Market Sentiment Improves After ECB LTRO

BBH CurrencyView

• US dollar is mixed vs. majors Thursday as market sentiment improving a bit in the wake of ECB’s 3-year LTRO
• Merkel advisor Bofinger warned that the euro zone has six months to solve the debt crisis; Greek creditors reportedly balking at IMF haircut proposal; France downgrade rumor made the rounds again
• HUF stabilizes after S&P downgrade but further weakness likely; Turkey central bank leaves rates steady at 5.75%, as expected

US dollar is mixed vs. majors Thursday in narrow ranges as euro zone sentiment remains choppy in the wake of the ECB’s LTRO. After being unable to extend its rally Wednesday, the euro has traded heavily but is finding some modest support near 1.3050 for now. Choppy conditions likely reflect market uncertainty about the efficacy of the LTRO. While liquidity helps the banking system, underlying solvency and debt issues have not been addressed by the ECB’s actions and so further euro zone tensions should reappear soon. So far today, the dollar bloc and sterling are outperforming vs. USD and are up on the day while the Scandies are underperforming vs. USD and are down modestly on the day.

Equity markets are mixed, with Asian stocks largely down and European stocks opening up. Euro Stoxx 600 is up 1.1% (financials up 1.2%) while US equity market futures are pointing to an up open.

Bond markets are mixed. Periphery yields are mostly higher, as 10-year Greece down 38 bp, Portugal up 4 bp, Ireland up 3 bp, Spain up 6 bp, and Italy up 1 bp. The US 10-year yield is down 1 bp, Germany up 1 bp, France down 1 bp, and UK down 3 bp. The 2-year US-German spread is at -2 bp vs. -4 bp Wednesday, which was a new low for the year.

The commodity complex is mixed, with oil and copper up, gold down. EM currencies were mostly firmer. ZAR, RUB, and PLN are outperforming in EM vs. USD and are up on the day, while KRW, INR, and MYR are underperforming vs. USD and are down on the day.

German Chancellor Merkel’s advisor Peter Bofinger said the future of the euro will be determined in the next six months, and that its survival will require Germany to change its stance. He added that the ECB could help by capping yields on Italian and Spanish bonds. It appears that Greece’s private sector creditors are balking at the IMF’s proposal for a 5% coupon on restructured debt, as the haircut is seen as too deep. Lastly, another French downgrade rumor made the rounds, one of these days the rumor will be correct.

Overall, the ECB’s aggressive liquidity measures have yet to address the underlying solvency issues, which is why Bofinger’s warning strikes a chord. More stress, more policy responses, and more concessions by all parties will be seen in the next several months. Q1 12 will be very challenging for policy-makers and the markets alike.

What to look for today in EM:

Hungary October retails sales was stronger than expected, up 0.6% y/y vs. -0.2% y/y expected and +0.3% y/y in September. Two rate hikes will impact an already weak economy, and so a recession seems likely for Hungary in 2012. This will keep downward pressure on its ratings, too.

Poland November retails sales was stronger than expected, up 12.6% y/y vs. 10.5% y/y expected and 11.2% y/y in September. Polish economy is best-suited in the region in terms of avoiding fallout from the euro zone recession, but it is not immune. We think NBP will cut rates in 2012, but for now is on hold as data hold up and inflation remains high.

Brazil November unemployment rate was lower than expected, falling to a record low 5.2% vs. 5.7% expected and 5.8% in October. The central bank seems intent on cutting rates still, but low unemployment will keep wage pressures on the front burner. Authorities will have to tread carefully in 2012.

Turkey central bank held a policy meeting and kept rates steady at 5.75%, as expected. It noted growth remains strong, but that loan growth was moderating and current account gap narrowing. FX intervention was minimal today, with $50 mln auctioned and $181 mln bid.

Mexico mid-December CPI due out at 9:00 AM EST, 0.32% m/m expected vs. 0.97% in mid-November.

Colombia Q3 GDP due out at 11:00 AM EST, 6.0% y/y expected vs. 5.2% y/y in Q2. Economy remains strong, and helps explain the surprise 25 bp rate hike in November. However, minutes suggest that was an insurance hike and the bank is now likely on hold. In 2012, we think it will be easing like the rest of the world.

What to look for today in DM:

NZ Q3 GDP growth was 1.9% y/y vs. 2.2% y/y expected and a revised 1.1% y/y (was 1.5% y/y) in Q2. Economy remains fairly resilient, and kelps explain the dovish wait and see stance for now by RBNZ. NZ will suffer from slower global growth, but so far has remained resilient as it recovers from the earthquake.

UK GDP growth was revised up to 0.6% q/q vs. 0.5% q/q expected.

Italy October retail sales was stronger than expected, up 0.1% m/m vs. -0.2% m/m expected and -0.4% m/m in September.

US November Chicago Fed index, Q3 GDP, weekly claims, November leading index are all out today. US data has been coming in on the strong side recently, and good numbers today should add to the upswing in market sentiment.