A Euro update ahead of the ECB meeting

As we are in the middle of a market turmoil, with equities down 10 to 15 percent since the beginning of the year, we thought that a quick update on the Euro (and where it is going) could do it. With Eurostoxx index down 12% and peripheral sovereign and financial risk spiking (Banca Monte Paschi di Siena down 60%, trading at 51 cents), markets’ participants are questioning themselves ‘what more could the ECB do?’ Currently on a €60bn bond-purchases program (which duration was extended to March 2017) combined with a NIRP policy (deposit rate at -0.3%), there is not much that Draghi could offer to the market in order to depreciate the single currency to lower levels (parity?) and stabilize the market.

Since the Euro’s recovery when Draghi’s credibility was threatened at the December’s meeting (no increase in the asset purchase programme), EURUSD has been trading sideways over the past 6 weeks within a 350-pip range (1.07 – 1.1050). It looks like the single currency is struggling to break trough the 1.10 strong resistance, and We believe that a lot of bears are waiting to go short around that area. However, we would be cautious on a new disappointing news coming from the ECB that could potentially send EURUSD to new highs. Unless the Governing Council reveals a new plan to stabilize the Euro Zone economy and its stagnating inflation rate (+0.2% in December), there are no main reasons why the Euro should decline drastically tomorrow. One chart that we like to watch when volatility spikes is EURUSD and its correlation with the VIX index. As you can see it on the chart below, the 10-day correlation has moved from 0 to 74% over the past two weeks, with the VIX index trading slightly below 30. We think it could be interesting to watch the overnight session and its impact on tomorrow’s trading session, as we know that the single currency can act as a safe haven asset in periods of high volatility (and low liquidity). The last time was on August 24th as we wrote it in our article EURUSD and VIX last September.


(Source: Bloomberg)

Global Macro: trade on China’s weak signs and Draghi’s Will to Power

This article deals with a few current hot topics:

  • The main one gives an update on weakening signs of giant China
  • The second one reviews the ECB Thursday’s meeting, presented with a couple of FX positioning
  • The last one is on the debt ceiling debate and risk-off sentiment

China desperately flowing…

As I am looking at the current news in the market, there has been a lot of interesting topics to study over the past couple of months. I will first start this article with an update on China and its weakening economy. Since the Chinese ‘devaluation’ on August 11th, I have been focusing much more in the EM and Asian Market as I strongly believe that the developed world is not yet ready for a China & Co. slowdown. I heard an interesting analysis lately, which was sort of describing the assets that had performed since the PBoC action more than two months ago. As you can see it on the chart below, Gold prices (XAU spot) accelerated from 1,100 to a high of 1,185 reached on October 14th, and Bitcoin recovered from its low of 200 reached in late August and now trades at $285 a piece.


(Source: Bloomberg)

One additional explanation that I have for Gold is that I believe that the 1,100 level could be an interesting floor for long-term investors interested in the currency of the last resort. The weak macro, loose monetary policy, low interest rates and more and more currency crisis in EM countries will tend to bring back gravity in Gold, especially if prices become interesting (below $1,100 per ounce) for long-term buyers.

Looking at the CSI 300 Index, we still stand quite far from the [lower] historical high of 5,380 reached in the beginning of June last year. Since then, as a response, we had a Chinese devaluation, the PBoC cutting the minimum home down payment for buyers in cities last month (September 30th) from 30% to 25% due to weak property investment, and then a few days ago the PBoC cutting the Reserve Requirement Ratio (RRR) for all banks by 50bps to 17.50% and its benchmark lending rate by 25bps to 4.35%. Looking at all these actions concerns me on the health of the Chinese economy; it looks very artificial and speculative. In a late article, Steve Keen, a professor in economics explained that the Chinese private-debt-to-GDP ratio surged from 100% during the Great financial crisis to over 180% in the beginning of 2015, amassing the largest buildup of bad debt in history. Its addiction to over expand rapidly have left more than one in five homes vacant in China’s urban areas according to the Survey and Research for China Household Finance. Banks are well too exposed to equities and the housing market, and it looks that they have now started a similar decline as the US before 2008 and Japan before 1991. To give you an idea, the real estate was estimated to be at 6% of US GDP at the peak in 2005, whereas it represents roughly 20% of China’s GDP today.


(Source: Forbes article, Why China Had to Crash)

I wrote an article back last September where I mentioned that the Chinese economy will tend to slow down more quickly than analyst expect, therefore impacting the overall economy. We saw that GDP slide to 6.9% QoQ in the third quarter, its slowest pace since 2009 and quite far from the 7.5%-8% projection in the beginning of this year.

