ECB President Draghi calms market fears by pledging the ECB will do “whatever it takes”

The president of the European Central Bank, Mario Draghi, has asserted this morning that, within its mandate, “the ECB is ready to do whatever it takes to preserve the euro, and believe me, it will be enough.” He added that the solution was “more Europe,” which again was music to the market's ears. Unsurprisingly, the euro has rallied on Draghi’s positive comments; EUR/USD has bounced by almost two cents.

These comments build on the relief story that was delivered yesterday by ECB policymaker Nowotny. Nowotny indicated that the European Stability Mechanism could be granted a banking license, which would in turn increase its lending capacity. The eurozone’s inadequate ‘firewall’ has long been a major gripe of investors and the fact that there are members within the ECB looking to address this was greeted with open arms. It goes without saying that Nowotny’s comments are a long, long way from becoming policy and he will certainly meet some stiff opposition within the central bank.

This week’s jawboning really ramps up the pressure on the ECB to deliver some emergency policy response of note at its monthly meeting next Thursday. If it fails to deliver a convincing plan on how to bring down Spanish and Italian bond yields which are threatening to force both countries into bailout territory, the euro is likely to come under some fresh and considerable selling pressure. Restarting the ECB’s bond-buying programme, which has been on hold for several months, would be welcomed enthusiastically, as would quantitative easing. Some action will surely come next week, as the ECB is forced to fill the policy vacuum left by the EU’s dithering politicians.

Richard Driver
Analyst – Caxton FX
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Market fears reach new heights as Spain edges closer to a sovereign bailout

The bad news for the euro just keeps on flowing. Spanish 10-year bond yields have now risen to a fresh euro-era high above 7.60%, which is a fairly accurate bellwether of market tensions that have built towards Spain and the debt crisis as a whole in recent sessions. Sustained yields above 7.0% pushed Greece, Portugal and Ireland into requesting a bailout and the chances of Spain following suit are rising all the time – another few weeks at current levels and Spain may have no choice but to ask for help.

Meanwhile, German 10-year bonds have recently fallen as low as 1.14%, and 6-month bond yields have even dipped in to negative territory; such is the appetite for safe havens, investors are actually willing to accept losses just to park their funds in the safety of German short-term debt.

The Spanish regional govenrment of Valencia has asked the central government for financial aid, and six other regions including Catalonia and Murcia are expected to do the same. Considering a €100bn bailout was only signed off for Spain’s crumbling bank sector on Friday, these signs of panic from Spain’s regions are the last thing Spanish PM Rajoy needs, particularly as he is trying to quell market fears by insisting that Spain will not require a full-blown sovereign bailout. Spain’s economy minister De Guindos is meeting his German counterpart Schaeuble today and there will be suspicions that a full sovereign bailout will be considered.

The IMF may well be hardening its stance on granting aid to failing eurozone economies, if the rumours of a possible withheld contribution towards Greece’s next aid tranche. So again, these Spanish headlines have come at unfortunate moment.

Spain is continuing to call for intervention from the ECB, De Guindos said on Saturday that "somebody has to bet on the euro and now, given the architecture of Europe isn't changed - who can make this bet but the ECB." If the ECB restarts its programme of buying up distress debt, then Spain can stop paying such high borrowing costs. The ECB has stood firm on this issue for nineteen straight weeks, claiming that the lead on solving the debt crisis should be taken by EU politicians. Stodgy progress in this regard is likely to force the ECB’s hand in the end, particularly as Italy edges closer to disaster.

Spain has major repayments to be made by October, so a full-scale Spanish bailout could well come before then. Amid all these concerns around Spain, Greece is heading towards the exit door, so it should to come as a surprise when we reiterate our bearish view of the euro.

Adam Highfield
Analyst – Caxton FX
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Cyprus joins the queue for aid and the euro is looking vulnerable

Cyprus has become the fifth Eurozone country to apply to Brussels for an emergency bailout, after similar calls for help from Portugal, Ireland, Greece and Spain. Heavy dependence on the Greek economy has pushed Cyprus into this corner. The Cypriot banking sector is oversized for a country with only one million residents and it suffered badly from significant write-downs on Greek sovereign bonds. Cyprus hasn’t been able to access the debt markets since 2011 since being downgraded to ‘junk’ status by Moody’s and S&P, Fitch’s move to follow suit yesterday provided the final push to force the country into a bailout request.

