EUR Bucks Rate Message, Waits for ECJ

Currently, there are many moving parts in capital markets that have investors bracing themselves for an extended clear out at a moment’s notice. The knock-on effect throughout the various asset classes from plummeting crude prices has global bourses seeing red, bond yields printing new lows, and commodity currencies experiencing some of the worst runs against the U.S. dollar in a number of years.

The renewed weakness in the price of oil, and subsequent lower equity prices combined with inflation expectations, is pushing U.S. Treasury yields even lower and back toward frontend price levels seen 18-months ago. The U.S. benchmark 10-year yield is again trading near the mid-October “flash” crash yield of +1.865% despite a plethora of upcoming new issues. The U.S. Treasury is scheduled to sell +21B of U.S. 10’s this afternoon.

Loonie Sees Red after Oil Plummets

The break below $45bbl for West Texas Intermediate crude has hit the currencies of oil-producing nations hard throughout the Asian session overnight and the European session this morning. Canada’s loonie, as the one dollar coin is known, has managed to post new five-year highs ($1.1987), while USD/NOK ($7.77), and USD/RUB ($65.55) have been able to reverse recent downticks and are now looking to be heading toward their own recent highs. For the CAD in particular, U.S. dollar stop-losses above $1.2000 are believed to be large and dealers expect the inevitable. Any further drop in oil (today it’s already down -2.7%) is expected to feed into linked currencies. Option traders are already reporting good demand for strikes above $1.25 and $1.30. A sustainable follow through was last witnessed in 2008. There is no key Canadian data on the horizon to provide the CAD with any support. Next up is manufacturing sales on January 20 and Canadian consumer-price index (CPI) data three days later. The “black stuff” remains the loonie’s biggest influencer near term. After last Friday’s disappointing employment numbers, the USD pullback has been rather limited. Until market dynamics change, this will remain the current game plan.

EUR/USD Still Bucking Message from Rates Market

The 19-member single unit continues to trade within an arm’s length of the overnight lows (€1.1800) despite U.S./German spreads shifting further in favor of a EUR rebound. The rates market indicates that both the two- and 10-year Treasury/Bund spread has narrowed a further 2bps from the European open and 5pbs from last Friday’s nonfarm payrolls survey. A narrowing of spreads would suggest an uptick in the level of support for the EUR. The two spreads have managed to compress 18bps and 26bps, respectively, since late December. Nevertheless, it seems that speculators wish to continue to ignore the rates market and bet on expectations for a January 22 European Central Bank (ECB) quantitative easing (QE) announcement. The shift in thinking seems to also favor selling EUR strength rather than adding to current EUR short positions on any break lower.

Do not be surprised to see the EUR continue to hover around the €1.18 handle ahead of tomorrow’s European Court of Justice non-binding advice on the ECB’s Outright Monetary Transaction (OMT) program. The Advocate General is due to rule on Germany’s challenge of the ECB’s more limited OMT program, which questions if the ECB has the mandate to buy sovereign bonds of eurozone countries. The most import question is whether the ECB would have a priority over other creditors in the event of a default. Germany argues that that if the ECB does not and its bond holding can be written down, it would be an illegal act of monetary financing. What investors only need to worry about is that if the court sides with Germany, ECB President Mario Draghi and company will have a much harder time delivering an effective QE program. This particular outcome could instigate a rather nasty snap price reaction from the EUR.

A Tale of opposite Central Banks

Sweden’s December CPI came in much hotter than expected this morning, but is unlikely to sway the Riksbank from again lowering its rate path outlook. It fell -0.3% on the year, which was smaller than the -0.5% drop expected. The main support came from ticket prices for foreign flights. This component happened to boost CPI, month-over-month, by +0.1% more than expected. The headline surprise managed to give the SEK a boost. USD/SEK plummeted from $8.0890 to $7.9734, while EUR/SEK tumbles from €9.57 to €9.48 and NOK/SEK from 1.0425 to 1.0340. The December reading should now be capable of reducing the probability that the central bank will implement unconventional measures at next month’s monetary policy meeting.

In contrast, the U.K. economy experienced the slowest annual growth in consumer prices in 10 years. The U.K. December joint-CPI reading was the lowest since comparable records began in 1989, with the annual rate of inflation falling to +0.5% from +1% in the previous month. The usual suspects provided the lower price pressures: a drop in food prices coupled with the plummeting price of oil. The decline marks the first time that annual inflation has been more than 100bps below the Bank of England’s (BoE) +2% inflation target. The dramatic shift now requires Governor Mark Carney to write a letter to Chancellor of the Exchequer George Osborne explaining the reasons for the fall, and how U.K. policymakers intend to lift inflation back to target. The letter will be published on February 18 along with the bank’s Monetary Policy Committee minutes.

The weak inflation headline has managed to see GBP extend its declines (£1.5076 — a six-month low). Nevertheless, low inflation experienced by the U.K. is different to that in mainland Europe. In the eurozone, falling prices are a symptom of a struggling economy; sluggish prices in the U.K. are driven mostly by cheaper oil and food. This would suggest that low inflation could actually boost the British economy (far quicker than the eurozone’s), as households get an increase in their discretionary incomes. This is certainly what Prime Minister David Cameron should be focusing on ahead of the U.K. general election in May. Even Carney and company expect the current weaker inflation spell to prove transitory, and have signaled that they still expect to raise interest rates rather than further QE. The fixed-income market sees the BoE raising interest rates later this year or in the first quarter of 2016.

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