By Dean Popplewell
I thought I was being jaded and biased, but it’s officially true, the EUR is currently trading in the tightest range in five years based on last week's range as this summer lull has sent G10 currencies mostly to sleep. Global scheduled and unscheduled holidays, thrown in with a few major sporting events and the market has reason enough for not wanting to get too involved ahead of September’s event laden calendar. The single currency has been rather resilient with dips being actively bought, leaving the topside rather vulnerable as market participants slow to make it back onto the playing “field.” Next month's Cbank and German constitutional decisions, along with a few euro emergency meetings, will provide a clearer directional picture for the single currency.
Providing much needed fodder for market talk is a Der Spiegel article doing the rounds this morning. The paper is supposedly touting an article, sources unknown, saying that the ECB is discussing interest rate thresholds for each individual eurozone country. This is certainly thinking outside the box and falls under the description of being innovative. They suggest that if yield spreads move beyond a particular level then this would trigger intervention. This is very similar to FX intervention by Cbanks. The market realizes that given the ECB promise of full transparency on its interventions when they are carried out, the prospects of yield thresholds cannot be ruled out.
There are certainly pros and cons for using this method. The advantage of using a threshold is that it would create an “asymmetric bias in the market.” However, there is much credibility to be lost if the thresholds are “not” maintained. This would require the ECB to be as firm in the bond market as the SNB is in EUR/CHF. This type of innovative “balloon” is probably being allowed to float ahead of September to see how much traction it could get in the marketplace. In FX, it is currently providing EUR support and making some of the weak EUR shorts nervous. In FI, bunds have fallen while sovereign bond yields for Italy and Spain have eased.
Economists are arguing that the eurozone's crisis has come down to one of faith. Voters and investors trust of their neighboring countries within the EU has very much evaporated. It seems that confidence in the ability of any of the peripheral economies to dig themselves out of this economic hole is not likely to come back quickly. Even more dangerous is that all the faith that remains in the single unit rests squarely on the ECB’s head.The last time all EU country members experienced the same financial attributes, in effect, when investors saw no difference between bonds issued by Germany or Italy, Spain and Ireland was back in 2005. This crisis goes to show not everyone is created equal.
Data this morning reports that construction output in the region shrank in June for the third consecutive time (-0.5%, m/m and -2.8%, y/y) and adds to concerns that the region is again heading back into recession. Analysts note that it’s worth pointing out that construction data can be very volatile. However, production in the in the sector has also shrunk (-0.1%, m/m), providing some validity for the construction headlines. With momentum in many parts of euro economy slowing at the end of Q2 and surveys pointing to further weakness ahead is strong proof that the whole region is slowly slipping into its second recession in three years.
With very little price movement in the past five-trading days, the overall market is nursing its predominately short EUR position average around 1.23. The retail sector above, has decided to go small short ahead of Friday’s highs and continues to job this market due to lack of firmer direction. More neutral selling interest appears at 1.24, a key resistance level and tough nut to crack, through to 1.2450. Medium term bias continues to look to the downside as these lofty heights remain uninspiring. However, there is much talk in the market place of German demand to own EURs around 1.23 again.