In the very short-term, €1.8bn (around 10% of its domestic output) is required to recapitalise its second largest bank, Cyprus Popular Bank, while its largest bank, Bank of Cyprus has reportedly called for aid of around €500 million. Plenty more will be required for state financing and the country really requires a buffer from any further spillover effects from Greece.

The bailout is expected to amount to approximately €10 billion, which is equal to over half of the Cypriot GDP, currently standing at €17.3 billion. Along with the Spanish application for bailout funds for its banks, Cyprus’ bailout application has today been formally accepted by the Eurogroup. The funds will come from either the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM) when it becomes active. This comes after controversial but ultimately unsuccessful bailout negotiations with Russia and China. Dimitris Christofias, the Cypriot president, had expressed his wariness of the strict conditions that would come with an EU bailout. In particular, Cyprus’ rock bottom (10%) corporate tax threshold may be a cost of the bailout request. The terms of the bailout will surface in the coming weeks.

In terms of the impact on overall sentiment towards the eurozone, the Cypriot request for a bailout will not in itself weigh too heavily. Whilst it is another worrying example of debt contagion and does build on increasingly negative eurozone sentiment, Cyprus is the eurozone’s third smallest economy and this bailout request been a long time coming. Market nerves at the moment are more firmly fixed on the eurozone’s fourth-largest economy- Spain. The euro is posting significant losses across the board; the key EUR/USD pair looks likely to retest its multi-month lows of $1.2285 in the near future.


Adam Highfield
Analyst – Caxton FX
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Greek opinion polls provide some hope but confidence still fragile

Greek opinion polls give the market some hope

The euro was given some relief in early Monday trading by the positive news that in Greece, the conservative and pro-austerity party - New Democracy – has edged ahead of the anti-bailout party Syriza in the opinion polls. If New Democracy can hang on to their lead and re-establish a pro-bailout, pro-austerity and pro-euro coalition, then fears of a Greek exit should subside. Judging by the euro’s brief and fairly minor bounce since the weekend though, the market remains understandably cautious.

Concerns over Spain are also growing, as the country’s ten year bond yields climb towards 6.50%, bringing into view the dangerous 7.0% benchmark which forced other peripheral nations, like Portugal and Greece, into requesting bailouts. Spain’s fourth-largest lender Bankia requires a bailout and the Spanish region of Catalonia is also in need of help to refinance its debt. Consequently, the risks of a Spanish sovereign bailout are increasing, which would create a huge amount of stress on the EU’s aid resources, as well as raising major question marks over Italy.

In addition to these mounting Spanish concerns, growth data from the eurozone was all pointing the wrong way last week. Figures from the German, French and eurozone-wide services and manufacturing sectors almost all disappointed, suggesting that the eurozone’s avoidance of economic contraction in Q1 will prove temporary.

With respect to the issue of Eurobonds, Germany doesn’t look like it will budge. What’s more, Austria, the Netherlands and Sweden have joined Germany in expressing their opposition to the idea of common eurozone bonds, so market hopes for a silver bullet have once again been quashed.

US GDP figure should confirm slowdown

This week brings two important growth figures from the US, in the form of the revised GDP estimate for the first quarter of 2012 (due on Thursday). The figure is expected to be revised down from 2.2% to 1.9%, well off Q4 2011’s impressive quarterly reading of 3.0%. Friday brings the monthly update from the US labour market and improvements in this area are expected to be moderate at best.

The US dollar’s safe haven status has very much come to the fore in the past month. Clearly ongoing softness in US figures keeps QE3 on the table as far as the Fed is concerned but we see safe-haven demand helping it appreciate further across the board. In particular, we foresee heavy losses for EUR/USD in the second half of this year, which will inevitably drive GBP/USD lower too.

Sterling is trading up above €1.25 this afternoon, with the positivity surrounding the Greek opinion polls already having dissipated. Sterling weathered some awful data last week, including a downward revision to the UK’s Q1 GDP figure to -0.3% and a steep drop in the domestic inflation rate. However, sterling’s safe-haven status still looks likely to push it even higher against the euro.

In contrast, sterling is always going to be under pressure against the US dollar. It should benefit from a minor short-covering bounce soon, though a return anywhere close to $1.60 looks a stretch now. Risk appetite away from the US dollar is likely to be hard-pushed to return in force ahead of the June 17th Greek elections.

