Highlights
The US dollar was stronger vs. the majors as pessimism with regards to Greece intensified yet again after Trichet and ECB offered little in the way of euro support (see below). Risk off trading picked too late in the day as equities plunged, with EM really taking it on the chin again (see below). We still target the 2009 low for EUR of 1.2457, with an eye on the birth rate around 1.18-1.19 further out. Yen was stronger across the board again and outperformed the buck and so dollar/yen slipped below 88 briefly. Only gainers on the day vs. USD were JPY, CHF, and TWD, while biggest losers vs. USD were PLN, TRY, BRL, SEK, and NOK. EM currencies were weaker, and we see little hope of EM recovering much ground until the Greek crisis is resolved (see below). Swiss franc firmed, with talk heard that the SNB stepped away from efforts to prevent currency strength (see below). Czech cut surprise 25 bp.
US equity markets were lower but recovered from the intra-day lows. At one point, DJIA was down almost 1000 points. Sentiment remains fragile, even though some chatter chalked up the free-fall to erroneous trades. DJIA, S&P, and NASDAQ ended down 3.2%, 3.25%, and 3.4%, respectively. European markets were lower too, with Euro Stoxx 50 down 2.5%. Asian equities are likely to open down today as Asian ADRs were lower during N. American trading Thursday. 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 15 bp, respectively. European bond markets were mixed, as 10-year yields in UK, France, and Germany were down 2 bp, 2 bp, and 7 bp, respectively. Greek 10-year yields rose 113 bp, Portugal 33 bp, Ireland 23 bp, Italy 22 bp, and Spain 24 bp. Peripheral yields are now above what they were before weekend Greece package. Short end was worse, with Greek 2-year yields up 145 bp.
Currency Markets
The euro has been sold to new lows in the aftermath of the ECB meeting and Trichet’s press conference. Trichet did not say or do anything to stop the rot. There was no attempt to address the liquidity squeeze that is apparent not only in the euribor market but also in short end of the dollar LIBOR curve. To the extent Trichet addressed the euro itself, he showed no real concern. Indeed his silence in the face of the euro’s near free fall this week (-5% against the dollar) was deafening. German Economics Minister Bruederle was quite explicit: he is not worried about the euro’s depreciation. The headline appeared to coincide with the break of $1.27. In the past, Trichet has used strong words to protest the price action in the foreign exchange market. Boiler plate comments about the euro being a good store of value is hardly sufficient in the current environment. Despite Trichet’s defense of the ECB’s decision to accept Greek bonds as collateral regardless of their credit worthiness, it failed to erase the sense that the central bank succumbed to political pressure. In sword fighting, it is said if you feel mush, push. Feel steel retreat. The market feels mush. The pain threshold of European policy makers has not been reached. Trichet’s comments have not only encouraged euro sales, but the pressure on the beleaguered Meds’ bonds continued apace. It is getting increasingly difficult to see how the rot stops. At various points during the crisis, there have been opportunities for officials to get ahead of the curve of market expectations. They failed to do so each and every time. Look at what Italy said. Its debt to GDP forecast was raised to 118.4% this year from 115.8% last year and Finance Minister Tremonti blamed this on the pledge to support Greece. Tomorrow its parliament is expected to take up the Greek assistance funding. Even if Tremonti is being a bit disingenuous, the fact is that assistance to Greece from other weak credit countries can prove to be very counterproductive. At the end of last week, the idea was that the EU/IMF package could buy Greece three years to get its house in order before having to go back to the capital markets. Almost immediately observers questioned whether the amount was sufficient. Now, the IMF let it slip that Greece won’t have to go to the capital markets for 18 months–half the time the market initially expected. In fairness, the euro is not alone in selling off. Sterling has broken the $1.50 level and quickly dropped another cent. Election jitters are blamed and a UK clearer was supposedly a featured seller. Earlier, the SNB had stepped away from its effect to prevent CHF appreciation and the euro immediately plunged to record lows against the franc. There is some talk that after the euro fell from above CHF1.43 to below CHF1.4050 that the SNB, or an agent, may have shown their hand again and this may have helped steady the euro-franc cross at sharply lower levels. The yen is a major beneficiary of the unwinding of positions and risk-reduction. This will not set well for Japanese exporter shares or the Japanese government, which continues to wrestle with deflationary pressures. Earlier today a second government panel called for a weaker yen. There is not much dollar support ahead of the JPY91.50-JPY92.00 area.
With market fallout from the Greek crisis intensifying, risk off trading is back in vogue as EM currencies are mostly weaker on the day and the last week. We warned last week that while EM fundamentals are very strong (some might say stronger than G10 fundamentals), we were not confident that EM could decouple fully from developments in Greece, and this week’s price action bears this out. Recall that during the early stages of the financial crisis, some analysts were touting EM as a safe haven. Eventually, EM succumbed. We continue to be pessimistic about Greece, regardless of the money that’s thrown at it. While we think most EM policy-makers will welcome this latest bout of currency weakness, it’s only if it doesn’t turn into a rout. Commodities and equities are largely lower on the day too, so it’s a classic risk off trading day. In our view, it will be impossible for EM currencies to grab a toehold until the Greek situation has been stabilized. EMEA remains the weak link in EM, due to poor fundamentals as well as too much reliance on Western Europe for trade and growth. BRL is the worst performer in EM today, but is followed by PLN, RUB, TRY, HUF, ZAR, and CZK. Turkey remains one of our favored EM currencies, and while it has held up relatively well compared to the rest of the region, it too is getting hammered today. The fact that Czech central bank cut rates today underscores just how worried the region is about the economic outlook. Hungary will continue cutting, as will Russia and Romania. Czech may cut again, and we may start to hear talk of Poland restarting its easing cycle as Polish data have been mixed of late. Again, EM weakness still has a ways to go near-term, as we believe recent Greek/Europe developments are going to worsen after having already taken a toll on market risk appetite. Given that EM exchange rates vs. the dollar are going to be driven by gyrations in risk sentiment as the Greek saga continues, we would advise investors stay short EM near-term.
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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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