EUR/USD (1.3005) In his speech before the European Parliament on Monday, ECB President Draghi not only reiterated that the austerity programmes cause short-term economic contraction, he even gave clues as to what ‘short-term’ meant. He believes ‘euro area economic activity should recover in the course of 2012’. His critics, however, note that the benign-sounding growth contraction actually exacerbates the need for more austerity, thus leading to a vicious cycle which further pushes the horizon where fiscal sustainability can be achieved and growth can be kick-started. The markets are anyway now focussing on the ECB’s three-year LTRO which starts Wednesday. The recent fall in yields of short-term eurozone government bonds suggest that the markets expect the banks to use the cash to buy bonds. So, in contrast to earlier periods where some stigma might have been attached to drawings from ECB facilities, a large take-up may be seen as positive. The Reuters’ forecast on the allotment ranges from €50 billion to €450 billion. The ECB’s recent loosening of collateral rules and reserve requirements has certainly unlocked a new pool of eligible securities to be put to this use.
Although a short-squeeze could help the euro to rebound at any time, we believe that an on-going capital outflow from eurozone will keep it under pressure until it reaches 1.2885/00. To the upside, the first tough hurdle remains at 1.3140.
Market Bias Index
The markets showed moderate price swings yesterday and thus the index too reflects an unchanged bias – the EUR continues to be perceived as undervalued principally against USD and JPY.
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Deutsche Bank
Fixed Income Research – Global