WISE MONEY

The euro enjoyed its first strong day of 2012 yesterday with signs that some confidence could be returning to the single currency. One of the main topics of discussion at the moment is the ongoing Greek debt deal.

Negotiations had taken a turn for the worse over the weekend after the authorities asked investors to accept new bonds yielding 3.5% rather than the previously agreed 4%.

The Greek government had hoped to complete talks by Monday, but as yet, no agreement has been made.

However, Greek finance minster Evangelos Venizelos said progress was being made and this was one of the main reasons for the euro strength.

He has now set a new date of 1st February to conclude talks.

Although these comments have improved the confidence level of a deal being agreed, until any deal is signed, expect the euro to remain weak as the threat of a default is still alive.

The Bank of Japan kept their interest rates fixed at 0.1% as the bank noted that the Japanese recovery is moving slower than expected.

The strong Yen remains a problem for the economy with corporate revenues likely to be down as a consequence.

The ongoing debt problems in the eurozone remain the biggest risk to the Japanese economy.

Sterling has remained in the middle against its major rivals as the euro strengthened against both the Dollar and the Pound dragging Cable higher with it.

The main news out this week for the UK is the release of 4th Quarter GDP with a -0.1% figure expected.

This significant change in momentum has been priced into the value of the Pound though it will be a massive blow to the global recovery and could be the first of many negative GDP figures from around the World as a second recession starts to bite.

The volatility that ended 2011 has yet to return the markets with Sterling, Euro and the US Dollar all remaining relatively stable against each other. This may start to change with tomorrow’s central bank interest rates announcements.

Both the Bank of England and European Central Bank are expected to keep rates unchanged at 0.5% and 1% respectively, but the press conference with the newly appointed chief of the ECB, Mario Draghi will be closely monitored.

Any comments about the economic conditions and the ongoing debt crisis in the Eurozone will have a large impact on where the markets move next so no pressure Mr Draghi!

More pressure was piled on the sovereign debt predicament a number of European countries continue to be on many of the credit agencies “negative watch”.

Fitch announced that it is likely to slash Italy’s credit rating at the end of January, which will make it even harder and more costly for the struggling nation to borrow funds.

Spain, Belgium, Ireland, Slovenia and Cyprus are also on the list as the credit agencies remain eagle eyed on how conditions change.

With much of the focus on the Europe and its single currency, expect the US Dollar and commodity currencies like the Canadian, Australian and New Zealand Dollars to remain strong as investors look for safer havens to keep their money during these worrying times.

Further euro weakness could also be on the cards if negative comments are realised on Thursday.

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.

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.

The euro continues to underperform especially against the US Dollar and the Japanese Yen- where it hit a two month low. There is a growing concern that rating agencies will downgrade European sovereigns in the near term.

In addition the lack of a clear plan moving forward from the EU summit is denting confidence in the single currency.

The market was also fearful in advance of this morning’s bond auctions from euro sovereigns- it is understood that appetite was ok but there was rumours of a little help from the ECB.

Asian stocks have also declined in line with the growing concern for Europe.

The key level for EUR/USD is the 1.31 barrier- a move below this level could open the door for a push under 1.30; this would help GBP/EUR push towards the key 1.20 level.

Data from the UK was largely ignored with UK CPI coming in for November at + 0.2%, that is + 4.8% year on year- this was largely in line with expectations.

Following last week’s isolation from Europe- so far the Pound has reacted positively.

The Pound could actually perform better moving forward; last week we saw the European Central Bank cut interest rates again and we now have the threat of downgrades for European sovereigns.

One aspect the UK government has managed is to be clear in their strategy to the markets- the austerity plans for the UK have been very clear for some time and this has helped to sure up the UK’s AAA status.

It may transpire of course that enforced austerity was the wrong call but for the markets the UK has embarked on a course of action with clarity.

In the eurozone it has been a prolonged mess and we are still no nearer to seeing a full solution- this could spell further problems for the Euro and as a result the Pound could shine.

The UK markets are AAA, have high liquidity and recently bond yields have fallen indicating more demand as a safer shore.  In the unlikely event that the Bank of England ceased their QE programme, then the Pound could come to life.

In light of further warnings by S&P the ratings agency on the possibility of downgrades to a whole host of European banks as well as the triple-A rating of France and Germany, the wise money markets are beginning to ask if the rating agencies actually matter any more. Why are they six months late to the party?

The market has been asking questions about the health of European banks for long enough for it to be widely accepted, even by the general public.

John Heimann, former vice chairman of Merrill Lynch, suggests the function of the rating agencies is to “visit the field at the end of the battle and shoot the wounded”.

Let’s hope the market shrugs of the news as quickly as the announcement earlier in the week and moves onto the more pressing matters of an ECB interest rate decision today and the announcement tomorrow over further fiscal integration of the eurozone.

