Two days ago we highlighted [6] the growing divergence between Italian sovereign credit spreads (tightening) improving while EURUSD was deteriorating rapidly - suggesting (for those with deep pockets) an interesting convergence trade. It seems that whatever message the FX traders are hearing is being ignored by equities too now as today US equities diverged even more dramatically joining the rest of risk assets in their divergence from strong USD, weak EUR flows. It seems risk assets broadly are pricing in 'an event' and then thinking ahead to the subsequent 'intervention' that will inevitably float all boats. However, what is clear, in our view from the EURUSD price action, is that unlike many who expect the Fed to save the day, EUR weakness implies some form of monetization by the ECB (or reduces the market's implied expectation for Fed QE3/4). Given tonight's weak equity futures performance (ES -7pts from late highs), we suspect the FX market has it right and momos are over-thinking the reaction impulse function as a given - or more clearly - if Greece exits and no other risk-assets drop (having already anticipated the central bank reaction), will the central bank reaction come?
[7]
Either equities and Italian Bonds have it right and EURUSD should be more like 1.28 (with the ensuing short-squeeze causing chaos in currency futures); or the S&P 500 should be under 1300 and Italian Bond Spreads over 60bps wider at 480bps?
We can't help but think the latter seems more reasonable here - whether as a path or the end-point given the event risk potential.
It does seem that the other large and majority professional market for swaps is following EURUSD's path lower also (though interestingly implies a EURUSD level similar to US equities aroudn 1.2700) while the more manipulated peripheral bond market and algo-driven chaos that is ES are pushing higher on hope...
[8]
Chart: Bloomberg