Risk Returns on Successful ECB Tender

Highlights

• The US dollar is generally softer, consolidating yesterday’s moves.  In fact, the three best performers yesterday and for the month of June, namely the Swiss franc, British pound and Japanese yen, are the laggards today.  Month-end and quarter-end adjustments are commingling with normal market forces after outsized moves the previous day.   The key event of the day has been the 3-month ECB tender ahead of the expiry of the 12-month 442 bln euro funds tomorrow.  The relatively low demand for the 3-month funds helped lift the euro to the session highs and encouraged some risk taking in other currencies and markets.
• Asian equities trading heavily, but European markets are posting modest gains.  The MSCI Asia-Pacific Index fell 1.3%, led by a nearly 2% decline in the Nikkei to seven month lows.  Basic materials, exporters and chipmakers were among the weakest sectors.   Those markets that were open late, however, like India, Singapore and Indonesia did manage to turn positive.   European bourses are mostly 0.5%-0.8% higher, though Spain is gaining over 1.5% today, led by a recovery in the financials.  Financials are also among the strongest sectors in the Dow Jones Stoxx 600 today, roughly doubling the 0.75% advance near-midday. 
• The successful ECB refi operation and the stabilization of global equity markets have taken eased the safe haven bid for Treasuries and bunds.  This was too late for Japan though and benchmark 10-year JGB yield slipped 3 bp to 1.07%, the lowest in seven years.   UK gilts are continuing to outperform bunds.  The spread has narrowed 32 bp this month.  Today the gilt yield is 3 bp lower at 3.35% , while the bund yield is 3 bp higher today at 2.38%.  The 2-year schatz auction in Germany saw lukewarm reception at best, with a lower bid to cover and the Bundesbank keeping a relatively larger amount.  Low yields and the uncertainty around the ECB’s operation may have deterred participation. 

Currency Markets

There has been much anxiety surrounding tomorrow’s expiry of the 442 bln euro 12-month funding operation.  Spanish banks in particular were believed to be facing difficulty.  Euribor rates had been creeping up.  Banks were holding a large amount of funds overnight with the ECB, though earning less than they would in the interbank market.  The ECB offered unlimited 3-month funds today.  Estimates were that generally between 200-300 bln euros would be taken down.  In fact about 132 bln euros were taken.   This is a much lower than expected amount and was seen as a sign that market fears were exaggerated.  Banks had prepared for this well known event and as the ECB’s Noyer hinted earlier this week that the expiry would not be disruptive.  The markets have responded favorably.  The euro fully recovered yesterday’s losses to test the $1.2300 area.  A break of this could see $1.2350, but the short-term market may not have the conviction to move it through there.

Many investors have found it cruelly ironic that sterling appears to be moving more in sync with the safe haven Swiss franc and Japanese yen than the euro.   In fact, sterling is the second best performing G10 currency this month, rising 4% against the dollar.  The Swiss franc takes top billing with a 7.3% rise.  Sterling’s gains have been fueled by several factors, including the fiscal austerity that strengthened ideas that the UK’s AAA rating is safe(r), M&A flows, talk of foreign interest in the UK property market, and some suggestion that sterling’s role as a reserve currency may be enhanced at the expense of the euro.  Sterling is trading heavier today.  Some of its weakness appears to be related to month-end activity. There was also some disappointing data that may have encouraged some profit-taking as well. The June Nationwide house price index was softer than expected.  The 0.1% increase translates into an 8.7% year-over-year rise.  In May the year-over-year rise was just below 10%.  Separately, GfK consumer confidence measure slipped to -19 from -18, which represents a new 6-month low.   Sterling dipped briefly below $1.50 before the ECB tender and then returned toward session highs.  Resistance is seen near $1.5100 and $1.4980 has shown itself to be healthy support.  The euro had fallen to 19-month lows against sterling yesterday, recording a low near GBP0.8070.  The euro gained a big figure to GBP0.8180 today, but appears to have run out of steam.   Initial support is seen near GBP0.8140.

Sweden reported stronger than expected retail sales yesterday, underscoring expectations that the Riksbank will hike interest rates tomorrow.  In contrast, Norway reported disappointing retail sales figures today.  The consensus had expected a 0.5% increase in May sales, but instead fell 0.1%.  There was little market reaction to the disappointment. There has already been a notable shift in market expectations.  The Norges Bank was one of the few central banks to hike rates last year, but in recent months the economic data has softened and central bank has signaled expectations for slower growth and slower normalization of monetary policy.  Sweden’s Riksbank has not tightened monetary policy yet, but is expected to tomorrow. Sweden’s repo rate stands at 25 bp and there are widespread expectations for a 25 bp rate hike. Recall that the Riksbank has set a negative deposit rate (-25 bp).  Although operationally, we are under the impression that it was not an onerous as it may sound, but assuming a repo rate hike tomorrow, look for the deposit rate to at least be lifted formally to zero.

The IMF has indicated that it is working on a new pre-cautionary lending facility.  It is going to have more conditions that the Flexible Credit Line (FCL) that it has created during the crisis, but no as much as a normal credit line.  Recall that few countries really qualified for the FCL, which had few conditions and reserved for countries that the IMF judged had sound fundamentals. This new program will target “countries with good track records”, but do not qualify for FCL. Although the IMF course did not pre-announce likely candidates, Hungary appeared to declare interest almost immediately.   Note that Hungary will hold talks with the IMF in July, seeking to extend by two months the existing IMF facility (until the end of the year) and negotiation a new precautionary line for 2011.  While this has lent support to the forint, news of a larger than expected Q1 current account surplus of 344 mln euros (the consensus expected a 212 mln surplus) and an acceleration in producer prices (3.8% in May after a 1.6% rise in April), probably provided more support.

Upcoming Economic Releases
The ADP provides their estimate of private sector job growth at 8:15 EST/12:15 GMT.  The consensus is for a 60k increase (55k in May).  At 9:45 EST/13:45 GMT the Chicago PMI is due out and a slight decline from May’s 59.7 is expected.