EUR and Dollar-Bloc Rally As Stocks Surge

Summary

The EUR and dollar-bloc currencies gained ground today in volatile market conditions, after comments by ECB President Trichet and an unexpectedly positive surprise in US housing data bolstered global equity prices. 

Headlines

IMF: Managing Director Dominique Strauss-Kahn said that after Greece and Ireland, which received bailouts while "at the edge of the cliff," some other countries in Europe are "not far from the edge of the cliff." The whole euro region "has now to deal with medium-term fiscal consolidation," he said. "The European Central Bank is doing perfectly its job, and the institution that has been built six months ago for the Greek crisis, namely the so-called European Financial Stability Fund, will work as expected for Ireland," Strauss-Kahn said.

EU: The ECB left its benchmark interest rate unchanged today at 1.0%, in line with consensus expectations. The interest rate corridor was also left unchanged, with the overnight deposit rate at 0.25% and the marginal lending rate at 1.75%. Moreover, the Governing Council decided to continue conducting both its main refinancing operations and special term refinancing operations with full allotment "at least until the end of the third maintenance period of 2011 on 12 April 2011."

During the Q & A session, Trichet said that the extension of both the non-standard monetary measures to provide financial markets with liquidity and the ECB program to purchase government bonds were driven by "acute" tensions in financial markets. He stated that an "overwhelming majority" of the Governing Council had backed the "ongoing" purchase of government bonds, but gave no indication that an increase in the pace of government bond purchases has been considered.

EU: ECB Council Member Axel Weber said global authorities must take further measures to make the financial system more resilient against future crises, including the orderly unwinding of a bank if necessary. It's "unarguable that we need to take measures in order to guarantee global financial stability in the future," Weber said. "More stable banks are the first line of defense against any systemic crisis."

US: St. Louis Fed President James Bullard said a recent increase in market interest rates doesn't mean quantitative easing measures are failing. While the QE II program "puts downward pressure" on rates, successful policy would generate faster growth and higher real interest rates while also increasing inflation expectations, Bullard said today. "Therefore, looking at the level of nominal rates alone is insufficient to judge the success of the program." "USD depreciation is a normal by-product of an easier monetary policy, provided all else is held constant in the rest of the world." Bullard said he doesn't see any spillover effects of the European sovereign debt crisis in the US just yet. "At this point, I don't see any but I'd be cautious about that."

US: Pending home sales surged 10.4% m/m in October from -1.8% m/m in September, on consensus expectations of -1.0%. However, pending home sales remained deeply in negative territory from a year ago, at -22.4% y/y in October from -24.9% y/y in September. The National Association of Realtors projected existing home sales of 4.82M this year and 5.12M in 2011, compared to 5.16M in 2009. The median price for an existing home is estimated at 172K USD in 2010 and 173.5K USD in 2011, compared to 172.5K USD in 2009.

Brazil: Industrial production rose 0.4% m/m and 2.1% y/y in October, on consensus expectations of 0.6% m/m and 2.5% y/y. This represented the fastest pace of output in three months. Production of durable goods rose 2.8% m/m in October even as capital goods production, a barometer of future investment, fell -0.2% m/m. Brazil's retail sales expanded for a fifth consecutive month in September on record low unemployment. Sales rose 0.4% m/m and 11.8% y/y in September, on consensus expectations of 11.1% y/y. Unemployment fell to 6.1% in October.

Dow 11,362.41.78, +0.9%; NYMEX Crude Oil $87.97, +1.4%

The EUR and dollar-bloc currencies gained ground today in volatile market conditions, after comments by ECB President Trichet and an unexpectedly positive surprise in US housing data bolstered global equity prices. The EUR/USD rallied as high as 1.3247 from a low of 1.3060, trading back to 1.3225 at the close. GBP/USD closed nominally lower at 1.5600 from last night's close of 1.5620, trading in a range of 1.5510 to 1.5670. USD/JPY sold off sharply following Trichet's press conference, hitting a low of 83.49 by 11:30am from an overnight high of 84.36, trading back to 83.90 by the close. In the dollar-bloc, USD/CAD traded steadily lower to close near session lows of 1.0030 from an overnight high of 1.0190, while AUD/USD rallied as high as 0.9780 from overnight lows of 0.9625. Global equity markets rallied for the second day, with the Nikkei up 1.8%, the FTSE up 2.2%, the DAX up 1.3%, and the CAC up 2.1%. The DJIA managed a 0.9% rally today on the back of yesterday's stellar 2.3% surge, keeping alive hopes of a Santa Claus rally this month going into year-end. USD weakness helped to support commodity prices with the NYMEX crude oil benchmark up a further 1.4% to close at $87.97/bbl.

