Dollar Mounts a Sharp Recovery as ECB Hope Falls Flat
The exceptional volatility for the dollar and capital markets over the previous 24 hours should have surprised no one. Anticipation of the European Central Bank’s pseudo-stimulus program fed into the market’s insatiable appetite for speculative rallies derived from government intervention. Yet, the flash of volatility that resulted from this known catalyst was not at extraordinary as the resultant lack of follow through. Despite the exceptional market reaction to the news of a massive infusion of liquidity for the European banking system, we note that the S&P 500 Index (our benchmark for risk appetite) notched volume on par with the previous trading days – in other words, surprisingly light. Volatility does not guarantee trend generation and follow through, and the volume figures on the equity benchmarks (as well as Forex futures contracts, gold, Treasury futures, etc.) remind us of that fact. Without the necessary market depth to mount a full run, we may have seen the market’s last and best potential opportunity to make a year-end drive pass us by.
For those embargoing fundamentals or financial headlines of any kind this week, we have just passed the allotment of the ECB’s Long-Term Refinancing Operation (LTRO) facility. This program was a liquidity injection aimed at preventing a credit crunch within the European banking system. Was this an effective initiative? It is easy to right off the event as a failure because the speculative markets would completely retrace the day’s risk-positive response. However, that doesn’t appreciate the dampening effects of thin liquidity (which work both ways – curbing optimism as well as pessimism). The 36-month lending tempers the immediate threat of European banks (an enormous segment of the global system) collapsing under a wave of debt maturing in the open of the New Year. In other words, they have put out an immediate fire; but they have not solved the underlying troubles. Buying time is an art – and becoming increasingly expensive.
What does this mean for the dollar? Shallow markets have prevented what could have been a more concerted effort to build up speculative positioning (a more probable scenario in reaction to this event just a few months ago). That, naturally, is a boon for the greenback – a safe haven for those seeking absolute liquidity. Furthermore, if risk trends are to temper into the close of the year; we would expect the same from the speculative antithesis. However, these are not the conditions in which to ignore the risk in the unexpected. If we were to weigh the scenarios for an unexpected surge in risk versus risk aversion, it is far easier to envision panic finding an easier footing than greed in these conditions. That being the case, we will keep an eye out for a critical European downgrade and keep track of the remarkably strong demand for Treasuries.
Euro Traders See Little Relief in Banking System, Bond Yields after LTRO
We cannot garner a fair gauge of whether the ECB’s liquidity program was ‘successful’ in these kind of market conditions. An optimistic slant would find that short-term need for refinancing for banks that have been drawing excessive yields has been answered and perhaps the financial institutions will be encouraged to lend to each other and the governments (buy government bonds). However, the pessimist would say that this yet another rescue effort (an overly concentrated one) that does not answer the underlying troubles. It isn’t hard to interpret 523 banks asking for 489 billion euros in three-year funds as a very real sign of stress. If everything is stable and calm until the markets fill out against early next year; perhaps a sense of stability can return. On the other hand, if a AAA-rated EU country or the EFSF program is downgraded; the market’s calm will certainly be disrupted. That isn’t a far-fetched concern either with the ECB still buying Italian bonds on the day of a liquidity program…
Japanese Yen Losing Stability after BoJ Hold, Shirakawa’s Warning, Downgrade
Some policy officials and exporters in Japan may feel any decline in the yen is a good one; but those with long-term scope and a feel for the money markets know that you want a controlled depreciation. Yesterday, the Bank of Japan maintained its policy bearings (including its asset purchasing and credit purchasing programs). However, with that announcement Governor Shirakawa gave voice to a true concern: the impact of a spreading European financial crisis to Japan (recall the 1980’s and 1997). And, then there was the Tokyo-based R&I’s downgrade of Japan.
British Pound Surprisingly Buoyant after BoE Signals Future Stimulus
I didn’t have high expectations for the Bank of England minutes as we know their generate lean towards wait-and-see (hoping the EU will stop the bleeding). Yet, there was something there to note: that some of the members were already starting the argument for more bond purchases early next year. The sterling has little, meaningful scheduled event risk through the rest of this wing. Watch the euro connection.
New Zealand Dollar Fails to Mount Rally on Strong 3Q GDP Showing
The New Zealand dollar has been fundamentally primed to the point that it has shown buoyancy on even the most mundane development – a benefit of a positive bearing on yield expectations when the rest of the world is cutting. However, a genuine, better-than-expected 3Q GDP reading couldn’t drive the kiwi to a meaningful run. That is the power of speculative interests. Sentiment can anchor data releases and LTROs…
Swiss Franc Ready to Extend its Decline as Country Mulls Capital Curbs
The market didn’t add much volatility to the news that some policy officials are trying to push forward an agenda of capital controls and negative interest rates – which is reasonable enough as the Parliament shot them down. Enacting rules aimed at stymieing banking interest in a banking economy is difficult to sell. However, if the Swiss want to push their currency down when the threat of mass panic is high, the bar is set high.