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The Week Ahead – EU focus to trump
Publication date: 23 January 2012
Author: John J Hardy, Saxo Bank
Another Monday finds us looking at the week ahead, a week in which EU issues are likely to continue to dominate as the EURUSD starts off the week in full squeeze mode. The FOMC decision is up Wednesday, but may not be a watershed event.
EU still front and centre
The focus on EU issues will inevitably continue this week ahead of next Monday’s EU summit. Meanwhile, other EU meetings abound. Today, we have EuroGroup finance ministers meeting, ESM ministers meeting, and later a meeting on the fiscal compact (the key part of the new EU treaty/sub-treaty that may be formalized at the next summit). Tomorrow we have an EcoFin meeting of the EU-27 finance ministers.
The Greek PSI negotiations continue, but appear to be a question of details. These may be agreed next week, but the deals specifics are likely to be far less interesting than issues like how the “voluntary” uptake of the deal proceeds. If it does not proceed smoothly, we have the possible complications from so-called CACs that force the deal on the creditor hold-outs and the CDS implications of those CAC and risk of contagion to other Euro Zone peripherals, etc. Second, will Greece still be able to function even after this deal and are we moving towards a real default and reintroduction of the drachma on the other side of Greek elections?
Bank capital rules
Meanwhile, last Friday was the deadline for EU banks to prove they met capital adequacy ratios after the December stress tests. Though there was plenty of “stress” as banks moved to meet the requirements – most notoriously in the case of Italy’s UniCredit as its equity price collapsed earlier this month when it moved to raise capital via a rights offering – bank shares across Europe have been rallying in recent days as peripheral debt yields have also come in. And over the weekend, we even have rumours that the next move could be to relax capital adequacy rules. The extend-and -pretend game continues.
We’ve seen a number of negative earnings surprises out of US companies and weaker outlooks and analysts long ago began to reduce year-forward earnings expectations, so even if equity valuations look fairly cheap in the rear-view mirror, relative to the prospects for forward earnings, they may be pricey.
Of course, markets are setting new highs almost daily in celebration of yet another short-term success in the central bank liquidity-enhancement game – with the ECB in the vanguard this time around rather than the US Fed. A number of measures suggest complacency is very high, and volumes are low – is this a risky combination for bulls who are late to the party? Wednesday’s FOMC could be a key test for the market if there is any sense of disappointment over the prospects for QE3.
The USD is suffering in this risk-on environment, and the Euro shorts certainly got ahead of themselves (nothing like a rear view mirror for assessing this) as EURUSD has been caught in a squeeze. It appears that the argument that the expansive ECB is negative for the currency is being at least partly offset by the latest ECB success in reducing the immediate risk of widespread sovereign defaults, etc. For EURUSD, 1.30-1.32 is a comfortable zone for the pair to find resistance – anything above that and it begins to become uncomfortable for the bearish view.
AUD continues to thrive as investors can’t get enough of a higher yielding, AAA sovereign in this environment – and copper is rallying to boot. Who cares if the domestic non-mining economy is collapsing? The central bank is likely to really rattle its cage on the currency’s strength at its Feb. 7 meeting.
JPY crosses are turning higher as we staged a strong reversal in government bond markets last week (see below) though the USDJPY cross refuses to move much.
GBP is weaker as the Euro relief spells pound misery (0.92 correlation for EURUSD and EURGBP for last 200 trading days)
CAD can’t get any respect though it is egregiously undervalued against the Aussie. The recent WTI oil sell-off and the country’s low yield are seeing it find no respect relative to the high flyer from down under and it’s little side-kick , the kiwi.
A bit surprising to not see more EUR upside against CHF as it recovers – not the consensus behaviour expected.
Last week saw a technical reversal on the long term bond charts, with a strong weekly candle from close to the lowest yields for the last several months. But is this a red herring? Let’s see what long bonds do if and when the equity rally pivots. Another potential source of short term volatility is the Wednesday FOMC meeting, though we suspect the Fed remains in a holding pattern.
Gold and silver soaring as the liquidity remains the name of the game. Crude is critical to watch as geopolitical tensions remain high.
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