End of week forecast
GBP / EUR 1.26
GBP / USD 1.5750
EUR / USD 1.25
GBP / AUD 1.6050

Richard Driver
Analyst – Caxton FX
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Swedish Krona March Outlook

The Swedish krona and other risky currencies finished 2011 strongly and made an impressive start to 2012. Risk appetite has been spurred on by the ongoing impact of the European Central Bank’s (ECB) mid-December LTRO (cheap loan offering), further improvements to the US economic recovery and the emergence of a Greek bailout agreement.

However, huge uncertainties surround both the Greek and wider eurozone debt situation. In addition, data this year clearly points to the onset of a recession in the euro-area. The risks to a downturn in market sentiment, which will inevitably weigh on the krona, are all too apparent.

In terms of the Swedish economy, growth has deteriorated and the prospects for this year have weakened. Amid diminishing internal and external demand and rising unemployment, the Swedish economy contracted by 1.1% in the final quarter of 2012. Accordingly, the Riksbank is forecasting growth of just 0.7% for 2012.

The Riksbank cut the Swedish interest rate by 25 basis points to 1.50% in February, following the rate cut we saw in December. Further monetary easing this year cannot be discounted if conditions continue to worsen. In addition, after an impressive surplus last year, the Swedish National Debt Office has recently announced that it expects a budget deficit of 11bn krona this year.

We hold a pessimistic view for Greek and eurozone developments this year, on both the growth and the debt front. This should weigh on risk appetite and combined with the Swedish economy’s downtrend, the outlook for the Swedish krona is decidedly vulnerable.

GBP/SEK

Interest rate developments have gone against the Swedish krona in recent months, with the Riskbank reducing its yield from 2.00% to 1.50%. The moves were down to both diminishing global and domestic growth. With the eurozone accounting for more than half of Swedish exports, the recession that the region is heading into is likely to weaken Swedish growth to an even greater degree. The Swedish inflation outlook is also distinctly tame, so there is little scope for a Riksbank rate hike this year, while a further cut will certainly be considered if conditions both internally and externally deteriorate.  

This Swedish downturn contrasts with the good news that has emanated from the UK economy in the past few weeks. UK retail sales figures have been excellent; the services sector continues to show decent growth and the construction sector also bounced back in February. These firmer figures have made a return to positive growth (after last quarter’s -0.2% GDP figure) highly likely in Q1 2012. This in turn should dissuade the MPC from deciding on further UK quantitative easing this year. It also increases the likelihood of the UK hanging onto its prized AAA credit rating, which is a major pillar of support for sterling.

The ECB’s cheap loans have fuelled a rally in risky assets in the past three months, as shown by the FTSE 100’s recent climb to a seven month high. However, an improved outlook for the UK economy (and therefore sterling), a deteriorating Swedish economy and a fairly sharp decline in risk appetite have seen GBP/SEK show signs of resuming last year’s uptrend. In line with a pessimistic view towards the overall eurozone situation, we see GBP/SEK consolidating on its recent bounce in the 10.7-10.8 area over the next few weeks. In the medium and longer-term, the risks are skewed towards a further upside move towards 11.00.

EUR/SEK

There have been some positive developments in the eurozone in recent months. The ECB’s cheap loans have ensured that credit conditions in Europe have eased this year and have fuelled a rally in eurozone equities and brought key peripheral bond yields in Italy and Spain down to more sustainable levels. A long-awaited Greek bailout agreement finally arrived in February, quelling fears of a messy Greek default in mid-March (albeit temporarily).

However, the market also remains incredibly tense about the Greek situation. A Greek bailout is by no means assured, which means we may yet see a messy Greek default this month. Greece has until the evening of Thursday 8^th March to convince enough private bondholders to sign up to the debt-swap arrangement, failure to do so could result in a credit event in which credit default swaps are triggered.

The potential Greek scenarios that are currently on the table are many and varied and this lack of certainty is what is weighing on risk appetite at present. Even in a best case scenario in which Greece gets its second bailout and avoids a default without triggering a credit event, there are strong arguments that suggest this is simply an exercise in buying time and we could be back in bailout and default territory before long.

In addition, eurozone growth remains a key concern. The region contracted by 0.3% in the fourth quarter of 2011 and judging by growth figures out of Germany and the region as a whole, a slide back into a prolonged recession is now looking somewhat inevitable.

By virtue of the Swedish krona’s negative correlation with low levels of risk appetite and in line with our view that we are entering a period of damper market confidence in which safer assets than the krona will be turned to, we are confident that EUR/SEK will continue to climb. We have seen a sharp spike from 8.80 to over 8.90 in the past week and we are looking for a push towards 9.00 in March.

