French Downgrade Comes And Goes As Europe Open Fills EURUSD Gap
Another day, another melt up overnight wiping out all the post-Moody's weakness, this time coming courtesy of Europe, where following the French downgrade, the EURUSD filled its entire gap down and then some in the span of minutes following the European open, when it moved from 1.2775 to 1.2820 as if on command. And with the ES inextricably linked to the most active and levered pair in the world, it is is no surprise to see futures unchanged. It appears that the primary catalyst in the centrally planned market has become the opening of said "market" itself, as all other news flow is now largely irrelevant: after all the central planners have it all under control.
In other central planning news, the BOJ did not engage in QE 10 a month after QE9 and two months after QE 8, largely as expected: after all why bother - the bank's farcical independence (as that of all other central banks) will be officially lost once the opposition LDP wins next month's elections, and the BOJ becomes a branch of the government, proceeding to engage in "infinite" monetization (where have we seen this before), one reason why the JPY has seen a weaker tone recently. That this escalation by Japan will merely result in further aggressive easing by all other banks is obvious. Elsewhere in Asia, Australia kept its benchmark rate unchanged with some harsh language threatening more cuts, somewhat denying recent storylines had rebounded and that Australia does not need to easy any more.
In China, the reverse repo ultra-short term easing continues as the PBOC continues to refuse to engage in wholesale easing so critical to the EPS of tech companies everywhere, leading to yet another Shanghai Composite session closing in the red, and at a fresh 7 week low, ever closer to the 2000 barrier.
Looking at the lost continent, Europe is supposed to fix Greece for good today in the latest and certainly neither greatest nor last Eurogroup meeting. Or not.It is also unlikely that EU budget talks will be any easier following the downgrade. Finally downgrade watchers will estimate what the impact of the imminent Moody's downgrade of the French banking system which always follows a sovereign downgrade means for embedded collateral triggers.
Key events to look forward to today via SocGen:
It's supposedly another make or break Eurogroup meeting today with regard to keeping Greece at the table and negotiations over how to put the country back on a realistic track where debt payments do not stifle future economic growth, and public finances can be sustainable within the next decade. At the heart of the latest meeting of euro creditor is a standoff between the IMF and Germany where next year's election is not inspiring a great deal of motivation to deal with Athens once and for all. What will we get today: more can kicking or a further escalation of the debt talks? It was suggested yesterday that a ‘tentative' go ahead will be given to disburse EUR44bn shortly, with payment coming on December 6th. Short-term currency volatility in EUR/USD and GBP/USD continue to get crushed and even USD/JPY has retreated from last week' high as spot stays bid. There are also other hoops for the broader market to juggle including the Middle East crisis. We caution against reading too much in yesterday's relief bounce in risk (though this time the AUD did take notice aided by IMF designate ccy reserves report), and wait to see how the market digests the France sovereign downgrade.
Full recap courtesy of DB's Jim Reid:
The main story overnight has been Moody’s downgrade of France from Aaa to Aa1 (outlook remains Negative). Their long-term growth outlook, a sustained loss of competitiveness and the uncertain fiscal outlook were cited as reasons for the downgrade. The market reaction has been fairly modest though with the EURUSD off 0.3% initially, but now trading back around pre-downgrade levels of 1.280. In the coming days, we’re likely to hear more about the follow-on impact on the ratings of the French banks (Moody’s views France as a “high support country”) and that of the still Aaa-rated EFSF and ESM. This move brings Moody’s into line with S&P after their downgrade to AA+/Neg in January this year. Post Moody’s action overnight we are left with a dwindling pool of Aaa rated sovereigns. Indeed on Moody’s scale we are left with only 9 of them in continental Europe (being Austria, Denmark, Finland, Germany, Luxembourg, Netherlands, Norway, Sweden,
French 5yr OATs are now trading at a spread of 39bps over Bunds which is a long long way off the wides of 183bps seen in November last year when each OAT auctions were nervously followed by the market and questions were raised around contagion into the core of the EU architecture. Current French govvie spreads imply a 5-year cumulative default probability of 3.3% (assuming a recovery rate of 40%) or a spread implied rating of somewhere between Baa and Ba. Overall had this downgrade occurred at a time the EFSF/ESM was being used heavily this might be more of a concern than it’s likely to be today. Markets have also got over the shock of some of the major economies of the world losing their top rating so this move probably won’t have much short-term impact. Greece, the Middle East and particularly the fiscal cliff remain the main short-term drivers.
