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).

EURCHF

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

(Source:Bloomberg)

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.

EZrecaps

(Source: MS Research)

ECB shakes the market

In addition to an ‘interest rates corridor cut’ (refi rate down to 5bps, deposit rate to -0.20% and marginal lending rate to 0.30%), the ECB surprised the market today after Draghi announced that the central bank will start buying securitised loans (portfolios of transparent ABS which will include loans to the real economy and real estate assets) and euro-denominated covered bonds in order to boost lending to small and mid-size companies (further details next meeting on Oct. 2nd).

 It was clear that ECB aims to get the total assets of its balance sheet back to the levels seen in  2012, which is to say a 1 trillion-Euro expansion. The ECB balance sheet (total assets) is now standing at 2.038tr Euros according to the EBBSTOTA index from Bloomberg, 34% lower than June 2012 high of 3.1tr Euros. This would bring back the Fed-to-ECB balance sheet ratio (one of the pair’s strong drivers) to 1.22 within the next few years, down from 1.67 where it stands at the moment, therefore adding pressure to the single currency.

 EURUSD started the day quite flat, trading at around 1.3150, before it was sent to 1.3000 at first during Draghi’s conference and even lower below 1.2940 as core European bonds yields turned negative to 2Y as you can see it below. French 2-year yield is now trading at -2.8bps, Austrian 2-year yield at -0.6%. German yields are now negative up to 4 years.

CoreYields(Source. Reuters)

In addition, the Governing Council reduced its growth and annual inflation to 0.9% and 0.6% for 2014, down from 1% and 0.7% respectively.

If you have a look at the picture chart below, which represents the full ‘ECB bailout scheme’ in order to sustain the European economy, you just start to think ‘what else could they do more?’

MRO, LTRO, ZIRP, SMP, OMT… and now T-LTROs, ABS and covered bonds. There are talks that Europe is heading towards a long period of stagnation / deflation period, where QE will be the only [pretended] option to get out of the negative spiral (have a look at Japan since Abe took office in December 2012 and see if QE is the solution).

ECB-bailing-out-Europe (Source: Bawerk.net)

If we have a look at EUR/CHF, it ‘only’ went down 20 pips (bottomed at 1.2044) after the ECB’s action; therefore we think that the SNB has already started buying some Euros in order to protect its floor at 1.2000.

USDCHF broke through the 0.9300 level to trade at 0.9330 earlier this afternoon, slightly below its 50-percent Fibo retracement of 0.8700 – 0.9980. The next resistance on the topside stands at 0.9450, followed by the psychological 0.9500.

CHFSNB(Source: Reuters)

Watch the correlations…

As EURCHF is barely moving, trading within a 60-pip range (1.2120 – 1.2180) over the past month and a half, EURUSD and USDCHF continues to trade almost ‘perfectly inversely’. Over the past the 18 months, the correlation between the two pairs stands at -97%. The ECB’s May conference followed by the introduction of a package of ‘easing’ measures from ECB policymakers have triggered a Dollar Strength environment. As you can see it on the chart below, EURUSD (black bar) is down 6.5 figures while USDCHF (orange bar) is now trading almost 4 figures higher at 0.9075.

In addition, the 6 consecutive NFP prints above the 200K level and a better-than-expected GDP print (Q2 GDP first estimate came in at 4.0%) played in favour of the US Dollar over the past few months. Yellen sounded quite hawkish at her last testimony in front of the Congress, and it seems that US policymakers have regained some confidence concerning their ST monetary policy (according to the July FOMC meeting).

However, it didn’t take too long to see weak figures again. Yesterday, Mortgage applications fell 2.7% in the week ended August 8. The smoothed 4-week moving average is now back to September 2000 levels despite lower Mortgage rates (30-year Mortgage Rate is now stands at 4.35%, down from 4.7% in January). Moreover, we saw slightly later that retail sales missed expectations for the third month in a row with an unchanged flat print in July (vs. expectations of a 0.2% rise and down from the 1.5% growth rate seen in March). With retail sales accounting for one third of consumer spending in the US, the IMF cut once again (end of July) its 2014 growth forecast from 2.0% to 1.7% after the National Retail Federation cut its 2014 retail sales growth outlook from 4.1% to 3.6% (Winter blamed).

If we have a look at the chart below, we can see that the US Dollar has been stable since the beginning of August. We are pretty much bearish on the Euro based on poor fundamentals (Q2 GDP first estimates disappoints again and came in at 0.0%) and aggressive ECB easing; our EURUSD medium term target (H2 2014) stands at 1.3000, which corresponds to July 2013 levels. Investors could potentially fly to the Swissie in the middle of this high-pressure geopolitical environment. We think that EURCHF is on its ‘slow’ way to test the 1.2000 SNB once again. Therefore, with a EURUSD target at 1.3000 and EURCHF at 1.2000, it gives us a USDCHF MT target at 0.9200.

CHF(1)

(Source: Reuters)