USD/SEK

To buck the global trend of weakening global growth, the US recovery has really gathered pace in recent months. The US economy grew at an impressive annualised pace of 3.0% in the fourth quarter of last year and there have been significant improvements to America’s chronic unemployment problem. This upturn seems to have caused US Federal Reserve Chairman (Ben Bernanke) to indicate that QE3 will not be utilised, which is a real positive for the US dollar.

By contrast, the US dollar made a very weak start to 2012 but we believe the greenback will be a major outperformer this year. With intervention doubts surrounding the other traditional safe-haven currencies (the yen and the swiss franc) and with the EUR/USD pairing looking increasingly vulnerable to a collapse, the USD is set for major gains in what will surely be a highly uncertain, dollar-friendly environment this year.

The bounce in the USD/SEK rate (from 6.55 to 6.80) in the past week should represent the start of a major reversal of dollar weakness. We see the USD strengthening in excess of 7.00 krona level in coming months, though over the next few weeks gains will probably be limited by the 6.90 level.  

NOK/SEK

The Norwegian krone has made an extremely impressive start to 2012. It is the top performing currency over the past month thanks to a combination of domestic economic strength and soaring oil prices.  Norwegian manufacturing and retail sector growth and declining unemployment has improved sentiment towards the NOK, while a widening trade surplus shows that exports are not being hit as they are in neighbouring Sweden.  The Norwegian economy outperformed the Swedish economy in the fourth quarter of 2011 by growing 0.6% (versus Sweden’s 1.1% contraction) and is almost certain to continue outshining this year.

Oil prices have risen by 15% already in 2012 amid worrying developments in Iran; Brent crude is currently trading just off a multi-month high above $125 per barrel.  As a major producer of oil, the Norwegian economy stands to benefit and so too does its currency.

The only real question mark hanging over the Norwegian krone is the monetary policy of the Norges Bank. The state of Norwegian economic growth wouldn’t suggest another cut to the Norwegian base rate, which currently stands at 1.75% (slightly higher than the Swedish 1.50% rate). However, Governor Olsen has reiterated that the Norges Bank will consider the strength of the krone when evaluating its interest rate policy. Another rate cut may well come if the NOK continues to appreciate but the krone is likely to remain in demand regardless.

With the NOK/SEK rate having bounced from just above 1.14 to just below 1.20, the Norwegian krone is the clear outperformer here. NOK/SEK is actually trading only marginally below a 25-month high. However, the current pace of appreciation is unlikely to persist for another month as Norges Bank intervention concerns will inevitably temper progress. Still, we should not see too much of a downward correction away from the current 1.20 trading level.

Greek set to receive bailout but euro's upside potential looks limited

The euro has enjoyed a remarkably strong start to 2012, rebounding considerably from what was a very steep decline at the end of last year. Greece has been the primary focus of recent weeks - talks stalled between Greece and its private creditors over a debt swap deal and the Greek coalition has struggled to agree on the necessary austerity measures. At last, a Greek deal has been announced, which should pave the way for a €130bn second bailout that will avoid a messy and potential disastrous Greek default.

Growth in the UK economy picked up a little in January, which has fuelled some hope that the British outlook may not be as gloomy as once feared. Growth will remain sluggish even in a best case scenario, so it was always a question of by how much, not if, the Bank of England would increase its quantitative easing programme at its recent meeting. £50bn of additional asset-purchases has been announced but sterling was unaffected as the move was fully priced in.

Despite building eurozone concerns, risk appetite is in fairly good shape at present and this has seen the US dollar weaken off in recent weeks. Nonetheless, we maintain a bearish outlook for risk assets this year and a bullish view of safer currencies such as sterling and the US dollar.

GBP/EUR

Sterling’s progress against the euro has stalled in recent weeks. The imminence of further quantitative easing has pegged sterling back somewhat. However, the key resistance factors for GBP/EUR have been some intense short-covering by a market that had bet heavily against the single currency and some relieving (albeit frustratingly slow) progress towards a second Greek bailout that will avert a default in March.

The current Greek situation remains highly uncertain however. The deal may broadly have been agreed but the Greek parliament still needs to approve it; it contains further crippling austerity measures, which will likely be a tough sell to Greek MPs.

