Euro Losses Accelerate As Germany Bans Some Short-selling

Highlights

The US dollar was stronger vs. the majors, as the euro was unable to hang on to its recent gains above 1.24.  Euro selling accelerated after news of German regulator BaFin banning some short sales (see below).  Euro made a new low for cycle vs. the buck at 1.2161 before seeing a modest bounce near the end of North American trading, but continues to trade heavy.  Yen was firmer across the board and outperformed the buck and so dollar/yen fell back towards 92.  EM FX was largely softer.  Biggest gainers on the day vs. USD were RUB, KRW, MYR, JPY, and IDR, while biggest losers vs. USD were PLN, HUF, NOK, ZAR, and SEK.  US data had little impact, as markets remain focused on what’s going on in Europe.  US PPI fell -0.1% m/m unexpectedly, while housing starts rose a stronger than expected 5.8% m/m.  Turkey kept rates steady but moved to new 1-week policy rate.

US equity markets were lower, as DJIA, S&P, and NASDAQ ended down 1.1%, 1.4%, and 1.6%, respectively.  European markets were up, though, with Euro Stoxx 50 rising 2.4%.  Asian equities are likely to open down today as Asian ADRs were lower during N. American trading Tuesday.  Nikkei futures point to a down open for Japan and the strong yen should hurt Japan exporters. 

US bond market was higher, as 2- and 10-year yields were down 7 bp and 14 bp, respectively.  European bond markets were mostly higher, as 10-year yields in UK, France, and Germany were up 1 bp, down 4 bp, and down 3 bp, respectively.  Greek 10-year yields fell 51 bp, Portugal fell 8 bp, Ireland fell 7 bp, Italy flat, and Spain flat.  European market were already closed when the BaFin news hit, so Weds should be an interesting trading day for ALL asset markets.  Bank of Italy suspended mark to market for Italian banks.

Currency Markets
German financial services regulator BaFin has put a temporary ban on naked short-selling of shares and CDSs on euro zone government bonds as of midnight Tuesday.  A ban on stocks by BaFin was done before on a temporary basis, but not on CDSs and so news is causing more of a ripple.  Recall that the US issued first issued a temporary ban on naked short-selling first in July 08 on 19 financial stocks.  Then on Sep 08, the SEC widened that list to 799 financial companies and banned ALL short-selling for two weeks.  At around the same time, the UK’s FSA also instituted a ban on all short-selling of 32 financial companies, while BaFin only banned naked short-selling with regards to 11 companies in the German financial sector.  Indeed, bans of some sort were also seen in France, Switzerland, Ireland, Australia, and Canada, to name a few.  In a proper short sale, the investor is supposed to borrow the stock, sell it, and then repay the borrowed stock that’s bought (hopefully) cheaper.  When it’s naked, the short-seller never borrows the stock in the first place and so will most likely result in a failed trade when that stock is never delivered.  For the CDS, that would mean that the buyer of a CDS doesn’t actually own the govt bond that needs default protection.  A big question is whether other countries follow suit.  Of course, the other euro zone members would most likely go along with Germany on this.  But given that this most recent leg of the crisis is centered on the peripheral euro zone, we can’t see why the US or the UK would get involved in this move.  And given the global nature of the financial world, couldn’t a German investor simply use a US counterparty to get around this ban?  The ban raises more questions than it answers.  Euro selling has accelerated, which we can attribute to two possible factors. First, the German ban seems to be a bit of “flailing.”  Given the questions we raised in our earlier note, it appears to be half-baked and not really thought out, and plays into market doubts about European policy-making credibility.  The second, and perhaps more important, factor is the fact that if the Europeans are in effect trying to take away legitimate investment vehicles, then investors that are negative on Greece and Portugal can only take recourse in limited ways, the biggest one being to simply short the euro.  Our near-term target of 1.18 remains in play (low from early 2006).  We think the momentum was to the downside even before the short-selling news.

Brazil Energy Ministry announced that the recent Franco oil well find may be the “best” in Brazil’s history.  Franco sits about 4 miles below the sea floor in waters that are close to a mile and a half deep.  The Brazil offshore region that has been drawing the most oil exploration runs along its coastline, and is called “pre-salt” because of the thick layer of salt that formed on top of the oil reserves.  Brazil is thought to have 50 bln barrels (bbl) of oil reserves in the pre-salt layer, but so-called proven oil reserves are still around 12 bln bbl.  Franco is estimated to hold more than 4.5 bln barrels alone, the biggest since and officials are now saying that another well being drilled nearby may hold even more.  Brazil is now the 12th largest oil producer in the world, with total oil production of 2.6 mln bbl/day has more than doubled from 1.2 mln bbl/day back in 1998.  The bad news is that Brazil is the 7th largest oil consumer in the world, with consumption just about equal to domestic production.  So while it is not reliant on oil imports, Brazil is not yet a major exporter that is helped by higher prices.  If these recent oil finds come to fruition, Brazil has the potential to become a major exporter, but for now, it remains eclipsed by Venezuela, whose proven reserves are close to 100 bln barrels and whose production of 2.5 mln bbl./day is much more than domestic consumption of around 775 thousand bbl/day, making it a major oil exporter.  Lastly, we contrast Brazil’s trajectory with Mexico’s.  Mexico output has plunged dramatically since peaking in 2004, and if the oil sector does not see a turnaround in exploration and investment soon, it seems only a matter of time before Mexico stops being a net exporter.  For now, BRL remains in a 1.75-1.85 range after hitting almost 1.90 during the Greece-related EM sell-off.  While investors can play that range, we continue to believe that there is limited upside for BRL vs. USD beyond 1.70, with gyrations expected due to general risk appetite.  Expanding on the oil outlook for each country, why not play BRL vs. MXN?  BRL/MXN has fallen back from the high around 7.861 posted in Nov 09.  If you believe as we do that the fundamental growth outlook for Brazil remains stronger than that of Mexico, then look to buy BRL vs. MXN at current levels around 7.0 for a move back to that 2009 high and then the 1998 high of 8.993.  Since bottoming around 2.47 back in 2002, this pair has been in a relentless march upwards that we believe is a structural trend that is set to continue.  Simply put, Brazil has much better potential for future growth than Mexico.  Plus, investors can get a nice bit of carry as well (9.5% for BRL vs. 4.5% for MXN).

Given all the Greece news, developments in Venezuela have not gotten much attention but are worth summarizing.  The government just published a new currency law in the Official Gazette, which marks the end of the parallel currency market that was announced last week.  Basically, the fact that the authorities want to control what had been a parallel, free market for bolivars suggests that the Jan devaluation has done little to correct the basic imbalance in currency supply and demand.  To us, these most recent actions suggest that the Jan devaluation may be followed by another one within the year.  Foreign reserves have been falling steadily to $27.5 bln, the lowest since Aug 07.

Upcoming Releases

Asia: RBNZ financial stability report; Australia wages Europe/EMEA:  BOE minutes; euro zone construction; Poland wages; S. Africa retail sales; Hungary central bank minutes Americas:  US mortgage applications, CPI, Fed minutes; Canada wholesale sales.  Fed’s Dudley speaks.

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This was the BBH CurrencyView by Marc Chandler. Marc is the Global Head of Currency Strategy at Brown Brother Harriman. For more of BBH’s currency views, visit the BBH FX website here.

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