“And it’s a hard, it’s a hard, it’s a hard, and it’s a hard It’s a hard rain’s a-gonna fall” – Bob Dylan
Apocalyptic commentators have always struck me as trying to have a free option – when they’re wrong you forget it and when they’re right, we call them sages. Speaking of which, both George Soros and Warren Buffet (“We’ve just entered act two” and “We could be standing on the brink of the next financial crisis”, respectively) are banging the drum of doom. I don’t know what data they’re looking at but I can see a few things that could cause big problems if they all happen together.
Club Med sovereign debt yields are moving north again, Greek CDS are at all-time highs, Spain is still denying it needs an aid package – and maybe it doesn’t – but continental newspapers are predicting that an application is imminent.
Banks in those Club Med nations are the biggest borrowers of funds from the ECB. As Reuters put it early in the week: “Banks in Greece, Portugal, Ireland and Spain account for more than two-thirds of the increase in lending to eurozone financial institutions by the ECB since the summer of 2008”. BNP Paribas’ FX daily strategy said on Thursday: “The data from the Portuguese central bank showing a doubling of the borrowing by Portuguese banks from the ECB to €36 billion in May highlights the difficulties being faced by the financial system at the periphery of Europe. There are also increasing concerns regarding the expiry next week of the ECB’s 12-month repo.”
Yes, the repo. Or the ECB’s long-term refinancing operation: €442 billion of liquidity maturing on Thursday July 1. And that is going to be replaced by what exactly?
Zerohedge quotes Barclays’ Joseph Abate at length. In short, it is likely that, with as much as €300 billion surplus liquidity being parked at the ECB, the rollover will only be partial: “The smaller the replacement LTRO is relative to the €442 billion roll-off, the more likely it is Libor will increase from 53bp currently”. But if the rollover is anywhere near full: “Not only would this indicate that banks still have lower quality assets on their balance sheets – but that the decline in market rates since last July has not been broad or deep enough to enable institutions to leave the security of the ECB.” Neither outcome sounds wonderful.
And, of course, before then we have the G8/G20. Interesting format and, if the climate conference in Copenhagen was any kind of example, not an event likely to result in harmonious agreement, let alone constructive progress.
At least BNP Paribas is a little more optimistic about both the G20 and liquidity, though it still manages to convert that into euro bearishness: “A pro-growth statement from the G20, with ample of liquidity being provided by global central banks suggests that Asian and commodity currencies will remain supported, with the euro likely increasingly being used as a funding currency.”
More disagreement than usual is likely at this weekend’s meetings, even though the problem of CNY revaluation has been cleverly taken off the agenda. Europe’s new hair-shirt austerity is at odds with president Obama’s call for more fiscal stimulus. As Paul Day points out: “The municipals are the real worry right now. Several states are bankrupt and any austerity measures risk tipping the US in to free-fall.”
And more stimulus is what Obama will carry on calling for after this week’s US housing data. On Thursday, FT Alphaville quoted RBS’s Andy Chator’s great summary: “As ever when a poor piece of data comes out it feels like the market falls over itself to find excuses. No inclement weather this time, so it comes down to the ending of tax credit. But everyone knew that the tax credits were ending and the Bloomberg consensus was for a big fall; the fact that the fall was massively bigger than expected, combined with the downwards revisions, is what is so worrying.
“One thing that comes out of the recent crisis in Europe is that Western governments are close to the limits in terms of what largesse they can provide and this is being withdrawn now. Yesterday’s data was the very obvious demonstration of what can happen when government support is withdrawn.”
Which brings us back to the ECB next Thursday: whatever the outcome, things will be fraught and it seems unlikely to be a risk-friendly environment.
If short EUR is still the way to be, there is still the problem of where to be long. Searching through the available research doesn’t help much: various reasons are suggested to make anyone wary of USD, CAD, JPY and AUD, and while EUR/CHF is working well (1.3550), is there another alternative? Perhaps NZD but technically short EUR/NZD looks dubious, having yesterday broken up through the trendline. A close back below the trendline, currently at 1.7350, would be positive though.
Morgan Stanley (and Credit Suisse to a certain extent) is bullish SEK. Morgan Stanley writes this morning: “The differentiated economic fundamentals between the eurozone and Sweden should translate into a lower EUR/SEK exchange rate this year. Furthermore, rate and growth differentials will play in SEK’s favour.” However: “We are aware that EUR/SEK has recently traded more broadly with global risk appetite and positioning. For this reason, we suggest expressing views through options.” With the risk reversal favouring EUR calls, a EUR put – with or without a topside knockout – might be worth pricing up.
Alternatively, and it hurts a little to write this, there are times when the best position is no position at all. It might be appropriate to cash up, sit tight and await developments.
