EUR Shortage Follows Hot On The Heels Of Pervasive USD Lack

Earlier, we pointed out that Euribor is surging, despite continuing verbal assault by European bureaucrats that all is well, indicating that the European overnight funding market is structurally broken even as the ECB has become lender of first, last and every resort. The problem, however, is that when it comes to currency liability mismatches, nobody, not even all the central banks in the world, have enough capital to satisfy demand. Which is what seems to be happening with the EUR right now, as the EURUSD surges each day by an unprecedented 100 pips (will someone please advise when in history has the pair been ever so volatile?). Nic Lenoir explains:

We argued at length yesterday the importance of funding and liquidity as the main driver (especially in this environment) of asset prices. Like many I have partly attributed the EURUSD strength in the recent equity weakness to a partial shift from funding difficulties in USD driving the move lower in risk to the recognition of a generally weaker than thought rebound in the US economy (and as a result world economy as world demand is still very much relying on US demand). But factoring in what we discussed about USD funding yesterday and drawing a parallel with what is going on in Euribor now, we see that there is much more than a shift in perception of the US economy versus the European economy. In fact I propose that economic strength has nothing to do with this move.

The Euribor setting has been creeping up, just like the USD 3M Libor 3 months ago. FX forwards indicate that the funding situation in Europe is getting tighter. Obviously LTOR matured at the end of June, and so more difficult funding conditions do make complete sense. Then we look at EURUSD and all of sudden it's a lot easier to understand why it has been rising vertically. When EURUSD sold off (and I am a long term EURUSD bear like few are) it surprised even the most bearish investors by the pace of the move. Well similarly here, the rebound and breakout through the 1.27 resistance has shocked everybody as the move is relentless. Yesterday was key, because as we pointed out yesterday asset classes decorrelated, or at least abandoned their traditional correlations, with DXY trading weak in tandem with weak equities. But AUDUSD was lower on the day, and USDCAD was higher. It is the EUR that was strong more than the USD being weak, and perceived weakness in USD was misguided as crosses such as AUDJPY and USDCAD pointed to risk aversion. But of course: it's a Euro funding squeeze. This should not be interpreted as a traditional EURUSD rally in tandem with equity strength. In fact this currency move is a sign of distress in the system and a reminder that any withdrawal of liquidity triggers a squeeze, in the US like in Europe, because the interbank cash market is still inexistant and if the central banks abandon their role of individual lender to each entity there is no cash circulation to make up for it. Velocity = 0, and one can see it in BAC's earnings this morning indicating that loan balances contracted 2%.

From there Gold which we drew attention to yesterday has indeed triggered its bear flag and I feel that from a technical standpoint the correction could be a lot greater than people expect, especially because long Gold in EUR is a very crowded traded and a EUR shortage will squeeze out everybody. So it feels that in the end commodities and bonds did point the way forward, and equities could re-correlate to the pack by selling off here. I stand by my sell recommendation from Tuesday (flat for now but hopfully that will change quickly).

Good luck trading,