Trichet's remarks initially pushed the EUR/USD lower hitting a session low of 1.3060 by 9:00am EST, as players expressed disappointment that the ECB was not stepping up the pace of its government bond buying program. Trichet punctuated this by stating the ECB was not pursuing "quantitative easing." However, the EUR/USD staged an unexpected rebound hitting a high of 1.3200 by 10am before trading back to 1.3180 by 11:15am. Similar market gyration were seen elsewhere. AUD/USD, which often parallels movements in the EUR/USD, surge to a session high of 0.9743 by 10:35am from 0.9630 at 9am. In the equity markets, Dow Jones futures surged over 120 points, while the Spanish IBEX 35 index surge a remarkable 3.8% to 9,910 at 10:40am from a low of 9,551 at 9:02am. 

The proximate cause of the rally in the EUR and risk appetite this morning appeared to be the narrowing of Irish and Portuguese bonds spreads. The 10-year Portuguese/German bond yield spread narrowed 43 bps to 370 bps, while the 10-year Irish/German bond yield spread narrowed 33 bps to 625 bps. At the same time there were credible market rumors that the ECB was on the bid for Irish and Portuguese bonds during Trichet's press conference. Regardless of the precise trigger, the rebound in the EUR/USD and subsequent equity market rally was an important development in terms of market psychology. Looking forward to tomorrow's non-farm payrolls, any disappointment could lead to a correction in what has been prematurely dubbed the Santa Clause Rally - dragging the EUR/USD lower in the process.
(michael.woolfolk@bnymellon.com)

Flow Analysis:

Our iFlow FX indicators show the Euro being very modestly net bought for the first time in nine trading sessions as risk aversion related to Eurozone sovereign debt concerns subsides for now. In the same vein, we are seeing net selling of the US dollar for the first time since last week as investor sentiment calms down. Investor demand for the Swiss franc has also abated. Amongst other G-10 currencies, market participants are venturing back into the New Zealand dollar and Swedish krona, while the Canadian dollar has also attracted net buying this week. 

Meanwhile, the Australian dollar is relatively out of favor for now amid latest economic data releases showing retail sales unexpectedly fell 1.1% in October while imports also weakened to the least since February. Amongst emerging markets, our iFlow FX indicators show Asian currencies such as the Indonesian rupiah, Philippine peso, Indian rupee Thai baht and Taiwanese dollar are especially being strongly net bought again.

Not only has risk appetite improved in general amid above-consensus Chinese manufacturing data suggesting regional growth will be sustained, but our iFlow equity indicators also confirm renewed net inflows into local bourses standing out – in fact, Indonesia, India and the Philippines are the strongest net bought equity markets across the board. This is also consistent with price action that saw all Asian stock indices having gained some ground on Thursday. Gradually easing tensions on the Korean peninsula have also helped soothe frayed investor nerves for now. Elsewhere, amongst Eurozone stock markets, we are seeing renewed net buying in Spain, Italy, France, Netherlands, Germany and Austria. Poland, Hungary and the Czech Republic are also seeing fresh inflows into their local stock and bond markets as sentiment improves. Even so, we would caution that risk appetite remains fickle, being hostage to the evolving news-flow, policy-maker comments and data releases. As a result, we would also draw our readers' attention to the fact that a set of global investors continue to favor US Treasuries and the Japanese yen in the event that risk aversion resurfaces.
(samarjit.shankar@bnymellon.com)

Key Economic Data Releases

ID: Bank Indonesia Rate Decision, consensus 6.50%; previous 6.50% (0600 GMT)
IT: PMI Services (Nov), consensus 51.4; previous 51.0 (0845 GMT)
FR: PMI Services (Nov F), consensus 55.7; previous 55.7 (0850 GMT)
GE: PMI Services (Nov F), consensus 58.6; previous 58.6 (0855 GMT)
EC: PMI Services (Nov F), consensus 55.4; previous 55.4 (0900 GMT)
EC: PMI Services (Nov F), consensus 55.3; previous 55.3 (0900 GMT)
UK: PMI Services (Nov), consensus 53.2; previous 53.2 (0930 GMT)
EC: Eurozone Retail Sales (Oct), consensus 0.2% m/m, 1.0% y/y; previous -0.2% m/m, 1.1% y/y (1000 GMT)
CA: Change in Employment (Nov), consensus 19.8K; previous 3.0K (1200 GMT)
CA: Unemployment Rate (Nov), consensus 7.9%; previous 7.9% (1200 GMT)
US: Non-Farm Payrolls (Nov), consensus 150K, previous 151K (1330 GMT)
US: Unemployment Rate (Nov), consensus 9.6%; previous 9.6% (1330 GMT)
MX: Consumer Confidence (Nov), consensus 90.1; previous 89.2 (1500 GMT)
US: ISM Non-Manufacturing (Nov), consensus 54.8; previous 54.3 (1500 GMT)
US: Factory Orders (Oct), consensus -1.2%; previous 2.1% (1500 GMT)
GE: Luxemburg's Juncker Speaks in Berlin (1600 GMT)