Euro Bears Camping out in Bratislava

BBH CurrencyView

• Global stock continue to push higher amid choppy conditions; EuroStoxx reaches 6-week high
• Slovakia’s rejection of the EFSF 2.0 is unlikely to derail ratification; EUR/USD breaches 1.38
• China’s PBOC reportedly intervened it the Chinese equity market after US Senate vote

The dollar continues to remain under pressure as global stocks push higher ahead of Barroso’s potential announcement today on plans for the recapitalization of euro zone’s banks. The news comes amid a very choppy overnight session which saw the EuroStoxx 600 swing between gains and losses, with a total intraday trough to peak swing of nearly 2%. Nonetheless, the benchmark index is set to advance for its fifth day in six with materials leading the move higher after an unexpected rise in euro zone industrial production. S&P futures are up nearly 1% as well. Against this backdrop, safe havens have fallen back with bund and gilts posting losses, with gilts outperforming bunds, supported by an unexpected rise in the UK unemployment rate. One blot against today’s backdrop, though, is that US-China trade tensions are likely to intensify after the US Senate passed the China currency bill.

Slovakia, the potential slayer of the EMU, continues to grab the headlines for the second day after it failed to pass the enhancements of the EFSF yesterday. While the no-vote did not come entirely as a surprise, given the euro has appreciated by 1.2% in the past two days, it has become apparent that with Slovakia contributing the most to the EFSF as a relative size of GDP (nearly 10% of GDP) that Slovakian interests tool precedent over the greater good of the euro zone. In any event, we continue to expect the government to pass the bill as early as today (according to recent press reports) but we also expect the government to resign a condition for passage of the EFSF 2.0 later this week. The euro’s sharp gains over the past few days, in our view, continues to be driven in part by extreme market positioning, which turned sharply against the euro over the past few weeks. In fact, over the past 8-weeks the market has sold nearly $13bln worth of euro speculative contracts on the CFTC, which to put in context has been nearly double the size of the second-most sold currency, sterling. That means, with all the euro bears moving to the one side of the boat, the euro has been sensitive to “positive” policy and economic data news. For today, the combination of better than expected EZ industrial production, a Slovak yes-vote and hopes of policy response from European officials is likely good enough to keep the euro afloat, along with a boost from the upside cross of the 5 and 20dma (which is also seen on the S&P, GBP and AUD). Elsewhere, UK economic news continues to sour, with unemployment rising by nearly 100k over the last quarter coupled with ex-bonus average incomes trending at less than half the prevailing rate of inflation. While the September UK August jobless claimant count came in at 17.5k, better than the consensus for a 24.4k rise, the claimant count rate unexpectedly rose to 5.0% from 4.9% and the internationally comparable August ILO jobless rate rose to 8.1%, above the consensus for 8.0% and from 7.9% last. Altogether, The ONS stats office reports that the UK now has the highest total number of unemployed since October 1994.

In China the PBOC was reported to have intervened in the Chinese equity (Shanghai Index, in particular) after the US Senate passed legislation on the China currency bill. It reportedly bought in size on the SSEC and turned an early loss of 1.25% to end the Asian session over 3% higher. The bulk of the demand was focused on financials, (with financial services up over 7%) which have been very attractive on a valuations basis and was the catalyst for heavy demand from China’s state fund on Tuesday. The state-run Central Huijin Investment Ltd was set up to hold stakes in banks and boosted its holdings after valuation fell below levels seen during the financial crisis around 2008. As we highlighted yesterday the 2008 action helped to spur a 21% week-long rally in the SSEC when it bought stocks in 2008 amid China’s widespread stimulus measures to help mitigate the financial crisis. However, ahead of this week’s monthly data from China follow through demand may be restrained, with larger investors sidelined for the time being. In terms of the currency bill, we think the bill is untimely and more importantly we suspect the probability of it becoming law is quite low at this juncture. Nevertheless, in the near-term the Senate’s passage is sufficient to dampen the outlook for bilateral cooperation between the US and China at a time when economic cooperation from two of the world’s largest countries is needed most to maintain global growth and stability. It is impossible to rule out the potential for its passage entirely, which in our view likely would lead to a US-China trade war (assuming China would be expected to retaliate, for instance, by taxing US goods to China). In turn a US-China trade war would likely dampen global activity and may prompt a double dip.