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FX Briefing - Euro: exit now after all?
FX Briefing 2 July 2010
ïƒ˜ European banks turn their backs on liquidity
ïƒ˜ Exit from quantitative easing much earlier than expected
ïƒ˜ Swiss franc and yen rallying
Euro: exit now after all?
This week started just like the last one ended: risk aversion dominated the markets. Weak economic indicators from the USA pointed to the global economy losing momentum. In addition, further widening spreads are signalling that the European debt crisis is far from over. EUR-USD therefore once again lost value, falling back to almost 1.2150.
Wednesday, however, brought a big surprise with the allotment of the ECBâ€™s three-month tender: one day prior to the maturity of the large-volume one-year tender, banks sought only â‚¬132bn. This bidding behaviour was interpreted as a sign that tension on the euro money market was much lower than had been assumed. This prompted the EUR-USD rate to rebound strongly to more than 1.25.
The Swiss franc, meanwhile, seems to know only one direction. Ever since the Swiss National Bank put deflationary fears aside and allowed the Swiss franc to appreciate, the currency has been hitting one high after another. EUR-CHF thus fell to below 1.31 this week. Only fears that the SNB might intervene again sent EUR-CHF back above 1.33 towards the end of the week. Following the change in political leadership in Japan and amid general risk aversion, the yen also continued its upward trend. Favourable economic indicators also played a role in this context: the Tankan improved much more strongly than had been expected. USD-JPY fell to 84.83 this week â€“ the lowest level seen in the last seven months.
Given that the bidding volume in the ECBâ€™s three-month tender was so low, the expiry of the one-year tender in the amount of EUR 442 billion resulted in the money market losing almost its entire liquidity buffer. Banks sought a further â‚¬111bn in the weekly tender on Thursday but this liquidity is available for a short period only. For money market players, the situation has thus changed fundamentally. Up until now, they had assumed that the announced tenders would lead to ample liquidity until the end of the year. As demand from banks is weak, liquidity might become scarce within the next few weeks already, all the more so as the ECB will continue its efforts to sterilise the government bonds purchased and the purchase programme for covered bonds has expired. All of a sudden the exit from quantitative easing is the main topic of discussion again. Money market rates and the euro have been rising accordingly.
It was also surprising that so few institutions participated in the two ECB tenders. One could conclude that the majority of banks no longer need funding support. The spread between thedeposit and the refinancing rate also makes it rather costly for the entire banking sector to hold liquidity.
The European Central Bank is likely to welcome this situation as it offers the ECB an elegant way of phasing out these emergency tools without the need to take any restrictive measures. The ECB has always stated that these operations would be of a temporary nature only. Central bank chief Trichet therefore showed little surprise and commented that from his point of view the transition had been as expected.
The market will adjust to the changed liquidity situation in the next few days. It will be interesting to hear what Trichet says on this topic during the regular ECB press conference next week. In the run-up to this conference, market participants will also be eager to see the allotment of the next weekly tender. If the European money market continues to get back to normal, this should provide further upside potential for the euro.
Even more so if US indicators were to confirm the slackening economic momentum. US labour market data published this Friday might also have some impact into next week. Apparently, employment growth has clearly lost momentum, even if we disregard the census effect. Interest hikes by the US Federal Reserve are then most likely to be postponed even further into the future.
Uwe Angenendt +49 69 718-3648
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus NÃ¤fken
+49 69 718-2688
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