Draghi’s Will To Power

One fascinating event this week was the ECB meeting on Thursday. Despite a status quo on its interest rate policy, leaving deposit rate at -0.2% and the MRO at 5bps, a few words from the ECB president drove immediately the market’s attention. He said exactly that ‘The degree of monetary policy accommodation will need to be re-examined at our December policy meeting’, therefore implying that the current 1.1 trillion-euro program will be increased. As you can see it on the chart, EURUSD reacted quite sharply, declining from 1.1330 to a low of 1.0990 on Friday’s trading session, and sending equities – Euro Stoxx 50 Index – to a two-month high above 3,400. Italy 2-year yield was negative that day (hard to believe that it was trading above 7.5% in the end of November 2011).


(Source: Bloomberg)

 I am always curious and excited to see how a particular currency will fluctuate in this kind of important events (central banking meeting usually). One thing that I learned so far is to never be exposed against a central bank’s desire; you have two options, either stay out of it or be part of the trend.  I think EURUSD could continue to push to lower levels in the coming days, with the market slowly ‘swallowing’ Draghi’s comment. I think that the 1.0880 level as a first target is an interesting level with an entry level slightly below 1.1100 (stop above 1.1160).

USDJPY broke out of its two-month 119 – 121 in the middle of October down to almost 118, where it was considered as a buy-on-dip opportunity. It then levitated by 3 figures to 121.50 in the past couple of weeks spurred by a loose PBoC and ECB. The upside looks quite capped in the medium term if we don’t hear any news coming from the BoJ. The upside move on USDJPY looks almost over, 121.75 – 122 could be the key resistance level there.


(Source: Bloomberg)

Potential volatility and risk-off sentiment coming from the debt ceiling debate

On overall, with US equities – SP500 index – quietly approaching its 2,100 key psychological resistance with a VIX slowly decreasing towards its 12.50 – 13 bargain level, I will keep an eye on the debt ceiling current debate in the US, which could trigger some risk-off sentiment in the next couple of weeks (i.e cap equities and USDJPY on the upside). Briefly, the Congress has to agree on raising the debt limit to a new high of 19.6tr USD proposed (from 18.1tr USD where it currently stands). The debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing obligations, and the current debt ceiling proposal’s deadline is November 3rd. No agreement would mean that the US government could default on its debt obligations, which could potentially increase the volatility in the market.

The chart below shows the increase of the debt ceiling since the early 1970s, after the Nixon Shock announcement which led to the end of Bretton Woods and the exponential expansion of credit.


(Source: The Burning Platform) 

The ‘Obama’ Dollar Rises…

Over the past few weeks, I had several discussions with some friends of mine to try to understand and clarify the US Dollar ‘pause’ we have seen since the middle of March. A dovish stance from the Federal Reserve, which obviously led to a status quo at the June FOMC meeting, may have halted the Dollar bulls, but it seems to me that the market is getting more and more confident about this year’s lift-off.

Based on the forecasts made in June, the Fed Staff expect policymakers to raise the Fed funds rate to 35bps by the end of the fourth quarter of 2015, which implies a one quarter-point hike this year (chances of an initial move at the September meeting stand roughly at 60%).

Quick recap’ on the macro figures

Even though the unemployment rate hit a 7-year low at 5.3% in June (with a strong NFP at 223K) and Q2 GDP came in at 2.3% (above the 2% ‘target’, but still below Wall Street’s consensus estimate of 2.5%), the rest of the figures and the overall macro/geopolitical situation both don’t look quite good. US inflation has average 0% since the beginning of the year (0.1% YoY in June), consumer spending YoY declined for the third consecutive month and both business fixed investments and net exports stayed soft. On a broader scale, the commodity-meltdown continues as demand from China may slow even further on the back of a weak manufacturing activity (Chinese PMI fell to 47.8 in July, its two-year low). For instance, NYMEX WTI September futures are trading near levels not seen since March, with September contract at $46.30 per barrel.

In addition, even though the Economic and Financial Affairs Council (ECOFIN) approved a 7.1bn-euro bridge loan to Greece last month (July 17th) given through the EFSM so that the country could meet its short-term obligations including a 3.5bn-euro payment to the ECB on July 20, Athens has no money left. That is problematic as a second big 3.2bn-euro payment is coming on August 20 to the ECB and there are talks that they may miss it as the bailout timeline is ‘unrealistic’.

Chinese economic slowdown, low oil prices, deflation and Greek payments are all subjects that I try to follow closely as it is the topics I believe that US policymakers are watching as well. However, I think this time the Fed officials are quite ready for a lift-off in September, and now I have been questioning myself about the US Dollar rally.

The Dollar Rallies…

The chart below shows the three dollar rallies that occurred since the collapse of the Bretton Woods system. The first big one is the Reagan dollar rally in the early 80s, fueled by the tight monetary policy. As a result of the second oil shock in 1979, chairman Volker orchestrated a series of interest rate increases that took the federal funds target from 10 to nearly 20 percent. If the Euro had existed then, the single currency would have depreciated by roughly 60%. The rally was eventually halted in September 1985 by the Plaza Accord signed by five governments to depreciate the US Dollar in relation to the Japanese Yen and the Deutsche Mark.

