Is this an ECB Set Up?

It seems that the FX market wants to end this week overlooking the negative Bundesbank opposition comments to the SMP and ESM banking license. Investors prefer to hold on to the hopes of new aggressive easing measures by the ECB. This market resilience is highlighting the high level of expectations for next week’s policy meetings. Are we being set up for a major disappointment if neither the ECB nor the FED pulls the trigger? Draghi’s well documented and orchestrated move to talk down this market is the strongest signal to date that officials are now fully-focused on preventing capital market pressure on Spain from forcing the euro zone into a full formal bailout. A sovereign Spanish bailout runs the danger of exhausting the euro zone’s rescue capacity. It’s no wonder there is a need of a discussion granting the ESM a banking license. A license would give the ESM virtually unlimited intervention capacity because of its ability to finance itself at the liquidity operations.

Below are some other highlights of the week:

EUROPE

• EUR: And just when you thought it was safe to come out of hiding, Spain and Italy both start the week banning short selling equities. It’s no wonder that investors are wading to the sidelines.
• ESP: Spain is officially in recession, contraction -0.4% in Q2, this after -0.3% in the first three months. The BoS expects the economy to shrink by -1.5% this year.
• GER: In contrast, the Bundesbank reports that the German economy is growing moderately, anywhere between +0% and +0.5% for this year and this expectation after a small drop of -0.2% in Q1.
• EUR: The collapse in Spanish sovereign markets following last week’s debt auction and finalization of bank rescue plans has been driving a retreat in global risk assets. Investors are concluding that assistance in funding the Spanish bank rescue will not be enough to remove the need for a broader sovereign rescue.
• Troika: On the record and off the cuff comments are making investors even more nervous. Some Troika officials have said that they will withhold aid unless Greece continues to meet conditions. Even the IMF has signaled it will no longer participate monetarily. The fear of deep systemic stress will be “met with proportional policy response.” The market is beginning to believe that the single unit “is likely to remain broadly weaker as future relief will include further monetary easing.”
• GER: Late Monday, Moody’s decided to cut Germany’s rating outlook to negative from stable. The latest hatchet job now leaves Finland as the only AAA-rated euro-zone member with a stable outlook.
• EU: Eurozone companies have managed to reduce output for the sixth consecutive month in July. This is even occurring in the biggest of economies, Germany and France and making it even more difficult for policy makers to get a firm grip on the overall regional situation. The composite PMI was unchanged at 46.4, a print solidifying contraction and another economic excuse to signal a euro recession based on the definition of two straight quarters of falling output. This is the first time core PMIs are below the level in the periphery suggesting the loss of confidence in the euro is having a broader impact on economic activity.
• ESP: Market rumors that the Spanish government is contemplating of putting on the table a possible Spanish withdrawal from the euro. Similar to any other fleeing member, they would have their own currency again and potentially restore competitiveness.
• ESP: The mid-week Spanish bill auction was unremarkable, but consistent, as the government again sold at higher yields.
• EU: Austrian central bank governor Nowotny said he sees arguments for giving the ESM a banking license. While he acknowledged there are also arguments against doing this, he said it was a matter for discussion.
• GER: The German IFO business climate fell to 103.3 from 105.2, below the 104.5 consensus. Even more prominent were the IFO expectations collapsing to 95.6, the lowest level in two years and below the weak readings in Q4 last year.
• EU: The ECB lending survey showed lending standards remained broadly stable in Q2 compared to Q1. At the same time, loan demand was particularly weak with a net 25% of banks reporting lower demand from firms.
• GBP: UK GDP surprised very weak contacting -0.7%, q/q, against expectations for a -0.2%, q/q, fall. The Jubilee holiday appears to have been a major driver for the weakness.
• CHF: SNB President Jordan told the Weltwoche paper that the SNB still has firepower to intervene. He noted that the current size of currency reserves is no obstacle to maintaining the 1.20 floor in EUR/CHF.
• EUR: Draghi’s comments that they will “do whatever it takes” dragged the EUR higher. Still, the EUR remains weaker on net vs. the commodity bloc, CE3, sterling, and the Nordic currencies. The reports and comments add to the perception that policy response is coming sooner than previously expected. A monetary component will ultimately allow the EUR to move broadly lower.
• EU: Euro-zone M3 rose +3.2%, y/y in June and above consensus. However, lending to corporates and households both declined further. At the same time deposit flight from the periphery continued. Greek bank deposits fell- €6.7b in June after a +€9.1b fall in May and Spanish bank deposits fell -€8.0b in June after a -€9.2b fall in May.
• TRY: The CBoT revised its year-end inflation forecast from +6.5%, y/y, to +6.2% in its quarterly inflation report, without making any explicit reference to the possibility of looser monetary policy.
• EU: Unsupportive comments from German and Bundesbank officials have failed to unravel the impact of ECB president Draghi’s comments from Thursday. Bundesbank has restated opposition to SMP and ESM banking license.
• CHF: The Swiss Kof leading indicator rose to 1.43 in July, up from 1.15 in June and well above consensus expectations for 1.20. This is the highest reading of the survey since Q3 2011.

AMERICAS Week in FX

ASIA Week in FX

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