- Stops were broken in EUR/USD once 1.35 broke in the middle of the night. That’s a repeat of what happened 24 hours earlier as we made our way through 1.36. The euro’s resilience in the face of the crisis enveloping Europe, is in danger of collapsing. Technically, the break of 1.3485 opens the way for a re-test of the early October low at 1.3145. Psychologically, it is much worse.
- The illusion that Europe was a single country and investment in any European country’s debt was an investment in European government bonds, has been replaced by fear of what might happen next. The repeated insistence of the ECB that it is up to the politicians to solve the fiscal crisis merely adds petrol to an inflammatory situation. Until or unless the ECB changes it stance on its role as lender of last resort, the crisis is likely to get worse, not calm down. German fear of repeating the errors of the early 1920, when the central bank printed money and hyper-inflation wreaked economic havoc, are well understood, but Eurozone M1 growth is running at 2%, compared to the 725 billion percent growth of 1923. There is room for more overt QE without going so far as to risk a repeat of 1923.
- The UK sees labour market data this morning – which won’t make pretty reading as unemployment probably rose another 25,000 – and the Inflation report. If GBP doesn’t weaken today, that will harden our resolve to sell EUR/GBP and buy GBP/CHF. The pound is so undervalued it can’t get much weaker, yet it can benefit from the mayhem on the other side of the Channel.
- The BOJ kept monetary policy unchanged (loose in their language) while warning of slowing growth. The FX market has resisted driving USD/JPY lower yet but policy inaction makes EUR/JPY looking very vulnerable. We also like selling CHF/JPY, as the Swiss fight he franc’s strength more convincingly than the MOF fights yen strength and AUD/JPY shorts as global markets get hit. The S&P held up very well last night as robust US data outweighed Europe’s woes. But then US isn’t an island and while CPI and industrial production data today are not a major threat, contagion from this side of the Atlantic will be much harder to resist.
- Dollar funding is making a comeback as a story line, but has for now weaker legs than the last time around. The cap should remain the USD funding facility at the ECB. KRW is holding fairly well for now, but as in Europe a larger scale breakdown is a matter of time, if the ECB stays put. The credit crunch has now reached US banks given their large scale sovereign issuance. Contagion does it steady work reshuffling the credit ratings cards and that is only a start. Front end vols bid.
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Societe Generale
Research & Analytics