Monday, 12 September 2011

Sunrise Market Commentary

From KBC Market Research Desk - More research on www.kbc.be/dealingroom

Resignation of ECBs Stark sends shock wave through markets

The resignation of ECBs Stark caused global core bonds to soar and a sell-off on peripheral bond markets. Fears of a Greek insolvency/default or that the clash between Germany and the ECB will result in Greece leaving EMU are higher than ever.

Panic sell-off hits the single currency

Tensions on the EMU debt crisis pushed the euro below key support levels. EUR/USD dropped below 1.3837 and EUR/GBP lost the 0.8611 range bottom. This smells like euro-panic.

Sunrise Headlines
US Equities dropped sharply lower on Friday on fresh worries about the debt crisis in Europe, which even intensified after the resignation of ECBs Stark. The S&P ended 2.67% lower. This morning, also Asian shares trade sharply lower. ECB Executive Board member Juergen Stark resigned unexpectedly on Friday in conflict with the central banks policy of buying government bonds to combat the euro zones debt crisis. The ECB confirmed that the chief economist would leave for personal reasons. After weeks of market turbulence, finance ministers and central bankers from the Group of Seven industrialised nations pledged a coordinated response to the global slowdown, but offered no specific steps and differed in emphasis on Europes debt crisis. Britains banks should shield their retail operations from riskier investment banking units and boost capital levels to protect taxpayers from future crises, according to far-reaching proposals that could cost the industry 7 billion a year. The Greek government announced yesterday that it would impose a twoyear property tax to raise 2 billion this year, closing a 1.7 billion budget gap that the EU and IMF said must be resolved or they would stop making bail-out payments. Frances top banks are bracing themselves for a likely credit rating downgrade from Moodys sources close to the situation said on Saturday. Several sources said that BNP Paribas, Societe Generale and Credit Agricole were expecting an imminent decision from the rating agency, which first put them on review for a possible downgrade on June 15. Chinese inflation is still too high and the country needs to maintain its prudent monetary policy, the central bank said this morning, adding that stabilising overall price levels remains the top priority of macro economic policy. Today, the eco calendar is thin with only the Italian industrial production data. The BIS holds its bimonthly meeting and Germanys Merkel and EUs Barrosso hold crisis talks. 1

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research

Monday, 12 September 2011

Sunrise Market Commentary

Markets: Fixed Income

On Friday, global core bonds once more profited from risk aversion. German bond yields dropped by 5 to 10 bps, US ones shed about 6 bps. The market barely reacted to the speech of president Obama in which he laid down an approx. $450B plan to help the labour market and get the economy going. Market participants apparently wait to see whether the plan makes it through Congress, which is indeed a question mark after the bitter fight over the increase of the debt ceiling about six weeks ago. However, developments in the European debt crisis primed all other considerations. Besides the deteriorating situation of Greeces fiscal situation and the increasing chances that the rescue operation will fall apart, the resignation of the German ECB executive board member, Mr. Stark opened another battle field inside the EMU that looks to be disintegrating fast. The resignation of ECB Stark shows that Germany is rapidly losing faith in the EMU construction. The resignation follows a similar action of Axel Weber, the previous Bundesbank president in February; sharp critique from the current Bundesbank president, Mr. Weidmann and very critical remarks by the president of Germany, Mr. Wulff, which is very unusual. Monetary Germany doesnt accept the ECB Securities Markets Programme (SMP) by which it buys bonds of governments under pressure. The SMP was introduced last year in June when Greece was under intense market pressure. At that time, the Bundesbank and German ECB member Stark already rejected the programme. However, it was reactivated in August of this year, after Italy and Spain became the next victims of the debt crisis. Mr. Trichet knew that buying government bonds was difficult to accept for the Germans and thus dictated to Mr. Berlusconi the austerity measures Italy had to take in exchange for buying its bonds. Mr. Berlusconi bowed and announced the austerity measures after an emergency weekend meeting of his cabinet. He however backtracked on his promises later on, putting the ECB and Trichet, who in the mean time had started buying bonds in a difficult position. More recently, Italy took other measures to fill the hole in the budget. However, the episode probably hardened the position of the German monetary policymakers, who saw their objections to the programme confirmed. Indeed, the SMP blurs the line with fiscal policy and takes the heat off the governments to take measures to heal their finances. The SMP of course saddles the ECB with a credit risk that, if things go wrong, lead to losses and eventually force the ECB to go cap in the hand to the political governments for a humiliating recapitulation. To accept the euro, Germany had two big conditions that found their way into the Treaty: the no bail-out clause and the independence of the ECB (including the prohibition of the direct financing of governments). Both have now been violated, which means that many in Germany come to the conclusion that the euro project has no big value any longer. The ECB reacted with the best intentions to the debt problems and came with inventive solutions to safe the system. It argued that the SMP did fit in its mandate, as it was needed to offset problems with the transmission of its policy towards the real economy. Lowering government bond yields did make its monetary policy workable again. While one may discuss the issue and arguments for both the ECB and the German position are available, it is obvious that the ECB has stretched its mandate quite extremely and doing so against the will of the biggest and strongest country of the area was extremely risky, as recent events bore out. Last Thursday, Mr. Trichet sharply lashed out against the big countries and especially Germany by saying that they were at the origin of the current problems because they had de facto put the Stability pact out of work. Was this the trigger for Mr. Starks resignation or will we get later today the announcement that the ECB had bought last week an enormous amount of Italian and Spanish bonds?