The Clinton Dollar rally started in the mid 90s fueled by the US Tech bubble and capital inflows into the US equity market in addition to the US government running federal surpluses. This surge brought the Euro down to 0.8230 against the greenback and USDJPY was trading at a high of JPY135 at the end of the rally (late 2001).

The recent Obama rally has started in early July last year as a result of monetary policy diverge between the US and the rest of the World. The commodity meltdown will continue to weigh on commodity currencies and especially on the Dollar-Bloc (CAD, AUD and NZD), as Greece will continue to make the headlines until Bailout#3 is eventually agreed.

As you can see on the chart below, I added a downtrend line that was broken in the beginning of the year. The US Dollar index hit a high of 100.80 in mid-March before its March-May consolidation. It looks to me that the greenback is gradually recovering from its quick contraction.

DXY avec MA

Source: Reuters

Despite a low volatile market at the moment, I am convinced that the US Dollar will gain strength in the end of this second semester. I will try to add a currency-detailed article by the end of the week with my new levels on the main currency pairs.

March: ECB’s painful month?

As you know, the Euro has been massively under pressure since the ECB’s May meeting last year and decreased from 1.40 to a low of 1.11 before edging back to 1.14. In my article The Euro Strength and The ECB’s options, I explained the ‘Euro strength story’ (July 2012 – May 2014) by the following three factors:

  • Narrowing peripheral-core spreads (After Draghi’s ‘Whatever it takes’ and OMT introduction)
  • Divergence between the ECB and the Fed’s balance sheet total assets
  • Current Account back into positive territories

During this ‘prosperous’ period, nothing was able to stop the Euro despite poor fundamentals (i.e. flat growth, high unemployment rate and declining inflation). Then, Draghi’s promise ‘the Council is comfortable with acting in June’ completely broke the upside trend and the market has been totally relying on the ECB’s balance sheet expansion plan. It is clear now that EZ policymakers’ goal is to see the central bank’s balance sheet expend by 1.14tr Euros within the next 18 months and reach June 2012 levels (approximately 3.1tr Euros). As you can see it on the graph below (EURUSD monthly chart), the market got really excited about this news and traders and investors have completely switch to a bearish view when it comes to EURUSD (and EURGBP). We saw that Bulge Bracket banks reviewed their EURUSD forecasts for 2015. Sell-side research predicts a EURUSD between 0.90 and 1.00 within the next 6 to 12 months. Moreover, if we have a quick look at the last CFTC’s Commitments of Traders report, ‘net speculative’ positions were approximately -186,000 in the week ending February 17, and are closely approaching June 2012 low of -215,000.

Screen Shot 02-23-15 at 12.44 AM

(Source: Oanda, CoT)

If you ask me where I see EURUSD in the long term, there is no doubt that my answer is ‘South’. With the Fed considering starting its monetary policy tightening cycle (June meeting for a first 25bps shift probably), monetary policy divergence will weigh on the currency pair in the LT and parity looks like a reasonable level to me. In addition, Grexit contagion effect to ‘scarier’ countries such as Spain could also trigger another episode of peripheral-core yield spread divergence and therefore add more selling pressure on the single currency.

However, I think that traders and investors should be careful at the moment. Over the past two weeks, volatility has dropped in the market and EURUSD has been trading within a tight 180-range (1.1270 – 1.1450). Based on the last discussions I had, some of the traders were clearly waiting for a breakout ahead of the Greek deal, therefore the 1.1270 support was carefully watched on Friday (this is the reason why I put my take profit slightly above at 1.1300, see article Pocketful of Miracles). However, the Euro looks resilient based on current market conditions and I have to admit that I see potential Euro strength in the month coming ahead. As you can see it below, EURUSD reached a 11-year low at the end of last month at 1.11 before coming back to 1.14. The Fibonacci retracements were built based on October 200 low of 0.8230 and July 2008 high of 1.6040 range. Unless contagion risk spreads to other EZ countries (i.e. higher core-peripheral risk), the bullish trend could last for a month or two (based on previous bull consolidation after sharp sell-off).

Screen Shot 02-23-15 at 12.50 AM

(Source: FXCM)

The ECB bond buying program: Ambitious plan, disappointing results?

We are aware now that the ECB has announced a round of measures in order to counter the deflationary cycle (inflation rate of -0.6% in January) and of course support investment and consumption, the two key contributors of the 19-nation economy. The last one was of course the January announcement of additional purchases (combined monthly asset purchases of 60bn Euros from March to September 2016). This programs involves private assets such as covered bonds (safe form of debt issued by banks), ABS and public debt (bonds of national government and European institutions). However, unlike the Fed, the ECB will have to seek them in the secondary market; in other words, find the banks that will sell them these bonds. And Draghi’s (and Co.) problem here is that the ECB may face unwilling sellers. As some of you know, banks’ treasury desks usually buy short-term bonds and use government debt as a liquidity buffer: regulators require banks to hold high-quality liquid assets – HQLAs – against future cash outflows in periods of market stress. As some of you may know, most bonds issued by banks are excluded as they may prove illiquid during a financial crisis; however, the eligibility requirements imposed on government bonds look loose. Therefore, this implies that that government bonds currently represent a considerable portion of bank assets.

