FUNDAMENTAL OUTLOOK at 0800 GMT (EDT +0400)
USD
The Eurozone leaders are releasing a statement on their agreements after marathon talks on Thursday and so far the market looks underwhelmed. First, the treaty will be for the Eurozone alone, with theUKandHungarychoosing to stay out. In addition,Germanyappears to have blocked key points which could have rallied markets, with the issue of providing the ESM with a banking license a key point of contention. This had appeared on the initial draft but was swiftly deemed as ‘out of the question’ by the senior Eurozone sources.
In the statement itself, Eurozone leaders merely said the ESM will adhere to IMF principles and be deployed in 2012 with 15% of paid-in capital to outstanding ESM issuance, but they are still counting on the EFSF to deliver the goods for now. One area which could represent somewhat of a concession byGermany was on the PSI, which looks like will be removed from the permanent mechanism. The Greek PSI was deemed ‘unique and exceptional’.Sweden and theCzech republic said they would need to consult with their parliaments before agreeing to join the ‘fiscal stability union’, but a dual-track European Union now appears certain.
The headlines so far will probably negate any positives attained from the ECB decisions yesterday, which were already discouraging to a market which was clearly looking for renewed bond purchases. However, the ECB did introduce extraordinary measures to ring-fence the banking sector and ensure their funding and debt-rolling needs are met beyond the immediate future, which should at least provide a floor for the sector. For the market though relying on the ECB is clearly not enough and there will be hopes that more agreements can be met on the ESM itself today, but investors will not be holding their breath.
We expect the EUR to continue to slide but surely the immediate priority would be to prevent government yields from spiralling if the sense of disappointment escalates. The removal of the PSI from the ESM accords should help in this respect, but the ECB should take note that the SMP may yet need to be called upon in size, whether they like it or not. Ahead today we expect more headlines to filter through fromBrussels. Overnight Chinese CPI came in lower than expected, which would be of some relief to Emerging Markets, and today the US U. of Michigan index will be out. EURUSD traded 1.3309-1.3372 and USDJPY 77.56-77.74.
EUR
The ECB cut its benchmark refinancing rate by 25bp to 1%, in line with market expectations. Draghi disappointed markets in noting the decision was not unanimous and a 50bp cut was not discussed. We expect another 50bp to be administered next year.
The ECB will conduct two longer-term refinancing operations (LTROs) with a maturity of 36 months and the option of early repayment after one year. Extended maturity LTROs were expected by markets but the ECB’s decisions were initially perceived as very generous.
The ECB decided to discontinue for the time being, as of the maintenance period starting on 14 December 2011, the fine-tuning operations carried out on the last day of each maintenance period. Our Fixed Income Strategists note this refers to the overnight liquidity drains that are carried out by the ECB at the end of every reserve maintenance period (i.e. once per month). These were responsible for a typical spike in the EONIA fixing.
The ECB will also reduce the reserve ratio, which is currently 2%, to 1% as of the reserve maintenance period starting on 18 January 2012. As a consequence of the full allotment policy applied in the ECB’s main refinancing operations and the way banks are using this option, the system of reserve requirements is not needed to the same extent as under normal circumstances to steer money market conditions.
Finally, to increase collateral availability by (i) reducing the rating threshold for certain asset-backed securities (ABS) and (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria. These two measures will take effect as soon as the relevant legal acts have been published. These measures were a surprise to some extent, and ECB President Mario Draghi was very clear in citing bank refinancing risks up ahead as the reason for their adoption. The EBA announced EUR125bn in recapitalizations would be needed across the Eurozone.
ECB President Draghi, however, said that markets had misinterpreted his comments on ‘other measures’, which were perceived as more aggressive bond purchases. He outlined the ‘fiscal compact’, and refused to comment on the SMP itself but repeatedly called for the spirit of the Eurozone’s treaties to be respected.
Despite multiple reports of financing for the IMF via the ECB, Draghi said that the issue is legally complex, so in theory did not rule this out. However, he said that the ECB financing Eurozone countries via the IMF would violate the spirit of the treaties. This suggests the ECB is opposed to such lines, though given funding may come from national central banks (technically) because the ECB is not an IMF member, the move may yet be possible.
The ECB has put its 2012 HICP forecast at 1.5%-2.5%. Clearly this is not low enough to justify deflation expectations, which may dampen ECB enthusiasm for more cuts by the central bank. The decision to ease by 25bp was not unanimous, with differences over timing, and 50bp cuts were not discussed. German CPI is out today.
Late on Thursday Reuters reported thatGermany was going to reject some measures, such as a banking license for the ESM, and allowing it to run with the EFSF concurrently. This news directly contracted earlier draft statements which stated the exact opposite. It is clear further talks on Friday will be aimed at resolving these key outstanding issues.
After key talks on Thursday it was clear that the European Union as a whole would not be willing to sign up to a ‘fiscal stability union’. The statement came early on Friday from Eurozone heads, which pledged to keep annual structural deficits below 0.5% of GDP and put in place for ex-ante debt issuance plans.
The ESM will be deployed in July 2012 and the size of the EFSF/ESM cap of EUR500bn will be reassessed in March 2012. However, the 15% ratio of paid-in capital to ESM issuance will be maintained, and there is still no word on whether it would receive a banking license.
There are clear risks of a dual-track EU emerging as the UK and Hungary will not sign up to the deal, while Sweden and the Czech Republic have said they will need to consult with their parliaments. Talks will continue today, leaving more time for fresh initiatives but the market’s expectations have been lowered.
GBP
After summit talks David Cameron said what is on offer is not inBritain’s interests. He said this treaty will not be presented to theUKparliament, as financial services need to be protected.
The Bank of England has kept policy rates and the asset purchase target unchanged.
Trade figures and PPI are due out of theUK on Friday.
JPY
3Q GDP growth was revised down to +5.6% annualized q/q from 1st estimate of +6.0%. (Consensus; +5.2% and UBSe +5.1%). This result is slightly stronger than expected. Also, 2Q GDP was also revised down to -2.0% annualized qoq from -1.3%.
Our analysts note the main drivers for 3Q revisions were capex (-0.4% qoq from +1.1%), consumption(+0.7% qoq from +1.0%), and net export (0.6pt contribution from 0.4pt). For more details, refer to the table attached.
TECHNICAL OUTLOOK at 0800 GMT (EDT +0400)
EURUSD BEARISH Momentum is negative; support lies at 1.3259 ahead of key low at 1.3212. Resistance is at 1.3487.
USDJPY NEUTRAL Support lies at 77.01 ahead of the key low of 76.58. Resistance is at 77.86 ahead of 78.11.
GBPUSD NEUTRAL Key resistance is at 1.5780 ahead of 1.5883. Support lies at 1.5561 ahead of 1.5526.
USDCHF BULLISH Key resistance is at 0.9331; a break above which would open 0.9401 next. Support lies at 0.9112.
AUDUSD BULLISH Initial resistance is at 1.0205 ahead of 1.0380. Support lies at 0.9943.
USDCAD BEARISH As long as resistance at 1.0344 is intact, watch for a move below 1.0041 to open 0.9975.
EURCHF BULLISH Key resistance is at 1.2474; a break above which would open 1.2646. Support lies at 1.2322 ahead of 1.2226.
EURGBP BEARISH Key supports to watch are at 0.8486 and 0.8456 the 61.8% retrace of the rally from 0.8068 to 0.9084. Resistance is at 0.8620.
EURJPY BEARISH Momentum is negative; support lies at 103.01 ahead of key support at 102.49. Resistance is at 104.53.
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