Fears of another eurozone credit crunch have eased in recent weeks, largely due to the ECB’s cheap loan programme to ease credit lines. The cheap loans scheme (which will be replicated at the end of this month) is in effect quantitative easing through the back door and has filtered into the eurozone bond markets, resulting in lower yields across most of the periphery, most importantly in Spain and Italy.

However, Portuguese bond yields have not responded as the ECB would have liked, which indicates that another crisis scenario is just around the corner. Speculation is building that we will need to see another second bailout scenario in Portugal, whose bond yields are on a very similar trajectory to Greece’s last year.

The UK’s AAA credit rating and the demand of UK gilts remain the key drivers of any sterling strength. The market has made its peace with increased quantitative easing from the Bank of England and the issue shouldn’t weigh on the pound too much this year.

A plunge back into recession, of which there is a significant risk, is the main risk factor hanging over sterling. Negative growth combined with ongoing elevated debt levels will surely attract the attention of the rating agencies and the rug could well be pulled from under the pound. Still, some strong January growth figures, typically led by the UK services sector, suggest there is some room for optimism. Add to this the growth-friendly effects of further QE and a double-dip may just be averted.

GBP/EUR has consolidated around the €1.20 mark since the turn of the year and we don’t envisage any major or sustained forays below this level. 84p (or €1.1905) should provide some decent support and the balance of risks look skewed to another move north of €1.20 in coming weeks.

GBP/USD

Sterling has had a superb run against the US dollar, bouncing well off its lows of $1.5250 to trade six cents higher. As evidenced by stronger stocks in January (an historically strong month for equities), risk appetite has been fairly prominent in recent weeks, which has weakened the US dollar considerably. As usual, GBP/USD has tracked a considerable rebound in the EUR/USD pairing, which we don’t see lasting too much longer.

The US Federal Reserve’s announcement that it expects to keep interest rates at record lows close to zero until late 2014 has done the US dollar few favours by fuelling risk appetite. Likewise the greenback’s strange relationship with US economic data has swung out of its favour. The encouraging signs out of the US economy, as evidenced by the lowest unemployment levels in three years, have added to the prevailing risk-friendly environment.

However, once market sentiment sours as a result of the eurozone crisis (as it inevitably will do) and investors flood back into safe-havens as we anticipate, then the robust figures coming out of the US economy should work in the dollar’s favour again.

GBP/USD’s rally looks to have some more legs in the short-term, which could see the $1.60 level tested. Beyond this though, we see the rate coming back down (perhaps quite aggressively) towards $1.55, in line with our bearish view for the EUR/USD pair.

Caxton FX one month forecast:
GBP / EUR 1.21
GBP / USD 1.5750
EUR / USD 1.3050

Richard Driver
Analyst – Caxton FX


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Eurozone cracks begins to show

After England’s demolition (yes I think we can go that far) of Italy at the weekend, the theme continues in the currency markets, with the pound rallying against its euro counterpart, climbing up .70% on the day and briefly touching €1.19.

After a lengthy absence from front page news, the eurozone cracks are finally beginning to re-appear, with a plethora of potential problems hitting the headlines once more.

The lack of news coming recently, coupled with euro strength had more or less duped investors into thinking that they had put the eurozone troubles behind them. This is not the case however, as Ireland and Greece reared their ugly heads with signs that all is not well in their respective camps.

Ireland’s main opposition party, Fine Gael, announced today that they would seek a renegotiation of the international bailout that Ireland received should they be elected on February 25^th. Meanwhile Greece, in a sign that they may be struggling to match debt repayments, criticised the IMF and European Union for the stringent terms that were imposed on them.

This comes on the same day that Portugal, (another member of the G.I.P.S.I. family) saw benchmark government debt yields climb to an all time high, above the psychological 7.00% barrier, to 7.37% - a bad sign for the countries borrowing costs. This raises the prospect that the country may yet be forced to appeal for a bailout.

In other news, reports suggested that rescue plans for ailing lender WestLB were under threat, assuring that euro sentiment remained sluggish at best at the beginning of this week.

The main driving force behind the currency markets, EUR/USD, broke below key technical support on this news, and continues to fall with little light at the end of the tunnel in the near term.

A frenetic start then to a busy week – focus has returned to the eurozone with Spanish and Italian bond auctions, and German GDP all still awaited. Meanwhile Britain’s inflation report on Wednesday is looking to overshadow the whole lot as Mervyn King takes the stand.

Edward Knox

Analyst - Caxton FX

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