WISE MONEY

Against all the odds the single European currency has been resilient this week moving up towards the year to date highs of 1.3068, clawing back its losses and more.

The euro’s ability to defend bad news in Europe has been remarkable and its gains have reflected a speculative market that has been extremely short.

As we are light on headline data today the markets will have to observe the outcome of the somewhat positive Spanish and French debt auctions while keeping one eye on Greek debt talks with private investors.

But for yet another failure of talks in Greece the EUR should continue on a positive footing.

How long this will last is uncertain, particularly given the dangers ahead but at a time when investors have become progressively more bearish on the euro it may just extend its bounce over the short term.

One country to watch is Portugal whose bonds have underperformed recently as markets speculate that it could be the next contender for any debt note.

Back to the UK and Retail sales have come been announced close to median forecasts of +0.6% m/m and +2.6y/y.

Sales have improved in December but the improvement is likely to be short-lived, suggesting any support to the Pound will be brief.

Sterling has underperformed even against the firmer EUR of late but this is supporting better levels for the market to take long positions versus EUR.

This explains the move in relative European/US interest rate differentials, which has been linked with the move in EUR/GBP.

Overall Sterling could outperform EUR over coming months to around 0.80, with the former continuing to benefit from the simple fact that it is not in the Eurozone and has therefore acquired a quasi safe haven status.

Rising bank shares have lifted European stock markets amid hopeful economic signals, results from US banks and a report suggesting the ECB was providing more loans to banks than had been thought.Successful French and Spanish bond auctions and falling US unemployment claims also helped improve sentiment.

Bank of America and Morgan Stanley’s results were better than expected.

Commerzbank shares rose 15% after it said it would be able to increase its capital without government help. Also in Frankfurt, Deutsche Bank rose 8%.

In London, Barclays shares rose 10% while Lloyds and RBS were both up 9%.

In Paris, Societe Generale rose 13%, Credit Agricole rose 9% and BNP Paribas gained 8%.

The soaring bank shares helped Europe’s benchmark indexes to strong closes, with the FTSE 100 ending up 0.7% at 5,741 points, its highest closing level since the start of August.

The Cac 40 in Paris closed up 2% while the Dax in Frankfurt gained 1%.

Some of the gains in banking shares were sparked by a report from Morgan Stanley, which said that the European Central Bank was flooding the eurozone banking system with even more cheap loans than had previously been thought.

A fresh wave of negative sentiment swept the wise money markets caused by doubts over euro banks’ capital raising plans and Hungary’s solvency.

This led to investors selling shares in the continent’s major lenders. Italy’s biggest bank, UniCredit saw its share price fall by over 17% after it announced a heavily discounted rights issue, which valued stock at less than a third of it current price.

Over in Hungary, the yield on 10 year bonds soared to over 10% after the government failed to find enough buyers for the 45bn forints (£116 million) of sovereign bonds it was trying to sell. This combination of weakness in the Eurozone led to the single currency dropping to 15 month lows against Sterling.

This weakness in Europe was countered by positive data from both the UK and US.

The UK’s biggest sector, services ended last year on a high while America’s efforts to improve their jobs market showed signs of progress.

The US private sector added 325,000 new jobs in December and the non-farm payrolls are due out today with a rise of 150,000 jobs expected.

Overall, it has been a simple week for the markets with the euro continuing to be weak while the US Dollar remains the strongest of all as investors put their money into the global reserve currency.

The ECB is set to flood the eurozone with cheap money on 3 year loan terms.  The money will be lent at the average of the ECB’s benchmark rate- currently one percent over the period of the loan.

Basically this is free money for banks and the aim is to keep the liquidity cycle moving on to companies and households- the danger and likelihood is of course that the banks take a piece of the cake and do not share.

However the aim seems to be to sure up the banks’ capital requirements.

The euro has pushed higher against the US Dollar on speculation for this move- hitting a high of 1.3185 and yields on Spanish and Italian government bonds have dropped.

The USD which is the largest safe haven currency at the moment has also weakened on the positive news; the risk appetite currencies notably the AUD, NZD completed the cycle and gained.

Over to the UK and the Bank Of England as expected voted 9-0 to keep interest rates and Quantitative Easing unchanged in December.

Overall the MPC saw little change for growth and inflation and thus the news was largely positive for the Pound. In addition UK November public sector net borrowing data came in slightly better than expected again helping the Pound.

Looking at the markets after a crazy year we are amazingly at exactly the same levels as 12 months ago for EUR/USD and very similar on GBP/USD after much volatility in the year.

