With the U.K. markets back online today after a holiday long weekend, playing catch-up is the order of the day. European credit markets are trading firmer this morning despite the non-rapturous applause in Asia that saw the Nikkei, Shanghai Composite Index, and Hang Seng Index close in the red after some quick profit-taking on the back of a strong rally over the past few weeks.
When it comes to forex trading these days everyone should know the rules by now: the central banks dictate market direction. Last week’s Economic Symposium in Jackson Hole, Wyo., will be regarded as a watershed moment for the eurozone’s survival. Despite Federal Reserve Chair Janet Yellen’s “neutral or less dovish” tone, it was “super” Mario Draghi’s assertion that the European Central Bank (ECB) stands ready to act again that has quickened the pulse of capital markets. Specifically, it was the ECB chief’s comment that plans for initiating asset-backed securities buying are moving forward quickly — potentially shifting the mix of the ECB’s austerity-driven plan to quantitative easing (QE). Draghi’s sense of conviction has incited many to call for the introduction of QE at the ECB’s next meet in September, and it’s the main reason for the ongoing current credit tightening after the indices were more or less closed in-line with the U.K.’s timeout.
Banker Chatter Reverberates
Smooth-talking central bankers have managed to reverse the hefty U.S. August correction in the markets, especially equities. Stock records continue to fall (S&P’s mythical 2,000 print, the Dow knocking on record highs), while U.S. 10’s rally to +2.37%. In Europe, the moves have been more pronounced. Draghi’s QE battle cry will naturally favor equities and bonds, and hopefully in the longer term manage to keep the EUR (€1.3199) on its knees in aiding regional growth prospects. It’s natural that a dovish shift in tone by any central bank official probably justifies some market optimism; nevertheless, it’s also important not to get too far ahead, especially in reference to the ECB’s QE idea. Structurally, the ECB is nowhere near ready for it to be introduced, and such plans are usually heavily data dependent. Before Europe can achieve its utopia, various positional squeezes will occur.
Positional Plays Influenced by Month-End
Draghi’s dovish comments on inflation, weak German Ifo data, and eurozone yields trading at record lows (10-year Bunds at +0.94%) will favor the EUR and maintain its allure as a funding currency. Nevertheless, the market’s weaker EUR short positions will be squeezed and eventually forced to exit from time-to-time; the single unit’s demise is not exactly linear. It’s been reported that influential reserve names continue to want to fade any EUR/USD upticks (€1.3225-35). The recent month-end dynamics (spot day this Friday) has seen U.S. corporations being better USD buyers to close out the month. The mighty buck seems to be consolidating some of its post-Jackson Hole pow-wow gains ahead of the release of U.S. Durable Goods Orders this morning. Even the techies note that the dollar may have drifted into ‘overbought’ territory — a possible reason for the lack of movement. Mind you, the appearance of a plethora of option barriers usually handcuffs a market until they come off.
The significant rate divergence rhetoric, coupled with U.S.-German two-year spreads climbing (+2bp to a new +54.5bp high) has encouraged the growth of EUR short positions on the international monetary market. Intraday sellers continue to be camped on the topside with €1.3245 providing strong resistance while €1.3150 barriers remain the focus for the next support. Some real-money buyers remain attracted to this area. However, EUR bears remain very much in control of the broader tone.
Follow the Yield Interest
It’s not a surprise to see U.K. gilts open sharply higher — they need to play catch-up after yesterday’s summer bank holiday. The whiff of implementing QE by the ECB will favor U.K. debt products and the pound (both a yield grab). Despite data and events remaining thin on the ground, the market will be looking for any evidence to favor owning sterling over euros. Sterling’s bounce from Monday’s five-month low (£1.6542) is threatening to force a break above the psychological £1.66 handle. A momentum breakthrough at this level certainly opens the way for further gains to £1.6635-50. Nevertheless, without sustainable harder evidence, Monday’s low will remain vulnerable.
Light buying from international and domestic interest continues to power the bid in the eurozone’s peripheral debt markets. Supporting the QE story is the significant outperformance of Spanish bonds over Italian bonds. The Bund-Italian spread has tightened -4bp to Bunds, which suggests that intraday dealers are bidding the market up as they grab the most liquid of instruments. Spanish bonds are doing even better: the 10-year benchmark to Bunds are -5bp tighter, probably reflecting investors’ greater comfort level for Spanish debt, and the fact that Italy does have midweek supply to contend with. Investors are factoring in ECB QE pricing. Now, all they need is the EUR to comply.