Persevering Euro Weakness, German Naked Short-Selling Ban Stays in the Limelight

Highlights

Euro weakness persevered into the European session, with Germany’s naked short-selling ban announcement still in the limelight (see below). The euro has broken through the $1.22 mark, down to a low $1.2144 in Asia -  a fraction above the important $1.2143 level, which is a 50% retracement of the rally from the all time low $0.8230 to the all time high of $1.6038. We identify further support at $1.2135 and then the important $1.20 level. The US dollar and the yen are in demand in the current context, while the NZD (-2.6%) and the AUD (-2.7%) were the worse performers in the G10 world overnight. RBNZ Bollard stressed that a gradual depreciation in the NZD is desirable while Aussie consumer confidence saw its largest monthly decline in 19 months in May (by 7%), all adding to the bearish sentiment in a rising risk aversion environment and bearing in mind the latest decline in oil prices. The Swiss franc is a winner this a.m but there has been market report of SNB intervention with the 1.40 level strongly protected on EURCHF. EMEA currencies are soft across the board on rising risk aversion. Fed meeting minutes are due for release and the ECB President Trichet is speaking later on. Not much on the data front today, just the US April CPI.     

Germany’s BaFin naked short-sales ban announcement weighed significantly on the equity market sentiment overnight, with the MSCI Asia Pacific index losing 1.1% and now trading 11% lower from its April 15^th high. Negative close were seen on the Nikkei (-0.5%), the Hang Seng (-1.8%), the Kospi (-0.8%) or again the S&P/ASX200 (-1.9%). The Shenzen SE (+0.4%) had a better day. European bourses have had a poor morning, with the FTSE 100 (-2.5%), the Dax index (-2.7%) and the Cac-40 (-2.8%) all trading lower by midday. The S&P future points at a negative open on WS later today. WTI crude oil prices have eased back below the $70brl mark, trading at $68brl by euro midday, down 1.34%.

Flight to quality trades supported the Japanese bond market overnight, with 10 year JGB yields trading down 1bp. Lower bond yields were also seen on the French (-5bp), German (-5bp) and Italian (-3bp) bond markets. Greek bonds underperformed, up 8bp. In the current context, expect a very successful Canadian 30 year bond auction today. German 10 year Bund auction produced decent results given the current context, with a bid to cover ratio at 1.4 (lowest ratio this year though). 

Currency Markets                                                                                       

The market is still digesting yesterday’s German financial services regulator BaFin announcement that a ban on naked short-selling of shares and CDSs on euro zone government bonds has been introduced.  In addition, there is a Ft story indicating that Austria proposed a generalization of the ban across the EZ, but the response from other EZ leaders has been rather muted so far. Note that France has had a similar legislation in place for French banks for a few years now, with limited impact, so the efficiency of such a ban can be highly questioned from past experience. 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 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.  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. 

Euro selling has continued overnight and will most likely continue into today’s session. Given the questions we raised in recent analysis, it appears to be half-baked and not really thought out and plays into market doubts about European policy-making credibility. Another important fact is 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) as we thought that the momentum was to the downside even before the short-selling news.

Sterling is vulnerable against the US dollar in the current context (see cable easing below the $1.43 level in European session), but we’d expect a stronger performance against the euro, with 0.85000 support likely to be tested soon.  The BoE May MPC meeting minutes were very much in line with last week’s Inflation Report and erred on the dovish side, suggesting that a) rate hikes are a distant prospect and b) that the QE card has not been totally abandoned yet. Note however that the higher than expected inflation environment of the past few months (well captured by yday’s CPI data) may lead to a less dovish monetary policy outlook – even though an actual rate rises are clearly not going to be on the agenda just yet.

The Fed will also release the minutes from its latest meeting later today and in the US, it is also clear that rate hikes are not on the agenda for now even if the normalization of monetary policy process is ongoing. Note however that the ongoing Greek debt crisis risk to delay the whole Fed’s policy adjustment. In this respect, the Fed’s recent reopening of its swap lines highlighted the international nature of the crisis and the fact that the US monetary authorities are not ignoring developments in the euro zone, rightly so. On the data front, the US April CPI is expected to pick up a fraction, with a yearly rate seen accelerating to 2.4% (from 2.3%) while core inflation remains very subdued (expected at just 1% y/y from 1.1%). This still subdued inflation environment in a moderate recovery context means that there is leeway to maintain a low rate environment for an extended period of time.

Upcoming Economic Releases                                                                       
America: US April CPI, latest mortgage applications, Cad March wholesale sales. Events: Fed to release minutes from the April 28^th mtg. ECB’s Trichet to give a speech.

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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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