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research

Monday, 12 September 2011

Sunrise Market Commentary

Markets were already very sceptical versus the EMU due to the debt problems and the German ECB rift will only exacerbate the scepticism. The endgame has now started in earnest (see also the Greek saga below). We suspect that capital preservation will become ever more engrained in investors behaviour. In this regard, German and its satellite bonds will continue to thrive, regardless of yield considerations. This means that the ECB will have to make an impossible choice: if it stops buying massively Spanish and Italian bonds, these countries will end up in the same situation the peripherals arrived, notably yields that are too high to carry and thus the inability to finance them in the market. If the ECB on the contrary continues buying bonds, German may pull the plug from the EMU construction. So, risks on a sore end are increasing. In Germany, chancellor Merkel might still be in the game of saving the EMU project, but she might soon find herself politically isolated. Of course, governments wont put too easily the EMU project on the line and thus a new far-reaching plan is still possible, but the window of opportunity is closing fast. Peripheral yield spreads widened on Friday as the resignation of ECB Stark caused another shock wave on financial markets. PIIGS bonds were sold en masse and intraday graphs seem to indicate that the ECB needed to intervene in Spanish and Italian bond markets to keep yields in check. In the end, German/Greek 10-year spread increased by 53 bps and the Italian, Spanish and Portuguese spread widened 23 bps. With Starks resignation, rumours that Greece would soon leave the euro zone took centre stage. Germany also keeps upping its rhetoric on the matter. German Economy Minister Roesler said that an orderly bankruptcy could no longer be ruled out; FM Schaeuble has ordered preparations to be made for a Greek bankruptcy according to Der Spiegel and a separate report suggested that the German government was readying a plan to recapitalize its banks in the event Greece did default. Over the weekend, Greek PM Papandreou made an (ultimate?) attempt to convince people that he would do whatever it takes to avoid a default and keep Greece in the euro zone. Yesterday, FM Venizelos announced that 2B extra austerity measures were approved to close this years budget shortfall. EU Rehn welcomed the steps ahead of the return of the Troika to conclude their review. The budget shortfall was more than likely the reason why the Troika suddenly interrupted their review last week but question remains whether this will convince Greeces official creditors to release the next aid tranche. Spreads will continue to increase this week on Greek insolvency fears and on the growing possibility that the clash between Germany and the ECB on the SMPprogramme (see above) will eventually push Greece out of the euro zone.

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research

Monday, 12 September 2011

Sunrise Market Commentary

Currencies:
Technicals EUR/USD Support comes in at 1.3499 (Reaction low), 1.3447 (Equality Cwave), at 1.3408 (50% Retracement 2010) and at 1.3381/75 (1st target off 1.3968/Weekly envelope). Resistance stands at 1.3622 (Reaction high), at 1.3688 (Broken daily Boll Bottom), at 1.3733/47 (Daily envelope/Weekly envelope), and at 1.3836 (STMA) and at 1.3872 (STMA). The pair is in oversold territory.

