Ugly LTRO Has The EURO Bleeding

Many will be happy to see the back of this week. A week that has been dominated by one-way traffic that has seen most asset class prices retreat. We should be thankful to Italy, and specifically the colorful Silvio Berlusconi, for keeping the markets interested in another country’s political outcome. By Monday, the comeback ‘kid’ might yet have another successful story to tell. However, event risk pricing fears a return to a “no overall political control” scenario in that country.

So far it seems that very little is capable of stopping German business optimism. Earlier this morning the ‘single’ currency managed to garner some fledgling support after the German Ifo data (107.4) came in stronger than expected for February. Both the country’s current and future assessment component significantly improved. While most of the other members remain stuck in recessionary territory, preoccupied with structural reforms and austerity, Germany, the backbone of European businesses, continues to “surf a crest of optimism.” For the Euro-zones survival, it’s mandatory that Germany’s reason for this fundamental decoupling becomes and stays a reality. A myth and a prayer will not be capable of acting as savior for the 17-member currency.

Across the pond, a large repayment of the first LTRO facility was made at the first opportunity, providing strong EUR support, but subsequent weekly repayments have since varied. The second LTRO was bigger than the first with more counterparties involved, offering potential for another large announcement today. However, the EUR did not get that support as today’s announced LTRO repayment disappointed. The ECB announced that 356 banks next week would repay just +EUR61.1b. The market had been looking for at least +EUR120b from among the 800 banks.

Yesterday, the Bank of Canada was somewhat critical of all G-20 members in its BoC quarterly review. It noted that so far, the G-20 framework has produced mixed results in terms of policy coordination. The current setup has yet to deliver sustainable growth as the inefficient peer review process continues to under-perform. The Bank expects the G-20 members to clearly outline how fiscal, monetary, exchange rate and structural reform policies should combine to provide for “sustainable domestic demand in member economies.” The Bank went as far as recommending that the IMF could potentially take the lead on reporting policy issues relating to exchange rate adjustments. This choice could promote more transparency of exchange rate policies. It certainly would do away with some of the currency war mongering headlines that have occupied the popular press of late.

Sterling has decided to take a break after completing its two and half year low print against the ‘mighty’ dollar. The British government reporting a +GBP11.5b surplus yesterday on public finances was capable of throwing a “temporary” life preserver to the triple-dip economy’s currency. A plethora of softer data, topped by concerns that the UK will miss deficit reduction targets has the “Old Lady’s” legal tender bleeding self worth of late. The market will probably view this as a short break in a new weakening cycle.

All week financial markets have been collecting and tabulating evidence to vindicate investors move into “risk off” trading strategies. Event risk surrounding this weekend’s Italian elections has investors feeling somewhat more cautious than usual. In hindsight, this “risk-off” move is likely to prove corrective rather than something more perverse.

This week’s price action has the EUR’s seven-month strengthening trend line in danger of being broken. The forex market is trying to make an “airtight” case for the single currency to trade lower now that it has penetrated some key support levels after yesterday mornings weaker Euro-zone flash data and this morning’s disappointing LTRO report. Stops are becoming exposed on the downside the longer we continue to wade near the lows. Perhaps one should start thinking about the last few months of selling yen short? Some of these weak shorts could trigger the next downtrend cycle!

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