Friday, July 2, 2010

Some interesting developments in Europe over the last few weeks #ECB $EWG

Some interesting developments in Europe over the last few weeks

· Despite all the noise around EU sovereign problems, the pound and euro are currently at multi-week highs.  Several countries throughout Europe have outlined substantial austerity measures in recent weeks (inc. Greece, Germany, Spain, and the UK), helping allay budget worries.  There have been a ton of debt sales, inc. from some of the most at-risk EU sovereigns (like Spain today), that have been absorbed by the market.  Meanwhile, the ECB is moving forward w/the withdrawal of extraordinary monetary measures (i.e. allowing the 12-month tender to expire and letting the covered bond purchase program to end on time).  In the UK, a couple BOE officials have made hawkish comments to the press (and the recent BOE minutes surprisingly revealed that Sentence pushed for a hike during the last meeting).  The funding situation in Europe is showing some signs of improving (despite all the noise in the press to the contrary – see the below update from JPMorgan’s A Roever).  The economic data points out of Europe haven’t been missing consensus expectations (see the European PMIs out Thurs) to the same extent as ones from the US and elsewhere (although this is in part b/c expectations for Europe were never all that high).  Inflation readings for Europe remain subdued (although this isn’t necessarily the case in the UK).  The Bottom Line: budget cuts + hawkish/tightening CBs + improved funding conditions + inline eco #s = stronger euro and pound.  As both currencies continue their climbs, there has been a reversal of some carry trades occurring (this has been the case Thurs especially) – the euro had become a funding currency for some (not so much the pound) but it is now being bought back as those trades are unwound (this also explains why the yen has been so strong of late).   The weakness in gold is related to this – gold is off more than 2% and breaking under its 50day MA (for the first time since Mar).  Part of the decline is due to carry trades being unwound but also the somewhat brighter outlook for the eurozone is helping take some of the risk premium out of gold prices. 

· ECB funding update – takeaways from the 3-month, 6-day, and 12-month tenders - Taken together, these data points do not paint a picture of a banking system in funding crisis. Yes, the ECB is providing significant support mitigating what would otherwise be a liquidity crunch, but both the value of the support provided and the number of institutions using its support is falling and these are positive developments.  Add to this that the ECB's support isn't going away anytime soon, as its committed to 3 more 3m LTROs between now and the end of September, and have also agreed to keep the MRO at 1% and full-allotment through October 12 (and we suspect it will extend these if conditions warrant).  Although these data on bank usage of ECB liquidity bear close monitoring going forward, we expect the ECB's continuing support will help feed further (albeit slow) improvements in Eurozone capital markets and that the number of banks and value financed at the ECB will decline in the coming months

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