and expect policy members to scale up its SMP program to take rates below 1% in Q1 2012.
• GBP: UK CBI reported sales falling below consensus to -19 this month from -11 in October. Expected sales in December also printed weaker at -6 from 4 in November. This would suggest further pressure on the cable.
• CHF: SNB Vice-Chairman Jordan stated that policy makers are “prepared to take new measures should economic prospects and deflationary risks make this necessary.” He gave no signal about whether the EURCHF floor, currently at 1.20, might need to rise. The market sees a case for further monetary stimulus for the Swiss economy is growing.
• EUR: European bond markets continues to send warning signs, with Italian 10-year yields again backing up ahead of Tuesday’s auction, and yields elsewhere in Europe unable to trade moderately lower.
• EUR: Italy auctioned EUR7.5b of bonds, a tad shy of the maximum 8b on offer. The issues were reasonably covered but the clearing yields were high, above +7% for all tranches.
• EUR: The cost of USD funding via EUR FX forwards continues to rise and is fast approaching the extremes seen in late 2008 despite the availability of Central bank dollar swap lines.
• Moody’s: The rating agency announced that it is reviewing ratings on subordinated and junior debt from 87 European banks for possible downgrade. They expect two-notch downgrades to subordinated debt and a one-notch downgrade on other debt. Austria, France, Italy, and Spain have the most banks under review.
• EC: Confidence surveys continue to show deterioration, with business confidence sliding to -7.3 from -6.5. The services confidence was worse than consensus at -1.7 after +0.1 last month.
• UK: Foreign investors bought +£12.5b of gilts last month (the most in 18-months), and up from +£9b in September. This suggests that concerns about systemic risk in the EZ and lack of AAA reserve alternatives will limit outright flight from GBP. However, significant deterioration in the EZ growth would likely stall a UK recovery and prompt further easing from the BoE.
• SEK: GDP grew +1.6%, q/q, in Q3, much stronger than the consensus forecast for a +0.4% rise.
• EU finance ministers: Agreed on disbursement of the next tranche of aid to Greece and endorsed Italy’s latest fiscal measures. Nailed down the details of how to leverage the remaining EUR250b of the EFSF (program may raise between EUR500-750b, below the EUR1t originally touted). Is the IMF to support Italy? It has been suggested that the ECB council is shifting towards a more active role.
• Most of the world’s major central banks (Fed, ECB, BoE, BoJ, BoC and SNB) agreed that they would take “coordinated actions to enhance their capacity to provide liquidity support to the global financial system.” Specifically the Banks have cut the price on existing temporary US dollar swap arrangements to USD OIS plus 50bp which is a cut of about 50bp from what is currently charged. It will apply this from December 5 to February 1 2013.
• CBanks: Agreed to set up bilateral liquidity swap arrangements to cover any of their own currencies should that be needed.
• GER: Unemployment rate edged lower to +6.9% from +7% as unemployment fell -20k vs. -5k. However, analysts expect further deterioration in the coming months given recent declines in leading indicators.
• NOK: Norwegian retail sales also surprised on the upside, rising +0.7%, m/m, in October, reversing the September drop. The Norges bank also announced that it will not buy FX for the Global Pension Fund this month.
• CHF: Swiss KOF leading indicator fell more than expected to 0.35 (lowest reading in two-years) and the current level is consistent with Swiss GDP growth close to zero.
• CHF: The SNB published its balance sheet as of 31 October and showed no FX intervention being carried out during the month. The market now expects the SNB would need to see “deeper risk of recession and/or deflation before it considers changing its intervention policy or raising the floor”.
• EUR: Comments from the German economics minister that the ECB “can do what it deems necessary” in a crisis and from ECB President Draghi that the next few days will be important for the euro area have helped support the news of a reduced rate on the Fed USD swap line. Draghi emphasized the limited nature of bond market interventions.
• ESP: Spain successfully auctioned EUR3.75b. worth of bonds. They again had to pay up to persuade investors to buy their product. This will most likely be the pattern for 2012. However, stronger demand pushed Spanish yields to their lowest level in two-weeks and happened to drag the EUR to a session high.
• EUR: November manufacturing PMIs fell deeper into contraction territory.The EZ and German manufacturing PMIs were left unrevised at 46.4 and 47.3 respectively. Spanish and Greek PMIs showed signs of stabilization at very weak levels. Italian PMI surprised to the upside, rising to 44 from 43.3.
• CHF: Their manufacturing PMI fell to 44.8 (weakest print in two-years) and in line with the weaker than expected KoF indicator. This suggests a bleaker picture in the coming months.
• UK: Their manufacturing PMI was a touch higher in November at 47.6 from 47.4 in October. However, employment fell to 46.2 from 48.6, suggesting likely further deterioration in the labor market condition.
• EUR: Merkel reaffirms opposition to Euro bonds

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