Indeed the market's behaviour since Friday night's more conciliatory US political comments demonstrates how dominant the fiscal cliff discussions are going to be over the next few weeks. The S&P 500 rallied 1.99% yesterday and is 3.2% off the intraday lows seen during last Friday’s morning trading session. Other major asset classes have also been well supported since that point. Indeed in Europe, the CAC, DAX, and the IBEX are about +2.9%, +2.5%, +2.3% higher from the recent lows. Credit spreads have also moved sharply since then with the CDX IG and iTraxx Main 9bp and 8bp tighter. Elsewhere Copper is up +2.8% and the riskon move also corresponded with a back up in UST 10yr yields (+5.5bp) and a dip in the Dollar index (-0.55%). Even the seemingly out-of-vogue Apple shares have posted a 12.1% gain since last Friday’s intraday lows.
This large global move was all on the back of vague comments that the cross party talks were 'constructive'. Such a move on so little shows how crucial this issue is and markets could still be 5-10% either way before year end depending on the nature of these discussions. We can all have a guess as to the outcome but the reality is that no-one really knows what the politicians are going to agree (or not agree) on.
As we suggested yesterday, the newsflow on this will be light this week given Obama's SE Asia visit and Thanksgiving so markets are likely to be in more glass half full mode given Friday's little morsel of hope.
To be fair there were other positive stories yesterday with Greece and US housing helping sentiment. On the former, reports suggested that Eurozone leaders will give the tentative go ahead for a EUR44bn payment to Greece, subject to the fulfilment of “prior actions” including the creation of escrow accounts to facilitate loan payments. According to Reuters, who cite “senior Eurozone officials”, finance ministers will make the final decision to pay the next tranche to Athens on Dec. 3 after which Greece and the European Commission will sign a revised MoU on Dec. 4. If all goes according to plan, Greece will get the funds on Dec 5th, although an agreement over Greece’s debt sustainability and how to fund the country from now until 2016 remain elusive.
Turning to US housing, existing home sales rose 2.1% (vs -0.2% expected) to 4790k (from 4690k previously). The effects of Hurricane Sandy were offset by gains in non-affected regions. Meanwhile the NAHB homebuilders index rose to 46 (vs 41 expected). This is the highest level in more than six years which probably bodes well for today’s housing starts number given the strong historical correlation between the two series.
Despite the French downgrade, overnight markets are trading stronger as another strong US session provides a positive lead to Asian markets. Gains are being led by the Hang Seng (+0.76%), KOSPI (+0.66%) and Nikkei (+0.1%). The AUD lost 15 ticks initially following the RBA’s dovish minutes, but has subsequently traded up to opening levels against the greenback (1.0414). As largely expected, the BoJ announced that it will hold fire on further asset purchases for the time being.
In other headlines, the conflict between Israel and Hamas continues as both sides present ceasefire proposals that remain far apart. UN general secretary Ban ki-moon arrived in Egypt late Monday and is due to meet with the Israeli PM and Palestinian president on Tuesday (AFP). Both Brent and WTI are down 0.1% in overnight trading after adding more than 2% yesterday.
Turning to the day ahead, the Eurogroup/ECOFIN meeting in Brussels, starting at 4pm London time, will be the main focus. In the US, housing starts and building permits data for October are due. Bernanke delivers a speech at the Economic Club of New York on the housing and mortgage market and it will certainly be interesting to see if he touches on the recent actions of the Bank of Japan and his take on the impending fiscal cliff.