G10 Currencies
EUR: Following the long meeting of the Ministers of Finance the press conference yesterday initially took the pressure off EUR-USD. And indeed the head of the Eurogroup Jean-Claude Juncker, EU Commissioner Olli Rehn and EFSF CEO Klaus Regling had good news to announce: The top-up of the EFSF was finally agreed (which had been due to take place in March). It will now be able to provide loans up to EUR 440bn. Also the ESM (which is to replace the existing bailout mechanism after mid-2013) made progress.
No reason for euphoria though as the press conference also made it clear that considerable risks remain. The Finance Ministers continue to pursue a dangerous strategy, as regards the integration of bond holders into the extended Greece bailout. According to Rehn we will see an involvement along the lines of the Vienna Initiative. In other words: there will be a gentlemen’s agreement on the part of important bond holders who undertake to maintain their Greece exposure. Rehn is convinced: “that would not lead to a credit event or a selective default”. That is far from certain though, in particular as far as Greece’s rating as an issuers is concerned. Rather than pursuing a safe approach European politicians continue with their fingers crossed attitude. More importantly: Europe’s politicians keep their eyes closed against the unavoidable reality. How else could we interpret Juncker’s comments: “it is clear that the debt [of Greece] is sustainable” in view of GGB yields of close to 30%. Nothing is further off from reality.
It seems absurd that EUR-USD was able to appreciate in spite of these events. By now the pair has retraced more than half the losses recorded last week. The picture of the EUR-USD risk reversal (riskies) however looks very different: they are at the lowest level since last June (see chart). This illustrates once again that the debt crisis is not reflected in the EUR-USD spot prices but only in the risk reversals. The latter continue to price in high downward risks for EUR-USD. Is this a contrast between spot and options market which will have to be overcome one way or the other? Will riskies have to rise soon or EUR-USD spots fall? Not necessarily. Yesterday’s trading session also demonstrated: in the absence of extreme events EUR-USD trends upwards. The debt crisis nonetheless hangs over the euro exchange rate like the sword of Damocles. Large down moves are always possible. Only that they do not have a marginal effect on EUR-USD. The situation of the riskies is very different: each news item emerging from the Eurozone affects the likelihood of a major collapse – and thus the riskies. The riskies – rather than the exchange rate itself – therefore constitute the barometer of the debt crisis.
USD: The FOMC meeting kicks off today. At best the event will be dollar neutral. In view of continued weak US economic data (today’s existing home sales for May are unlikely to make an exception) the FOMC will do anything in its power to reassure markets that the ultra-expansionary monetary policy will be continued for the foreseeable future. The recent new round of dollar weakness seems justified.
SEK: The Swedish krona is and remains at the mercy of market sentiment. That means it will only appreciate on a sustainable basis once market concerns about a Greek default have abated. A start was made yesterday allowing EUR-SEK to move away from the 9.20 mark. It is paradoxical really that the SEK loses against the EUR if the debt crisis in the Eurozone comes to a head. With the dynamic growth and the solid public finances in Sweden the krona should be able to outplay the euro easily. But as a risk sensitive currency of a small, illiquid market it quickly falls victim to the fears of investors, so that it has recorded the weakest performance against the euro and US dollar among the G10 currencies since the beginning of the month. The fact that Moody’s harbours no doubts regarding the country’s AAA rating underlines that this performance is not justified. The SEK will remain at the mercy of market sentiment over the coming days, though. As we assume that IMF, EU and Eurogroup will eventually agree on a Greek solution the krona is likely to appreciate again in the end. At this stage the yield differential will attract more attention again clearly favouring the krona – keep in mind that the next Riksbank rate rise to 2.0% will likely take place in early July. As a result levels in the area of 9.20 in EUR-SEK are selling levels for us.
Emerging Market Currencies
HUF: When trying to describe yesterday’s Hungarian central bank rate decision even the word “non-event” would be an understatement. As expected the MNB (Magyar Nemzeti Bank) left key rates unchanged at 6.00% and is planning to leave them unchanged for a “sustained period”. This is due to the assumption that weak domestic demand as well as continued high rates of unemployment will ensure that the inflation rate will return to its target – that is once the current effect of the high commodity prices has worn off. The MNB even seemed more dovish than at the last meeting as it revised its growth outlook downwards for this and next year (2011: 2.6% from 2.9%; 2012: 2.7% from 3.0%). On the whole there was a lack of momentum for the forint so that it is likely to now be driven by the Eurozone crisis again.
BRL: The rating agency Moody’s yesterday upgraded Brazil’s foreign currency rating from Baa3 to Baa2 leaving the outlook positive. With this step Moody’s honoured the efforts of President Dilma Rousseff since she took office at the beginning of the year. The new government’s aim is to reduce state spending and fight inflation. From the point of view of most observers these steps are not going far enough, but against the difficulties in the euro zone as well as the difficult budget situation in the US and Japan, countries like Brazil seem to be the golden boys. Thanks to rating improvements investor interest in Brazil is likely to increase. The real is likely to benefit from this development so that we see scope for further appreciation. In the current environment there is however the risk that
USD-BRL will temporarily trade higher. We consider prices above 1.60 as interesting entry levels.
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