In the European Union, there are two new ratios:

  • Liquidity Coverage Ratio LCR, requiring banks to hold a stock of liquid assets for an amount covering the net liquidity outflows which might be experienced, under stressed condition, over the following 30 days,
  • Net Stable Funding Ratio (NFSR), which requires that the amount of available stable funding (i.e. portion of capital and liabilities expected to be reliable over a one-year time horizon) should be at least equal to the required amount of stable funding or the matching assets (i.e. illiquid assets which cannot be easily turned into cash over the following 12 months).

These two ratios were enacted through a Capital Requirements Directive (CDR4) and Regulation (CRR) issued in June 2013. Based on the Basel 3 documents, liquid assets in the LCR should mainly consists of:

  • Cash
  • Central bank reserves (including required reserves)
  • Marketable securities representing claims on or guaranteed by sovereign, central banks, PSEs, BIS, IMF, the ECB and European Community, or multilateral development banks
  • Bonds issued by non-financial firms and covered bonds with a rating at least equal to AA, subject to a 15% haircut and a 40% concentration limit

The two questions now that comes to my mind are:

  1. Who will sell those bonds to the ECB?
  2. Suppose the ECB offers good prices (i.e. good realized PnL for bond trading desks), what will traders do with this new cash with a deposit rate now at -0.2%?

Disappointing ECB could lead to Euro strength…

To conclude, I think there is potential risk that the ECB disappoints the market in March based on their purchases as the central bank won’t find the liquidity in the market. In my opinion, this scenario could play in favor of the single currency. My point is that we may see a bull consolidation before reaching the parity level that everyone seems to be talking about. The next couple of resistances to watch on the topside would be at 1.1530 and 1.1680.

Pocketful of Miracles…

It is sure that things are not easy negotiating with its ‘partners’ as time goes on. As Latin poet Publilius Syrus once said ‘A small debt produces a debtor; a large one, an enemy’. In this article, we are interested to see where the negotiations will go within the next few days.

First, let’s review quickly what is going on with Greek’s liabilities.


(Source: Bloomberg)

The pie chart above shows us who ‘owns’ Greece’s public debt. According to the country’s Statistical Authority, Greece’s total public debt amounted €315.5bn  at the end of the third quarter of last year, which corresponds to roughly 180% as a share of the country’s GDP. As you can see it, the EFSF, the EZ temporary crisis-fighting fund, lent the country €141.8bn (which represents 45% of it) and the current weighted average maturity is 32.38 years with the last payment due in August 2053 according to the fund’s website. As you may have heard at the end of last year, the Board of Directors of the EFSF decided to grant Greece a two-month technical extension. The program will end on February 28th instead of December 31st last year. As a result, the remaining amount available (1.8bn Euros, which will raise the total amount to 143.6bn Euros) could still be disbursed to Greece (in need of assistance) until the end of this month.

Another major ‘creditor’ of Greek’s debt is the ECB, as a result of the Security Markets Programme (SMP), which currently owns about €27bn (i.e. represents 40% of the €67.5bn marketable debt outstanding). However, whereas EFSF loans where principal payments don’t start until 2023, Greek is set to pay 6.7bn Euros held to the ECB this summer (20 July: €3.5bn, 20 August: €3.2bn).

Eventually, the IMF is also an important creditor with 25 billion Euros according to the fund’s website, maturing currently. IMF loans in February and March are €3.5bn. As a reminder, the IMF’s policy is to never restructure its loan.

Therefore, if we add up the Greek Loan Facility (Bilateral Loans), the ECB holdings, the EFSF loans and the outstanding IMF credit, we get 246.7bn Euros, that is to say 78.2% of the total public debt. How convincing will the new Tsipras government be ‘against’ those figures?

It has been a rough start for Greece: the country’s news has been making the headlines since (and before) the election of the new government (January 25th). PM Tsipras has made it clear that Greek debt is unsustainable, condemning the country to a state of perpetual economic recession and deflation, and is trying to negotiate a write off with its debt creditors. In addition to that, he unveiled last Sunday plans to undo several austerity measures: gradually increasing the minimum wage, dropping the recent property tax and promised the retirement age wouldn’t be change (anymore).

However, this will be the tricky part of the deal – asking for a write off while easing austerity measures – as they don’t (or never) come together usually. Negotiate a debt write off, press for a relaxation of economic austerity, avoid a bank run, and on the top of that, maintain a political stability. It is interesting to see that investors are considering political risks once again after more than two years of main attention to the ECB and its programs and promises.