2012 will start with a heavy focus on US payroll numbers on January 6.

The US dollar has gained against the majority of its peers after confirmation came from North Korean state television that leader Kim Jong II had died of a heart attack. The US Dollar gained due to its attraction as a safe haven currency as fear is now growing that instability may arise in the region. The Yen fell against the USD as concern rose for Japan’s economy and security as destabilization of the Korean peninsula will now be a concern.

The Euro has seen no real improvement and is still floundering against the USD. This week the concern for the Euro remains that some of the regions largest economies may have their credit ratings slashed. So we have fear mode prevailing in the markets with the USD akin to gold as it soaks up demand from investors with a lack of appetite as we close the year.

The huge demand for the US Dollar as a safe haven does to a large extent dumb down the fact that the US was stripped of its AAA credit rating by S&P four months ago- maybe Europe need not worry about downgrades!

Mario Draghi the ECB president has certainly not helped ease concerns for Europe as he breached the taboo subject of discussing a Euro break up. His point in discussing was that countries who exit the euro will suffer more than if they remained.

He also sought to play down the ECB’s role in suring up the debt crisis; the financial markets are looking for a more prominent role by the ECB to effectively end the crisis and Draghi has sidestepped this potential solution consistently.

For this week, we will see final readings on third quarter growth for the US, UK and France with no changes expected. On Wednesday we have the Bank Of England minutes and the markets will be looking for more clues on further QE for the UK.

However in reality economic numbers will be of little importance this week as investors shelve risk and await the new year payroll number from the US on Jan 6.

They seem to be coming thick and fast at the moment, but there are two more risk events to watch out for today that have the potential to significantly move the currency markets. Firstly and very importantly the Swiss National Bank has just finished its monthly meeting and will keep the EUR/CHF peg steady at 1.20. There was a lot of talk that the SNB would be raising the peg to 1.25 which would have seen significant moves across the board in the Swiss Franc pairs and also the Euro pairs as happened when the central bank first introduced the peg.

The second risk event is a Spanish bond auction taking place at 9.30 this morning. The draining confidence in the Euro has seen large outflows from the single currency over the last week or so and it is very important to see if this leads to yields on Spanish bonds to increase once again.

Thankfully Britain retains its own currency, which is current market conditions seem to count for an awful lot. The UK also has a bond auction this morning but we will be looking for record lows, rather than highs when the auction is completed at 10.30.

In an interesting interview with a French newspaper the head of the Bank of France and ECB member Christian Noyer suggested it should be Britain, not France that loses its Triple-A rating.

It is almost unheard of for a central banker to speak out about another country’s credit rating let alone suggest that the markets should not accept the ratings as a valid guide to the strength of a nation’s financial health. Is Mr. Noyer priming us for an impeding French downgrade?

This afternoon there is a large amount of low importance US data due, which is unlikely to move the markets too much but important to watch out for given the Federal Reserve’s current wait and see stance.

After the blow to the euro following the Standard and Poor’s ratings news on Eurozone countries, the currency has managed to regain some form of stability ahead of the EU Summit commencing tomorrow. Hopes that the Merkozy French -German deal which was publicised on Monday will be finalised at the summit are high and the threat by S&P means that the stakes are getting higher should there be a halt in progress this week.

Apart from placing the ratings of fifteen Eurozone countries on negative watch, S&P stated that the EFSF bailout fund may be downgraded too.

The single European currency however, looks to have found form in advance of the summit and the ECB meeting tomorrow, as news of talks to structure the bailout fund into two separate forms looks to strengthen the currency.

In other news the decrease in the Royal Bank of Australia’s new cash rate applied further pressure on the Aussie.

It’s fair to say the timing of the cut was not fully expected however the Aussie drop was restricted by the somewhat neutral RBA policy report.

The announcement did not support the idea of additional easing in the months ahead coupled with the much firmer than expected Q3 GDP this suggests that markets are too dovish on Australian interest rate expectations.

The Euro has continued to fall lower against Sterling in recent times whilst teh Pound looks to have settled into a range.

Sterling sentiment has clearly deteriorated over recent weeks as reflected as the market looks to becoming increasingly short.

The Pound has not been helped with a run of particularly poor data  and yesterday’s UK house price data was no exception, indicating a fall in November house prices alongside retail sales which dropped more than expected.

We are set for an extremely busy and important week for the eurozone.The main event looks set to be the announcement of a deal on fiscal union between member states on Friday night, but what the market expects this deal to look like and what the deal actually looks like may well turn out to be two different things.

