By Dean Popplewell
It's not a big surprise to see capital markets trying to consolidate as we head into a long weekend either side of the Atlantic. Caution ahead of euro election results is keeping the European markets, particularly equities, in a holding pattern. Anti-European Union parties are expected to put in a good performance at a time when members' economic recovery remains relatively fragile. The lethargic reaction can also been seen in the bond market. So far, this asset class is showing a muted response to Spanish and Greek credit ratings being raised by the S&P and Fitch agencies. However, in currencies, the euro's 18-member single unit is keeping the market somewhat interested, especially as its currency has intentions to leak further beyond this morning's three-month low outright print against the dollar (€1.3622).
The common currency has been on a weakening binge ever since the ECB hinted that further easing could be on the way next month. Certainly giving a helping hand this morning is the disappointing German Ifo business climate print for May. It has come in weaker than expected with a reading of 110.4 compared to expectations for 110.9 and 111.2 previously. With all three components of the German survey missing their marks is pushing the EUR lower. The breakdown shows weakness in both current conditions as well as expectations. No surprise that the Ukraine crisis is behind the drop in sentiment.
Despite a lull seen in the German economy in May, the underlying momentum of "booming" Germany is very positive. Nevertheless, the worry for Europe is that, without more vigorous growth from its largest member, the eurozone will struggle to improve from the last quarter's meager +0.2% growth from the prior quarter or +0.8% on an annualized pace. This morning's print is perhaps signaling a note of caution for Germany. Despite the German economy being in a league of its own, no one economy is "invulnerable forever." Even as the economy continues to deal well with a relatively strong EUR, lower ECB rates would probably not help the impetus for the German economy. But German optimism waning may help the case for ECB easing in June.
Relative asset performances are seen as a key driver for many G10 currencies. The EUR is probably the most vulnerable given the overstretched positions of peripheral EMU markets – just look how periphery bonds have been trading over the past fortnight. Today's EUR breakdown below €1.3634 is generating a minimum downside target at €1.3588. The techs believe that a sustained break below opens significant downside risks towards the current 2014 low of €1.3475.
EU elections results fears this weekend had initially put a more defensive tone in the eurozone peripheral bond market and has accounted for the recent underperformance in European equities. However, exit polls to date are suggesting that euro-skeptics are not making dramatic gains. The UK is an exception; UKIP seems to be grabbing seats from the Conservative and Labour parties (final results due Sunday). So far, this is in contrast to the Netherlands, where the anti-EU party is beaten into fourth place. Most of the EU's 28 members hold their European vote on Sunday.
Not many people have realized that the ECB is about to have its own version of the Fed's Jackson Hole forum this weekend.
It will start on Sunday May 27th and will end next Tuesday May 29th. This will be an annual forum on central banking and will include government officials, central bank governors, academics, journalists and financial market representatives, exchanging views on current policy issues. The first such forum will take place in Sintra, Portugal, Sunday-Tuesday.
Draghi will give the welcoming address on Sunday evening and an introductory speech on Monday morning. He will also speak in the closing event on Tuesday afternoon.
The previous Fed Chairman Ben Bernanke did use the Jackson Hole Forum in the past to flag policy changes (such as QE2 in 2010). Is it possible that Draghi could do the same, particularly if he wants to make the first forum an event to remember?
This weekend's ECB soiree could be a game changer. Depending on how open and aggressive Draghi will be, throw in the holiday Monday on either side of the Atlantic and it could give us some volatility. Lack of liquidity will make some of the currency moves very interesting. Expect the SNB (EUR/CHF 1.2208) and the BoJ (USD/JPY 101.92) to be watching intently.