However, as many of you, we would agree that the market is underestimating the consequences of a Grexit clearly, not only the costs, but also contagion to other ‘weak’ peripheral economies (i.e. Portugal). What would happen to the Euro if the spread between peripheral and core yields (good sovereign risk indicator) starts to rise once again (like in early 2012)?

Quick view on EURUSD:

EURUSD broke its small resistance at 1.1350 yesterday after a quiet week, and seems on its way to retest the 1.1500 level. We saw earlier this morning that EZ grew by 0.3% in the last quarter of 2014, meaning that the 19-bloc economy grew by 0.9% during 2014, better than the 0.8% expected (see details in Appendix). However, Greek FinMin is making the headlines this morning: ‘Haircut preferable to loan extension’, which is obviously ‘capping the pair on the topside. A good entry level would be above 1.1460 (if it makes it up there), with a stop above for 1.1530 and a take profit at 1.1300. You can also play the bigger range, setting your stop above 1.1650 and take profit at 1.1200. However, we wouldn’t recommend to be too ‘greedy’ ahead of the Eurogroup meeting on Monday.

Otherwise, we stay strongly bearish on the Euro in the long term (vs. USD and GBP), as growth, monetary policy divergence, Grexit contagion, geopolitical tensions will clearly weigh on the single currency.



(Source: EuroStat)

January 2015: A Rough Start

The past month has been quite eventful in the financial market and I am sure that some of the decisions (if not all) surprised many of us. After the SNB announce on January 15th, the ECB took over and unveiled a €60bn monthly QE (not open-ended) through September 2016; so 19 months at €60bn equals €1.14tr. The ECB, which has already been buying private assets such as covered bonds (a safe form of debt issued by banks) and ABS, will add an additional €50bn worth of public debt (bonds of national government and European institutions) to its current program starting in March this year. The purchases of these securities (in the secondary market) will be based on the Eurosystem NCB’s shares in the ECB’s capital.
In addition, President Draghi also added that the ECB will remove the 10bp spread on the TLTROs, and the interest rate applied will be equal to the rate on the Eurosystem’s MRO (5bp).

We saw on Friday that EZ preliminary inflation fell by 0.6% in January after a -0.2% print in December, the largest decline since July 2009 when prices also fell 0.6% following GFC.

The ECB decision(s) sent the Euro to newest lows last week, down to 1.1120 (11-year lows) against the greenback and below the 0.75 level (0.7440) against the pound. But more importantly, it sent a bigger amount of government debt in the negative territory (yields). According to JP Morgan, there is currently (approximately) €1.5tr of Euro area government bond with longer than 1-year maturity trading at negative yields over time, and a ‘mind-blowing’ €3.6tr of global government bond debt (nearly a fifth of the total) with negative yields as the chat below shows us. For instance, the entire 10-year Swiss curve is  now negative.

Global NIRP(Source: JPMorgan)

Another interesting topic is of course the 3 consecutive rate cuts (in 10 days) by the Danish Central Bank, that lowered it deposit rate to a record low of -0.5% to defend its peg and keep the Danish kroner (DKK) close to 7.46 per Euro (ERM II since 1999). EURDKK went down below 7.43; we will see this week how much policymakers spent in January in order to counter a DKK appreciation (some reports estimated that the central bank had to sell more than DKK 100bn). As a consequence (of the NIRP policy), a local bank – Nordea Kredit – is now offering a mortgage with a negative interest rate.
I believe the Danish krone is a currency to watch (in addition to the CHF) this month if the situation in Greece deteriorates.

A Weak Swiss Franc…
Since the SNB surprise, the Swiss has remained weak against the major currencies, with USDCHF up 7 figures  (trading currently at 0.93) and EURCHF up from parity to 1.0550. Analysts slashed their forecast for this year and are now predicting a recession (-0.5% according to the KOF Swiss Economic Institute). I like the chart below which shows the 12-month Probability of the top 10 countries to fall into recession in the coming months according to Bloomberg economist surveys.

Probarecession(Source: Bloomberg)

Japan and JPY still under threat over the long-run
In Japan, the 10-year JGB yield rose by 9bp in the last 10 days and is now trading at 29bps. USDJPY tumbled below 117 overnight on Grexit comments and Chinese manufacturing PMI contraction in January (49.8 vs. 50.2 expected), breaking its 117.25 support and extending its trading range to 116 – 118.75. ‘Buyers on dips’ reversed the trend and the pair is now trading at 117.60.
If we look at the long-run perspective in Japan, late macro indicators showed us that Abe’s government will have to do more. Real wages are still declining and fell the most in almost 5 years and the economy has now entered in a triple-dip recession (0.5% contraction QoQ in Q3). On the top of that, inflation has been weakening for the past 8 months as energy prices (mainly weak crude oil) weight on Japanese core inflation rate.
In addition, we saw that Japan plans a record budget deficit for next fiscal year (starting April 1st 2015) to support the economy. FinMin Taro Aso reported that government minister and the ruling coalition parties approved a 96.34tr Yen budget proposal for FY2015/2016. And I believe that we haven’t reached the peak yet, as Japan’s aging population (i.e. increasing social security spending) will ‘force’ the government to print larger and larger deficits. The IMF predicts that the country’s debt-to-GDP ratio will increase to 245% in 2015. It clearly shows that the USDJPY trend is not over yet, and there is further JPY weakness (and USD strength) to come.

