Summarizing Last Night's Crazy European Action
There has been some ridiculous moves in overnight FX: as the chart below shows, those trading the CHF have had to consume several times the RDA of Dramamine to stay on this particular ride.
The whopping move was due to comments out of the SNB that the bank is "preparing for an exit." The bank softened its intervention language, noting that "deflationary" risks have largely disappeared (see note from Goldman below on full SNB implications). Ironically, this was the least of the night's highlights. As pointed out last night, the EURUSD was initially dropping on comments that the ECB will continue devaluing the EUR by buying bonds (and potentially commercial paper) until the situation stabilizes. But then Tim Geithner's idiocy v2 kicked in as all of a sudden everyone in Europe started touting the ridiculous straw-man that are Stress Tests: France's minister of economics noted that the "sooner banks publish results the better." And as we saw domestically a year ago, there is nothing more honest than the administration imposed stress tests (especially accompanied by a complete suspension of accounting rules). Hilariously, the vice chairman of one of the most insolvent companies in the world, the infamous STD, or Banco Santander, said he was convinced the stress tests will show the "extraordinary strength of Spain's banks." You just can't make this up. Then Germany also touted what a great thing stress tests would be. Somehow all this doctored propaganda managed to raise the EURUSD by over 150 pips, bringing the pair to almost 1.24. Lastly, Spain's horrendous auction, where the 30 Year closed at 5.908% compared to 4.758% previously, even with the ECB directly involved, was supposed to be seen as good news. All in all, EURUSD should be testing 1.22 support. Instead it is back to 1.24 resistance. Well played, Tim Geithner.
Some more on ever-deteriorating Spanish bond auctions from Reuters:
Spain's Treasury drew strong demand for its 10- and 30-year bond issues on Thursday, selling 3.5 billion euros ($4.3 billion), at the top of its target range, but paid a hefty premium compared with previous issues of the same paper.
The Spain/Germany 10-year bond yield spread narrowed to 222 basis points following the auction result, from about 236 basis points beforehand.
The 10-year average yield was 4.864 percent compared with 4.045 percent at the previous auction on May 20, while the 30-year yield jumped to 5.908 percent from 4.758 percent on March 18.
"Spain passes another market test with 10- and 30-year bond auction," 4Cast said in an investors note.
"Spain got its bonds away (even if the 30 years was underwhelming), and while that's not going to see off all the doomsayers it does at least buy some more time," analysts at the London-based research house wrote.
The auction helped ease market tensions over Spain's ability to meet this year's remaining bond redemption of 16.2 billion euros by the end of July.
Spain's 10-year bond spread against Germany has swelled to record highs since the euro zone was created amid media reports that the government may need European Union aid and its banks may be facing a liquidity freeze in international markets.
And here is the take of Goldman's Dirk Schumacher on the SNB announcement:
No change in stance for now - but SNB starts preparing for exit
Bottom line. The 3-month Libor target (0.25%) and the 2012 inflation forecast (2.2%) was left unchanged. At the same time the SNB softened its language on FX interventions and thinks that the deflationary risks have "largely disappeared". If it weren't for the Euro-zone debt crisis the SNB would start the exit from its super-accommodative policy soon. We still think that a rate hike in September would be too soon, but are less certain after today's meeting. Our central forecast is for a first hike in December.
Inflation forecast. The 2010 inflation forecast was revised up from 0.7% to 0.9% and the 2011 figure from 0.9% to 1.0%. The forecast for 2012 was left unchanged with inflation clearly breaching the SNB's target in the second half of 2012 (see chart). The SNB now also published a forecast for Q1:2013 showing inflation at 3.07%. We would have thought that the appreciation of the CHF would lead to some downward revision of the forecast. These forecasts are all based on the assumption of a stable Libor target clearly indicating that the current stance, if left unchanged, would be inconsistent with price stability as defined by the SNB.
FX interventions. The SNB says that the deflationary risk has "largely disappeared" on the back of the improving economic situation (growth for this year was revised up from 1.5% to 2.0%; GS: 2.0%). The debt crisis, however, implies higher risks and the SNB will take "all measures necessary" to prevent a materialisation of the risk to price stability stemming from an appreciation of the CHF. Put differently, the SNB will still intervene if FX moves are too dramatic but the hurdle for interventions seems to be higher now. The SNB also acknowledges the increased financial risk on its balance sheet resulting from FX interventions.
Excess liquidity. FX interventions have led to excess liquidity in the banking system which will need to be mopped up at some point. President Hildebrand said in its speech accompanying today's decision that the monetary base has reached a record high in May. Coupled with already quite lively lending growth this shows the inflationary risk from interventions if left unchecked. SNB board member Danthine presented in his speech the framework the SNB will use for absorbing the excess liquidity: issuance of SNB bills and reverse repos as a fine-tuning instrument.
Overall, the statement and the updated inflation forecast are slightly more hawkish than we had expected. Once the funding situation for the Euro-zone periphery stabilises the SNB will switch gears. We continue to think that a rate hike in September is too early, not least because we expect the CHF to appreciate further. But we are less certain now than we were before today's meeting.
The only winner out of all this... gold, which is once again pushing for an all time record.