Merciless Euro Squeeze Before LTRO Comes in for Landing Next Week

Yesterday, we chomped on the treacherous hook of a weak reversal from new highs in EURUSD, suspecting that this might be a sign the Euro squeezers were ready to sit back and relax until the other side of the LTRO. But this was not to be, as the remaining minions of Euro shorts faced another onslaught of Euro buying that has taken the pair to its highest level since mid-December and taken EURJPY on a stunning rocket-ride through its 200-day moving average.

Weak JPY – oil a factor, too
The money-printing/risk-taking meme continues to see the JPY scraping bottom among the major currencies, with only 1 day of weakness yesterday (after we suggested that it was very rare for a rally to maintain this persistence, we only saw a 1 day consolidation before new impressive highs in JPY crosses today – this is an extreme event). Truly this is remarkable and I remain a bit uncomfortable with the idea that this rally can continue unless we see more signs of activity (namely, selling activity) in the bond market.  Another key here is the oil market, as Japan is totally dependent on energy imports and the declining terms of trade theme has been aggravated by the latest run-up in oil prices. Japan must buy the dollars that it purchases oil with. It is also a large LNG importer, with imports growing massively over the last year due to the shutdown of its nuclear reactors.

JPY cross rallies have a tendency to end rather abruptly, as you can see from a quick consultation of the charts, though the current one will likely continue as long as bond markets remain quiet (or even if yields head higher) and as long as risk appetite remains primed for further gains and oil continues higher (the latter two are going to have a very hard time coexisting from here). The next test for JPY crosses is next Tuesday’s LTRO as this is the next main event risk for the QE theme.

Italian Consumers on Strike
The December Italian retail sales data was the weakest in years, registering a steep -1.1% drop for the month. One can hope that the situation will ease there since Italian bond yields have dropped sharply again and the market has withdrawn from panic mode, but remember the chronic risks to the economy from austerity in the pipeline – and petrol prices are guaranteeing that consumers will feel even more pinched in January and this month at minimum, as the price for crude oil expressed in Euro’s has reached a record high this week.

Chart: Italy Retail Sales
Here we showed Italy’s retail sales, indexed to 100 as of 31 January 2001. The latest data shows that sales have actually declined to approximately the same level they were 10 years ago. Spain sports a similar retail activity picture and must cut a third or more of its budget – far more than Italy – and has youth unemployment of above 50% by some measures.
NOK on a run
NOK is not making like its relatively weak commodity currency brethren as it continues to storm stronger versus the other major currencies. EURNOK looks to close today below 7.50, which would be the first time it has done so sinze 2003. Clearly a couple of things benefiting NOK here: relatively strong Euro Zone numbers of late and a stronger Euro are a big help vs. non-European currencies, while NOK has also benefitted from the highest oil prices (in Euro) ever.

Looking ahead
Our broken record outlook for the coming days is that the announcement and size of the 3-year LTRO next Monday/Tuesday will be the next key event risk in this QE-obsessed market. It’s interesting to note that we are almost precisely back to the level that EURUSD was trading when the ECB first announced the 3-year LTRO deals back at its December 8 meeting. Back then, we must recall that the worst panic surrounding Euro Zone sovereign debt levels had only just begun fading, while now we have had several weeks with plenty of Greek headlines, but with no real expression of worries that systemic risk is about to descend on the Euro Zone and its banking system. So since the LTRO is coming when markets are already complacent, it is unlikely to add to the complacency and may actually trigger the next round of concern (“concern” in this bizarre world meaning “lack of overzealous money printing”). In any case, the LTRO represents de facto liquidity being released into the European banking system and is therefore a Euro version of QE. EURUSD looks very expensive already, but who’s to say that it can’t squeeze higher still from here until the other side of the initial reaction to the LTRO?