On the other side of the Pacific Ocean, the US economy cooled in the fourth quarter. After the 5-percent Q3 print, GDP expanded at a 2.6% annual pace in the fourth quarter (first estimate). Net exports was the largest detractor from Q4 GDP (-1.02%) as imports grew faster than exports. King Dollar continues to benefit from the global weakness with the USD index trading slightly below 95. The equity market still handles the Fed’s withdrawal from the Bond Market with the S&P500 trading around 2,000 (looks like it is out of energy though), while US Treasury yields are compressing to new lows. The 10-year and the 30-year yields are trading at 1.67% and 2.25% respectively (which is quite concerning), and it seems the trend is not over yet. In regards to the inflation rate (that plummeted to 0.8% in December), the Fed delivered a hawkish statement last Wednesday (‘strong jobs gains’, ‘solid pace’ for economy), however dropping the entire ‘considerable time’ sentence and adding ‘inflation is anticipating to decline further in the near term’. The implied rate of the December 2015 Fed Funds futures contract is trading 30bps lower at 41 bps, while the December 2016 implied rate decreased by 60bps to 1.05bps in the past 6 weeks.

An important topic to follow this month will be developments in Greece which are moving very fast since the election on Sunday (January 25) and Syriza’s victory. ECB council Member Erkki Liikanen said over the week end that Greece needs to negotiate a deal before February 28th (when the Greek support program EFSF expires after the 2-month extension approved in December).

A CB surprise…

After October 15th last year, yesterday was another insane day in the market. We know approximately the impact of a lower (or higher) NFP report on the US dollar or a lower (resp. higher) than expected EZ inflation rate on Euro bonds; however when the surprise comes from a central bank, we saw the consequences…
But first, I am going to have just one quick digression before going for it, concerning the OMT.

OMT is legal

Almost a year ago, the German Federal Constitutional Court (GFCC) found ECB’s OMT bond-buying program illegal and incompatible with EU and German law. Given that the GFCC only has jurisdiction on matters of German domestic law, it decided to leave judgement to the European Court of Justice (ECJ). In his Opinion on Wednesday, the Advocate General Cruz Villalon observed that the program is compatible with the EU Law and that the ‘objectives are in principle legitimate and on consonant with monetary policy’. He added that the program is ‘necessary as well as proportionate in the strict sense, since the ECB does not assume a risk that will necessarily make it vulnerable to insolvency’. As a reminder, the Advocate General’s Opinion is not binding on the Court of Justice. THe judges are now deliberating and the Opinion is expected to reach its judgment by May.

The Euro plummeted by 100 pips to 1.1730 (9-year low) after the news, but came back above 1.1840 on the back of poor US retail sales figures. As a reminder, retail sales dropped 0.9% MoM on Wednesday, the most since June 2012, and missed expectations of a 0.1% decline.

However, the ‘recovery’ didn’t last very long as the single currency is currently trading at 1.1630 against the greenback. How come?

Definitely unexpected…

Yesterday morning, slightly before lunch time (Swiss local time), the Swiss National Bank announced that it was discounting the minimum exchange rate of 1.20 per Euro (that it has been ‘defending’ for the past 3-1/2 years). It also announced that it would go further into NIRP policy, pushing its interest rate on deposit balances to even more negative from -0.25% to -0.75%.

By letting the exchange rate float ‘naturally’, the consequence were brutal and EURCHF, which had been flirting with the 1.20 over the past couple of months, crashed to (less than) 75 cents per Euro, wiping out every single long EURCHF position, before ‘recovering’ to parity (now trading at 1.0140).


USDCHF is now trading around 0.8700 (back from above parity levels, 1.02 to be precise), and EURUSD was sold to 1.1568 before rebounding.

A Stressed Market

The Swiss curve is now trading in the negative territory for all the maturities until 10 years; the swiss market index tumbled to (less than) 8000 (almost 15 drawdown) and then stabilized around 8,400.

US yields are still compressing, with the 5-year, 10-year and 30-year trading at 1.18%, 1.72% and 2.37% respectively. I added a table below that shows the 10-year overall and definitely summaries the current ‘environment’. As you can see, Greece is the only EZ country where yields are trading at astronomic levels on the fear of a Grexit scenario in 10 days (See article here). I like the expression ‘the Japanization of Global Bond yields’ used by some analysts I read.

