EUR USD (1.2135) The euro started to rise yesterday after reports suggested the ECB’s Nowotny was in favour of giving the ESM a banking license. These reports need to be treated with some caution, however. To start with, the Austria central bank chief spoke essentially only of ‘pro-arguments’ and of ‘discussions’. As investors should know, there are also numerous counter-arguments, not least of which is a mandate prohibiting the ECB from directly or indirectly financing governments. Also, even if the decision on the banking licence were the ECB’s (which it is not), Nowotny is but one person on the Governing Council. One has to wonder, therefore, why traders gave his comments so much credit. One reason could be the new context within which markets currently understand communication from the ECB. As the crisis has worsened in recent weeks, there has been one very notable reversal of opinion at the central bank, its stance on haircuts for the holders of troubled banks’ bonds – even holders of senior debt. If the ECB can soften its stance in a domain where formerly its defence was staunch, concluded traders, perhaps it can change its opinion on the ESM too. We do not subscribe to the idea the euro rally to a shortsqueeze, as the recent pick up in implied volatility rather hinted that people had too few short positions. Hence, the euro strength is a puzzle. Still, while it trades below 1.2290 we continue to focus on the downside and the risk of weakness to 1.2010 and then to 1.1860.
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Deutsche Bank