Recent developments in EU peripheral spreads, a long forgotten indicator, show that “convergence trade” is over and done with, as Portuguese, Spanish and Italian rates have moved stealthily higher relative to their German counterparts in recent weeks. This is a direct challenge to European Central Bank Governor Mario Draghi’s OMT confidence game, which is precisely that, as he merely said in 2012 that he would do whatever it takes without really doing anything.
The market chose to believe him and took care of things itself, but these latest developments suggest that the confidence game may be up. Yesterday’s deepening concern about the Portuguese bank Banco Espirito Santo saw Portugal’s debt in particular blowing out sharply wider. Remember that we still don’t have debt mutualisation in the EU and that the sovereign market is still extremely vulnerable should investors take flight.
This would require a quick response from the European Central Bank and raise the prospect of political wrangling again as deepening ECB action quickly becomes political. Is the “EU situation” suddenly back from the dead? I think it may be. And if so, EURJPY will be a prominent focus for high beta ways to look for further Euro weakness.
Note that the peripheral sovereign spreads had actually been widening stealthily for some time before yesterday’s blow out in the Portugal/core spread. There is still no credible answer on how Club Med will be able to draw down its unsustainable debt load.
EURJPY
EURJPY is looking to close today within the weekly Ichimoku cloud and below the range since early in the first quarter. The next major level of note will be the bottom of the cloud, which stabilises at around 132.20 in the weeks ahead. Further downside is a risk on further EU turmoil and weak risk appetite. The Kansas City Fed president Esther George waxed hawkish yesterday, saying that she sees room for a Fed rate hike already this year (http://blogs.wsj.com/economics/2014/07/10/feds-george-sees-room-for-rate-hikes-this-year/) . As if. She bravely dissented last year when she was a voting member of the Federal Open Marker Commitee. She won’t be a voter again until 2016, when perhaps she’ll be ready to take over from a Janet Yellen that has resigned in disgrace? Just a thought – in any case, these hawkish minority Fed views don’t carry much weight in the market. The Fed Funds rate future is back toward the highs of the range in the wake of the dovish minutes and despite a weekly initial jobless claims that came in near the 7-year lows (304k vs. 4-wk average around 315k). Looking ahead We’ll have more FOMC members out jawboning today, including Plosser (hawk), Evans (ultra-dove) and Lockhart (in-line with Yellen?). Of these, only Plosser is a voter. Today offers us Canada’s June employment report, the final significant data point out of Canada ahead of next Wednesday’s Bank of Canada meeting. The USDCAD rate spread was tightening recently (in the favour of the USD) until the FOMC minutes knocked it back into the middle of the recent range. But it doesn’t appear that the market is trading USDCAD based on fundamental signals like rate spread moves or falling energy prices (there’s considerable noise from the big banks of a lot of reserve manager flow, which doesn’t tend to focus on these factors as acutely and could explain why both AUD and CAD have failed to take a cue from interest rate developments in recent weeks).
So, it’s tough to draw a bead on the market’s potential reaction to this data, though I would guess that the market is more vulnerable to weak data, given the strength of CAD in recent weeks.
Upcoming Economic Calendar Highlights (all times GMT)- Spain Jun. CPI (0700)
- Canada Jun. Unemployment Rate and Net Change in Employment (1230)
- US Fed’s Plosser to Speak (1515)
- US Fed’s Lockhart and Evans to Speak on Monetary Policy (1900)
- Bundesbank’s Weidmann to Speak on Saturday and Sunday
- New Zealand Jun. Performance of Services Index (Sun 2230)