Capture d’écran 2015-01-16 à 10.35.47


Our favorites, AUDJPY and USDJPY, both reacted to the SNB comments ‘bringing down’ the equity market with them. AUDJPY plunged from (almost) 97 to 95.30 and is now trading at 95.60. USDJPY broke below 116.60 and dropped to 116.28; before that, it reached a daily high of 117.92 during the ‘early’ Asian hours.

The S&P500 index followed the general move and broke the 2,000 level (closing at 1,992), and is now trying to find a new low. Is it going to be a buy-on-dips scenario once again? Clearly, the equity market is ‘swingy’, however I don’t think we are about to enter a bearish momentum yet and I still see some potential on the upside. Therefore, USDJPY should also help the equity market levitate and we should see the pair back to 120.

Discrete poor US fundamentals

Yesterday was also marked by a poor jobless claims report in the US, which was totally forgotten of course but surged to 316K (vs. expectations of 290K). In addition, the Philly Fed, an index measuring changes in business growth, crashed from a 21-year high of 40.2 in November to 6.3 in January (missing expectations of 18.7), the lowest since 2014. I know these figures are quite not relevant for traders and investors, however I do think it is worth noticing it. As a reminder, US inflation rate (watched carefully by US policymakers) decreased from 1.7% to 1.3% in November and is expected to remain at low levels (between 1 and 1.5 percent).

Overall, the global economy still looks weak, and we saw lately that the World Bank decreased this year’s growth projections to 3% in 2015 (down from 3.4% last June). Major BBs declined their forecasts on oil and expect prices to remain low in the first half of this year. We heard Goldman’s Jeff Currie lately saying that prices of crude oil may fall below the bank’s 6-month forecast of $39 a barrel. Remember the chart I like to watch (oil vs. inflation vs. yields vs. equities).

The next couple of event to watch are of course the ECB meeting on January 22nd, followed by the Greek national elections on January 25 (see below). For the ECB meeting, it is hard to believe that the central bank will do nothing after the SNB’s announcement.


(Source: MS Research)

Quick update on the ‘Grexit’

Not only last year was a bad year for Greek market, Greece Athex is one of the worst 2014 performers (total return) with a 29% drawdown, but the country has suffered from political instability since the beginning of June. Since Syriza’s triumph in European elections on May 25th, the 10-year bond yield has soared from a low of 5.5% on June 10 to over 10% on ‘Grexit’ fears (the 3-year bond yields trading at 13.6%, up 10% over the past four months). The – Hellenic Republic – 5-year CDS, a good measure of the country’s default risk, is up more than 1000 bps, now trading around 1500bps. There has been some speculation of a possible ‘Grexit’ scenario; and as Der Spiegel news reported lately, German Chancellor Merkel is ‘prepared to let Greece leave the euro zone’ if the country abandons fiscal discipline and does not repay debts to its creditors.

2015: another difficult year for Greece

This year, according to Nomura’s analysts, Greece will face total payments (Principal + Interests) of 22.3bn Euros; €8bn scheduled to be paid to the ECB (mainly in July and August). As you can see it on the chart below published by Eurostat, which shows EuroZone debt and deficit by country, with a debt-to-GDP ratio standing at an all-time-high of 175% (despite the debt ‘haircut’ back in March 2012) and a deficit of 12.7% in 2013, there is no doubt that the country’s debt is unsustainable.

EZfiscal(Source: Eurostat)

There is nothing to stop it growing except haircuts, i.e. ‘partial’ default. Even though Greece’s recession has ended last year after almost six years of misery (the economy is now 30% less than in 2008), financial conditions (unemployment rate at 26% in total and 50% for youth, deflation for the past two years) will weigh on the economy longer than many analysts expect, especially now with the global macro conditions.

How strong is the anti-austerity party in Greece?

To sum up briefly the events of the past few weeks, Greece failed to approve a president (Stavros Dimas) nominated by PM Antonis Samaras as the number of votes didn’t reach 180 after three consecutive rounds (in the last round, 168 Greek lawmakers voted in favor of Dimas, 132 against). Therefore, as the Parliament failed to elect the President, Greek Constitution provides that the Parliament is being dissolved and snap earlier elections.
Greek elections will take place in a couple of weeks (on January 25) and the question is What could it look like?

In the last days of 2014, I remember that a first poll done by Alco for Proto Thema suggested that no party will have a clear majority in the new parliament (as one party will need roughly 35% of the Greek votes in order to gain an absolute majority). At that time, Syriza, a leftist anti-austerity party led by Alexis Tsipras, was ‘leading’ the league with 28% of the votes, followed by liberal-conservative New Democracy (ND) with 23%.