Regarding the latter there was fierce debate in the House of Commons yesterday over how any treaty changes would impact on the British economy with several Tory’s including the Mayor of London calling for a referendum on the matter.

The two day meeting has not started but Britain has already been told off by Jean-Claude Juncker, head of the group of euro nations.

He was quoted as saying he does not want the UK setting aside entire pages to say the UK will not do what the others have to do.

Sterling remains relatively unchanged as a storm blows around it, but that may change against both the Dollar and Euro if the ECB, as expected, cut interest rates again.

The Bank of England is certain to keep rates unchanged but may increase the size of the asset purchase scheme (QE) in reaction to the slowdown in the British Economy.

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 US Dollar continues to benefit from a growing ‘risk off’ attitude developing in the markets. Furthermore, the recent improvement in US data, including October’s existing home sales yesterday reduced pressure on the Fed for additional QE, which in turn supported the Dollar.

We have an opportunity to see the Fed’s latest view on this subject during the FOMC minutes later this week, with the Fed set to keep the option open.

Despite the lack of union within the US Super committee to slash the US budget deficit by $1.2 trillion, this has not hurt the Greenback’s improvement as these talks were always expected to be difficult.

Further Dollar gains are possible but the speed of its upside move could slow.

Meanwhile Eurozone sentiment has deteriorated again, EUR/USD is holding onto the key mid-level of 1.35 in spite of several flirtations below here.

This is largely attributed to ECB bond purchasing which helped reduce some negativity on the single European currency however there are suggestions that the central bank has imposed a limit of EUR 20 billion on such purchases.

The Euro is not being helped by the continued rumours of a potential Euro break up regardless of the Greek PM Papademos downplaying the talk of a Greek exit.

Finally Sterling has become a problem child for the markets with the currency on track to test the October low of 1.5272.

The Pound will struggle to find support this week, with a potential dovish tone in the latest monetary policy committee (MPC) minutes likely to cause additional harm, with support from the MPC for more QE set to be exposed.

Ahead of the minutes, today we saw UK public sector net borrowing, excluding financial interventions, falling to £6.5bn in October.

The figure was down from £7.7 billion last year according to the ONS and slightly lower than expected, as growth tax revenue outpaced spending.

Sterling currently trades at 1.5656 against the Greenback and has also lost ground against the struggling Euro at 1.1560.

The UK’s monthly inflation report brought another set of disappointing expectations for Britain’s outlook over the next 3 years. Inflation is expected to fall rapidly in 2012 before dropping below the target rate of 2% in 2013 and 2014.

The report goes on to say the Bank predicts sluggish growth of around 1% for next year with the slump lingering into 2013.

Based on these forecasts and the Monetary Policy Committee’s dovish view, the forecast is for £50 billion more of quantitative easing in early 2012 and a further £25 billion towards the middle of the year.

This is on-top of the extra £75 billion extension to the asset buying programme.

BoE government Sir Mervyn King warned “We have been going through extraordinary times and in such circumstances, there are limits to what domestic monetary policy can achieve”. All in all, a pretty dim look going forward for the UK.

We also had the UK’s Retail Sales figure for the previous month released today showing a 0.6% increase MoM.

This had very little effect on Sterling as the markets are continuing to move on the bigger issue surrounding the European debt crisis.

The euro has remained weak on the back of this while the Greenback has continued to strengthen as investors look for a safer place for their money.

Bank of England governor Mervyn King was in a gloomy mood last night as he addressed an Institute of Directors meeting in Liverpool. Justifying the BOE’s recent resumption of Quantitative Easing (QE), he warned that Britain’s economic recovery had been destabilised by events in the eurozone and urged European leaders to urgently recapitalise the banking system to restore market confidence.

He also took aim at surplus countries – read Germany and China – suggesting those countries running large positive trade balances need to share the responsibility of getting out the current mess by expanding domestic demand and letting deficit countries increase exports and service debt repayments.

This is not the first time that the Gov has wagged a disapproving finger in the direction of Germany and China, but combined with his gloomy outlook and yesterday’s inflation figure the whole situation looks fairly grim and Sterling remains under pressure this morning against both the Euro and US Dollar.

Several high profile businesses in the US either reported losses or missed profit estimates and this is weighing on sentiment.

Corporate profitability has been a beacon in a sea of gloom over the past few years and any sign of margins beginning to fall will be extremely negative for equity markets and risk assets like Sterling and the commodity currencies.

Reports continue to be rife about the size of the EFSF, with reports yesterday evening suggesting €2 trillion is the figure that has been decided on, news which has lifted the Euro across the board overnight.

But it still remains utter speculation, some think the number will be deliberately exaggerated to grab headlines, but given that this remains in large part a physiological battle between politicians and the markets, the larger the better in our opinion.