Confusion Reigns
Following President Draghi’s comments yesterday, conviction is clearly lacking in the market, and further contradictory comments have failed to help investors seek any clarity. Dow Jones reported the Bundesbank as saying that it remains opposed to the SMP, given the false incentives created and prefers the use of EFSF/ESM resources. However, an article in Le Monde reports ‘sources saying’ that the ECB may engage in further government bond purchases, but this participation would only come via government bailout funds. While this is a slightly new twist to developments, it would still require Eurogroup approval, which of course takes time. Using the ECB as a vehicle for the EFSF of course has its own problems, in terms of resources available and funding requirements. The euro’s reaction was rather muted with clear signs of investor fatigue and we remain skeptical on any significant progress in a context of political stalemate and as UBS economics have noted,. policy maker “silly season”. Prompted by rising hopes of greater ECB intervention in the current debt crisis, risk has rallied and the EUR has returned to levels just under 1.2300. We question how much of the gains over the last 24 hours were due to a positioning squeeze, as opposed to genuine belief that the ECB has changed its position on the role of monetary policy (and its execution) in the coming months. Notwithstanding the institutional constraints on the ECB’s potential activities, the deterioration in data prints across the Eurozone over the past few weeks may have changed their stance under the assumption that disruption in sovereign bond markets are now starting to block the transmission of monetary policy, especially given conditions are now extremely accommodative. To be sure, there is a risk that the euro bulls get ahead of themselves, as one could argue that Draghi’s comments are not entirely new, the ECB may only be aiming to adjust the collateral eligibility framework for now, and the SMP provides no lasting solution for the problem anyway. However, with the ECB set to meet on August 2 – one day after the FOMC delivers its policy verdict – hopes for bolder action from Draghi will remain elevated in the interim. Thursday’s US data did little to temper the perceived risk of further Fed easing as early as next week, though our economists believe that should the Fed feel the need to act (which we do not expect), the September meeting would be a more appropriate setting. The 35k drop in initial claims could not be taken at face value given the volatility associated with the irregular timing of manufacturers’ annual retooling-related shutdowns. The 1.6% m/m rise in June durable goods orders topped the consensus, but the extransportation (-1.1%) and ‘core’ capex (-1.4%) components disappointed. Moreover, the June pending home sales index dipped 1.4% m/m. Ahead today, soft US Q2 GDP print – UBS is expecting 1.5% vs the 1.4% consensus – could further
undermine the US dollar.
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UBS Investment Bank