What the euro needs is further fiscal integration between members with the plan of a centralised treasury to eventually raise and distribute taxes.

What the French and Germans are likely to propose is the fiscally stronger countries get a greater say in how the weaker periphery run their economies.

Thursday sees the ECB monthly meeting, with another reduction in interest rates expected.

ECB head Mario Dragi has also hinted in a recent speech of large scale bond purchases by the bank.

The much softer tone suggests a deal on government budgets might be closer than the market thinks.

Keeping with all things Europe, we also have a large amount of data to digest this week including eurozone retail sales, German CPI and the closely watched ECB monthly report which will detail the size and scope of lending to European banks by the central bank.

Sterling continues to hold its ground versus the euro and Dollar despite the dire announcement by the Chancellor last week, who downgraded his growth projections for the UK economy.

The resulting changes to the UK outlook now mean the Government will not balance its books until 2016 at the earliest.

The reason for Sterling not pushing lower in the face of a worsening outlook is probably that it is the least bad option in the face of the continuing European problems and the potential for QE3 in the US.

That said the Bank of England looks set to announce an increase to its own asset purchase scheme on Thursday at the MPC meeting.

Governor Mervyn King was in very gloomy mood as his announcement the Banks financial stability report last week and it is likely that the BOE will take action this month rather than waiting for the New Year.

Fairly dovish comments by Bank of England officials and weak data will keep the Pound on the back foot over the short term. BoE governor King highlighted the risk of an inflation undershoot while Fisher noted that the BoE expanded QE by a minimum in October and can do more.

Yesterday’s Autumn statement was a mixed bag for the markets.

George Osborne announced two more years of austerity measures following official figures indicating that the national debt was spiralling out of control due to rising unemployment and flagging economic growth.

Fitch reacted by suggesting that the UK was now the most indebted AAA country in the world with the exception of Uncle Sam who lost their full status earlier this year.

The Greenback was dealt a blow by Fitch, the rating agency, as they changed their outlook on the US AAA long term rating to negative.

Nevertheless, Dollar reaction has been strong, with long positioning moving to multi week highs.

The Dollar could face a struggle from the rumour that the Fed is about to embark on a fresh round of QE by buying mortgage backed securities.

The strong start to the week in terms of risk appetite aided a brief Euro rally but the currency remains susceptible to event risk.

High among them the Eurogroup and Ecofin meetings this week, which will decide whether or not to approve Greece’s next loan tranche as well as EFSF leveraging options.

Development is expected to be restricted leaving the euro defenceless to a fall.

Under the spotlight today will be Italy’s sale of up to EUR 8 billion of Italian Bonds and the likelihood that the country may have to face a yield above the critical 7% threshold.

An increase in funding costs will not bode well for EUR sentiment especially following warnings by Moody’s about potential downgrades to sovereign ratings across the region.

At the time of writing there are rumours of ECB again getting involved in bond purchasing.

EUR/USD failed to follow through on gains overnight but as reflected in the IMM; speculative positioning may have some scope for further short covering given that the net EUR short position reached its highest since June 2010 last week.

Nonetheless, upside potential for EUR/USD is likely to be restricted to resistance around 1.3415.

The Italian treasury released a small positive for the global markets this morning by announcing good demand of their latest bond auction. With the Italian debt market being the most closely monitored amongst all of Europe, these comments brought some relief to the recent run of weakness in the single currency.

The euro is by no means out of the woods, but at least it is potentially the start of a period of euro stability.

This followed yesterday’s reports that the IMF is planning a €600bn package to help Italy and a credit deal for Spain could be in the pipeline.

These rumours were played down by IMF Chief Christine Lagarde who stated that “the IMF can only make loans available when a government asks for them” and as yet, Italy hasn’t.

The euro has strengthened slightly off the back of this news though we are very far away from a long term resolution so any real gains for the single currency are unlikely in the short term.

Reports out today stated that the UK will fall victim to a second recession.

The consensus, by a leading economic forecaster warned that the rise in unemployment will further damage Chancellor George Osborne’s hopes that he will be able to meet his deficit reduction target.

The figures will make grim reading for the chancellor, who will deliver his Autumn Statement today.

This is followed by more bad news for the UK recovery with millions of public sector workers walking out on strike tomorrow; a move that will cost the economy an estimated £500m.

The markets will continue to move on any more news from the struggling debt nations and on any bond auction updates from the eurozone.

The week ends with the non-farm payrolls figure from the US which is always viewed as a key indicator for how the global jobs market is performing.