On Friday, EUR/USD extended the post-ECB decline. There was also no reason at all to change tactics. The EU policymakers dont give the impression to come closer to a comprehensive solution for the debt crisis. On the contrary. In addition, the euro had lost one of its main assets against most other majors, being (the prospect for) additional interest rate support. At Thursdays meeting, the ECB made clear that the process of normalisation of policy rates has been put on hold. In this respect, a further repositioning out of the single currency should be considered as logical. During the day, sentiment on risk even deteriorated further. EUR/USD dropped already below the key 1.3837 support before noon in Europe. Later in the session, there were rumours in the market that Mr. Stark was to leave ECB because of a conflict over the banks bond buying plan. This added to the overall uncertainty and pushed EUR/USD further south of the key 1.3837. The news of his resignation was confirmed later in the session. At the same time, there were al kinds of other rumours, even on Greece defaulting this weekend. It was difficult to assess the correctness of these rumours. However, it is clear that the tensions are mounting on all kinds of issues and that Germany is becoming ever less clement on Greece. This kind of political risk and chaos made the euro an easy victim. The single currency was heavily sold and EUR/USD closed the session at 1.3656, compared to 1.3882 on Thursday evening. Today, the calendar of eco data is thin. However, this is no precursor for a calm trading session. On the contrary. The key question is whether there is still enough political will in Germany to give further support to Greece (and to other countries). The Greek problem obviously is the most imminent one. Over the weekend, the country took additional measures to reduce its budget deficit. The question is whether they will be considered enough by its sponsors. However, the rift on the ECB bond buying programme illustrates that Germanys unease is much more profound. Germany is on collision course with a big part of the EU and some if its core institutions like the ECB. As long as there is no sign on a solution of this problem, the euro looks extremely vulnerable. In this respect, it will be interesting to see the reaction from Germany on the amount of bond buying as announced by the ECB today. There is still plenty of event risk. In this respect, markets might still be spooked by rumours on a downgrade of the Italian sovereign debt rating (from Moodys). In the same context, there is also speculation on the downgrade of the major French banks due to their exposure on Greece. This smells like an outright euro chaos. So, there is absolutely no reason to row against the euro negative tide. The sell-off might continue at a fast pace. Global context. Since the EU summit on July 21, EUR/USD held within a remarkably tight sideways trading range. The outcome of the meeting was unable to prevent further contagion on the EMU government bond markets. On the contrary, Italy came also in the fire line. In theory, this should have been a negative factor for the euro. However, markets still saw a balance of weakness between the euro and the dollar as the news flow from the US was also far from inspiring. The eco data indicated that the US might be at the brink of a double dip recession and the outcome of the US budget debate illustrated that US policymakers have no comprehensive plan to address the debt situation. S&P downgrading the US AAA-credit rating reinforced this feeling and weighed on the dollar. The Fed committing to extend an extremely accommodative policy at least until 2013 was also no help for the US currency. So, EUR/USD hovered sideways in a range roughly between 1.4050 and 1.4550 in August. However, two weeks ago, sentiment on the euro turned for the worse as the EMU debt crisis came again in the spotlights. EUR/USD started a correction off from the range top. Last week, the news flow on the euro turned further negative. At the ECB press conference, the bank indicated that it changed tactics. There is even a risk of the ECB again cutting rates in the future. This removes an important support for the euro. On Friday, EUR/USD dropped below the key 1.3837 level (12 (July low). Already for quite some time, we indicated that a break below this level might be an indication that some kind of euro panic is building. It looks that we have reached that stage now. The targets of the triple top formation (neckline 1.3968) are seen at 1.3381, at 1.3240 and at 1.2996. We wouldnt be surprised if there targets would be reached rather soon.

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research

Monday, 12 September 2011

Sunrise Market Commentary

EUR/USD: panic selling as pair drops below 1.3837 support.