The market’s reaction was quite brutal as I said earlier as many investors fear that Greece may be forced to leave the Euro. The Syriza party wants to abandon the austerity measures imposed by the Troika as part of the €240bn bailout and wants a writedown on the nominal value of Greek Debt. I like the chart below (Source: Bloomberg) that gives you an idea of the government exposures to Greek’s public debt. The main bloc is held by official creditors (Euro-area governments: 62%; followed by the IMF, 10% and the ECB 8%). As you can see it in the chart, Germany is the major government-creditor of Athens and has more than €60bn in total exposure.

GreeceExpo(Source: Bloomberg Brief)

Greece bank shares (Alpha bank, Piraeus) all collapse over the past few weeks as fear of bank solvency and bank runs surged (Cyprus ‘bail-in’ regime continental template?). As a matter of fact, interruption of liquidity by the ECB to Greek banks will potentially lead to a ‘Cyprus type’ bank holiday.

Latest update: An article from the WSJ came up earlier this morning, and says that in nine separate opinion tools that were published in the Greek media in the last couple of days, Syriza is still on top and would garner ‘between 27.1% and 31.2%’ of the votes.

ECB meeting and consequences on the Euro.

As we know, any spike in Euro peripheral (or core) bond yields has usually bad consequences on the single currency. Even though Greece doesn’t represent a major risk for the 19-nation economy, I strongly believe Greece is and will be the ‘hot’ topic of the next couple of weeks (with the Yen as usual). And at the moment, Greece makes ECB policymakers’ life complicated, concerning the central bank’s introduction of its public QE in order to counter deflation now (yes, you read it, deflation of -0.2% in December).

EUR/USD broke its 1.20 psychological support earlier this year and is now trading slightly above 1.1800 (a 9-year low). The next support that traders will target now stands at 1.1640, which corresponds to 2005 low.

I don’t think the market will react aggressively at the next ECB meeting on January 22nd, and even though we don’t hear any update concerning its QE, the Euro is still capped on the topside. I added below a timeline from Morgan Stanley that sums up the Key risk events for the EZ this quarter.

EZrecaps(Source: MS Research)

Below is another chart posted by SG Research that shows the ‘global macro’ euro are agenda for January and the downside/upside risk scenarios. As you can see, it includes the (forgotten) OMT case with the European Court of Justice’s decision on the legality of the ECB program for sovereign bonds.


(Source: SG Research)

Don’t fall in love with your US Dollar positions…

As you know, the Fed stepped back from the market by announcing the end of the QE3 era last Wednesday. However, another major central bank, the BoJ, took over by increasing [eventually] the amount of its current bond-buying program by 10tr Yen to 80tr Yen (and tripled its purchases of ETFs to 3tr Yen). You saw the consequences since then, with USDJPY that tested a new 7-year high at 114.00, up almost 5 figures in two business days. The Nikkei closed above the 16,400 level on Friday (16,413.76), but didn’t participate to the overnight development as Japanese market were closed due to Culture ‘holiday’ Day.

To sum up, the Fed is done with QE [for the moment], however we have two other big players – ECB and BoJ – which are trying to do whatever it takes to keep pushing asset prices higher. As a reminder, the ECB plans to increase its total balance sheet by 1tr+ EUR within the next couple of years to come (now is it possible? That’s a different story. See article ECB dilemma: Whatever it can…).

It looks to me that the chart to watch now is the total big-4-central-bank balance sheet. As you can see it on the chart below, 10.5tr USD were injected into the market since the GFC; and from what we hear and read, we are far from done…


(Source: Barclays)

One thing that makes me uncomfortable at the moment is the sharp appreciation of the US Dollar against all the currencies. We believe even though US policymakers are conscious the USD will strengthen in the long term, however we think that they are looking for a slow and gradual increase.

In its last minutes, the Fed expressed its concerns about the rising dollar (too fast indeed is what they meant) and its negative effect on inflation and US exporters. The market has to accept that, otherwise the topic will come back on the table each time (minutes, meeting, semi-annual testimony…).

Quick update on the Euro

The single currency broke its strong support at 1.2500 against the greenback (which represents the 76.4% retracement of the 1.2040 – 1.3991 interval) and the pair is now trading at a 2-year [and 2-month] low, down 11% over the past six months. There are rumours (ECB Source) that the Fed launched currency war telling the ECB not to push it too fat (concerning its exchange rate). It tells you that the next and final retracement traders will look at is the 1.2040 low reached on July 20 2012.


(Source: Reuters)

FX positioning

We are still comfortable on being short EURGBP, targeting the 0.7750 retracement (entry level 0.8000, stop loss decreased to 0.8000). Watch the ECB and BoE meetings this Thursday.

We would like to add another position on today’s update: short AUDNZD at current levels (1.1270), with a target at 1.1140 at first and a stop loss above 1.1360. We know that the late inflation figures in NZ (which came in lower than expected at 1% YoY vs 1.3% consensus) will weigh on RBNZ officials to consider getting back in the tightening cycle, but we are comfortable with short the pair at the high of the range as you can see it on the chart.

AUDNZD03Nov(Source: Reuters)