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Foreign Exchange

FX research roundup: LTRO rollover – Apocalypse averted? Or Abyss awaits?

We should first give the Dodd/Frank legislation the coverage it rightly deserves...Ok, now let’s cover the other stuff.


I wrote last week with an undercurrent of impending doom. And I wasn’t alone.


The BIS annual report published early in the week wasn’t at all upbeat saying banks remained "highly leveraged and still appear to be on life support. The essential task of reducing leverage and repairing balance sheets is simply not finished...Losses on European bank balance sheets are expected to mount over the next few years. Some banks are rolling over existing loans rather than inducing foreclosures, thus delaying loss recognition."


And the headlines of a variety of research papers throughout the week are revealing: 


    “The G20 fissures – eerily reminiscent of the 1987 crash” – Saxo, Tuesday 

    “EUR – storm clouds on the horizon?” – BNY Mellon, Wednesday 

    “Market struggling to find silver linings” – Credit Suisse, Wednesday 

    “No respite for risk appetite” – Credit Suisse, Thursday


But by close Thursday it appeared that things were rosier, especially as far as Europe was concerned.


On Thursday night Nick Beecroft at Saxo published a piece entitled, “Will this be the day the dollar topped-out?” I don’t think so but Beecroft highlights yesterday’s dire US data and makes the point that, for the last six months, an equity dump and US Treasury rally would have led to safe-haven USD buying; but not now. He concludes: “This looks like the day that fears of a double-dip recession in the States, with all its attendant unpleasant consequences for the US Budget deficit, finally trumped Eurozone bank and debt concerns, which were somewhat put to rest over the last couple of days by benign drawdowns of ECB liquidity offerings and a good Spanish bond auction.”


BNP Paribas’ note this morning has a contrary angle to Nick Beecroft on the EUR rally: “While the recent run of weak data out of the US is undoubtedly bad news for the US economy, the implications maybe even greater for the Eurozone.”


It is true that most commentators were relieved at the result of the LTRO rollover. It certainly appeared to be the best result the market could have hoped for. I was wondering if something was being missed when I received a brief email from a savvy pal at the sharp-end: “The Euro auction was interesting...the market has taken it as a sign of confidence that less than €150 billion was subscribed...but...whereas the 1y auction was previously at 1pc, this 3mth was at the same level when 3's cash comes at 0.8...banks have just decided to try to get the cash cheaper NOT that they have plenty of available funds...just my take but the market is now VERY short and the carnage can begin...”


He might well have something. Certainly Credit Suisse on Thursday, while not as strident, is not convinced that all is now well: “The ECB is conducting a special six-day repo operation to help rate markets compensate for the €442bn 12-month operation rolling off today. While the market would likely view low allocation positively, we believe that upside pressure on rates in the coming days and reduced market liquidity will begin to feed renewed concerns about peripheral banking sector access to funds. We remain bearish the euro near term, targeting 1.16 on a three-month basis.”


Morgan Stanley, in a note published last night, feels that “the euro might stabilise for a while until one of the countries in the monetary union is forced to go to the EFSF [European Financial Stability Facility] for bailout funds.” The bank sees a possible bounce up to 1.2800 before the sell-off resumes down to the same level as Credit Suisse: 1.1600.


Friday morning and EUR/USD is up at 1.2510 on the US data and possibly the small matter of imminent option expiries: an American 1.25 one-touch (now touched of course) expiring Friday, a “very large” 1.2500 European digital expiring Tuesday and a big 1.2400/1.2500 call spread, also expiring Tuesday. These might ordinarily be enough to keep the spot hereabouts for a while. 


But strange things can happen on US holidays and preceding Fridays; particularly when the Friday is the first in the month. After yesterday’s US numbers today’s non-farm payrolls will receive even more attention than usual, if that is possible.


Finally, to use a well worn phrase: there is an elephant in the room. I draw your attention once more  (FX research roundup:...China crisis) to the Shanghai Composite index. The critical level is said to be 2363 – technically I’m told that a close below that could signal a sharp move to as low as 1250. The index closed on Thursday at a 15-month low of 2373.79 and didn’t exactly rebound vigorously today, closing at 2382.9


One percent away from a possible free-fall: beware the bear-trap, obviously, but just as much be aware of the death trap. This is not a risk-positive situation.


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