Technicals EUR/GBP Support comes in at 0.8529 (Reaction low), at 0.8476/73 (Weekly envelope/76% retracement), at 0.8455 (62% retracement), at 83.85 (Irr C) and at 0.8285 (Year low). Resistance is seen at 0.8591 (Broken Boll Bottom), at 0.8632 (Daily, envelope) and at 0.8687 (STMA). The pair is slightly overbought territory.

On Friday, trading in the EUR/GBP cross rate was also driven by the euro side of the story. So, EUR/GBP to a very large extent tracked the price swings of the EUR/USD cross rate. The UK PPI data were no factor of importance for trading. The rumours/news on ECBs Stark leaving the ECB pushed EUR/GBP for a test of the key 0.8611 area. The level was extensively tested, but contrary to what happened in EUR/USD, a break of this key level didnt (yet) occur. The pair closed the session at 0.8600, compared to 0.8698 on Thursday. Today, the eco calendar in the UK is again empty. So, the EMU debt crisis will also be the dominant factor for EUR/GBP trading. In this respect, the pair dropped this morning clearly below the 0.8611 support. This is also an important event for EUR/GBP trading as it makes the technical picture negative. However, later this week, the UK eco data are interesting too. We especially watch out for the labour market data and the retails sales. A poor outcome of these series might be seen as pushing the BoE for more QE in the near future. It is not sure that this will stop the decline of EUR/GBP if the panic on the euro-zone debt crisis persists. It will be interesting to see the market reaction. .

EUR/GBP: dropping below the 0.8611

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research

Monday, 12 September 2011

Sunrise Market Commentary

Global picture. The EUR/GBP cross rate reached a new high for 2011 at 0.9083 early July, but renewed uncertainty on how European policymakers would handle the spreading of the EMU debt crisis pushed EUR/GBP to the 0.8700 area. The 21 July agreement was no big support for the single currency as contagion also hit the Italian bond market. EUR/GBP reached a correction low at 0.8643 early August. However, the key 0.8611 level stayed out of reach. The ECB buying Italian and Spanish bonds eased the tensions on the intra-EMU bond markets and the euro entered calmer waters. Regarding the UK side of the story, there is still a decent chance that the BoE will enlarge its program of asset purchases in case UK economic growth remains weak. The risk of more QE in the UK of late capped any gains of the UK currency. We had a LT EUR/GBP bullish view as we expected the BoE to keep its policy loose for a prolonged period of time while the ECB was trying to bring its policy rate to a more normal level. However, the ECB normalization process is obviously put on hold sine die and even a rate cut might again come on the agenda. This clearly changed the balance between the BoE and the ECB. The flaring up of the EMU crisis is currently pushing EUR/GBP below the key 0.8611 range bottom. This obliges us to change our strategy in this cross rate. Euro panic clearly outweighs uncertainty on more QE and on the UK currency. So, we can not but cut EUR/GBP long exposure. It might look far at this stage, but 0.8285 (year low) is the next high profile target on the charts

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research

Monday, 12 September 2011

Sunrise Market Commentary

Calendar
Monday, 12 September Japan 01:50 BSI Large All Industry (QoQ) (3Q) 01:50 BSI Large Manufacturing (QoQ) (3Q) 01:50 Tertiary Industry Index (MoM) (JUL) 01:50 Domestic CGPI (MoM) (YoY) (AUG) Italy 10:00 Industrial Production (MoM) (YoY) (JUL) Portugal 11:00 CPI EU Harmonized (MoM) (YoY) (AUG) Events Bimonthly Meeting of Bank for International Settlements 01:50 BOJ to Publish Minutes of Aug. 4-5 Board Meeting 11:00 EU General Affairs Ministers Meet in Brussels 12:00 Gemanys Merkel and ECs Barrosso hold talks on Crisis 15:30 ECB Calls for Bids in 7-Day Main Refinancing Tender 15:30 ECB Calls for Bids in 1-Month Tender 15:30 ECB Announces Bond Purchases 22:00 Fed's Fisher Speaks on Monetary Policy in Dallas Germany Bubill Auction (4B Mar2012) US 3-Yr Notes Auction ($32B) Consensus --0.2% -0.2%/2.7% 0.2% / - -Previous -22.0 -23.3 1.9% 0.2%/2.9% -0.6% / 0.2% 0.1% / 3.0%

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KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research