Euro Undermined as Draghi
Undoes Trichet Rates
http://www.bloomberg.com/news/2011-12-12/euro-undermined-as-draghiundoing-trichet-interest-rates-removes-support.html
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By Lukanyo Mnyanda and Catarina Saraiva –
Dec 12, 2011 5:30 PM GMT+0700 Mon Dec 12 10:30:45 GMT 2011
European Central Bank President Mario Draghi
Hannelore Foerster/Bloomberg
Mario Draghi, president of the European Central Bank.
Mario Draghi, president of the European Central Bank. Photographer:
Hannelore Foerster/Bloomberg
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Dec. 12 (Bloomberg) -- Greg Gibbs, a currency strategist at Royal Bank of
Scotland Group Plc in Sydney, talks about the Australian dollar and the euro.
He speaks with John Dawson on Bloomberg Television's "On the Move Asia."
(Source: Bloomberg)
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Dec. 12 (Bloomberg) -- Russell Jones, global head of fixed-income strategy at
Westpac Banking Corp., talks about Europe's sovereign debt crisis. Germany’s
top central banker cooled speculation that the European Central Bank will
extend its role as European leaders pressed their case that a new fiscal
accord will deliver the region from its two-year-old debt crisis. Jones speaks
with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
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Dec. 12 (Bloomberg) -- Don Hanna, managing director at New York-based
hedge fund Fortress Investment Group LLC, talks about European Central
Bank monetary policy, the region's debt crisis and its implications for Asian
markets. Investors are fleeing assets denominated in the 17-nation currency
as European Union leaders fail to end concern that Italy and Spain would
succumb to a sovereign debt crisis that forced Greece, Ireland and Portugal to
seek bailouts. Hanna speaks with John Dawson on Bloomberg Television's
"First Up." (Source: Bloomberg)
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Dec. 12 (Bloomberg) -- Peter Garnry, an equity strategist at Saxo Bank A/S,
discusses the outlook for a fiscal union in Europe and his recommendation of
Hennes & Mauritz AB. He speaks from Hellerup, Denmark, with Owen Thomas
and Linzie Janis on Bloomberg Television's "Countdown." (Source: Bloomberg)
Enlarge image
President of the European Central Bank Mario Draghi
Hannelore Foerster/Bloomberg
Mario Draghi, president of the European Central Bank (ECB), reacts during a
news conference at the bank's headquarters in Frankfurt, Germany, on
Thursday, Dec. 8, 2011.
Mario Draghi, president of the European Central Bank (ECB), reacts during a
news conference at the bank's headquarters in Frankfurt, Germany, on
Thursday, Dec. 8, 2011. Photographer: Hannelore Foerster/Bloomberg
Enlarge image
President of the European Central Bank Mario Draghi
Jock Fistick/Bloomberg
Mario Draghi, president of the European Central Bank.
Mario Draghi, president of the European Central Bank. Photographer: Jock
Fistick/Bloomberg
Foreign-exchange strategists are reducing their forecasts for the euro at the
fastest pace this year as European Central Bank President Mario Draghi’s
interest- rate cuts remove one of the currency’s pillars of support.
Since Nov. 3, when Draghi began to undo the rate increases implemented
earlier this year by his predecessor, Jean-Claude Trichet, analysts have cut
end-of-2012 estimates for the euro to $1.32 from $1.40, based on the median
of 40 forecasts in a Bloomberg survey as of last week. It has weakened
versus every major currency except the Swiss franc since then, after gaining
against 12 of the 16 this year prior to that.
Investors are fleeing assets denominated in the 17-nation currency as
European Union leaders fail to end concern that Italy and Spain will succumb
to a sovereign-debt crisis that forced Greece, Ireland and Portugal to seek
bailouts. While euro bulls say sentiment is so negative that the currency has
nowhere to go but up, bears point to surveys showing the euro zone’s
economy will expand 0.5 percent next year, compared with 2.19 percent for
the U.S.
“There still has to be further monetary easing by the ECB to support growth
in the euro area for 2012 and beyond,” Ken Dickson, investment director of
currencies at Standard Life Investments in Edinburgh, which manages about
$235 billion, said in a Dec. 9 telephone interview. “There’ll be further
weakness, particularly in the first half of next year,” which may push the
currency to as low as $1.20 from $1.3386 last week, he said.
Relative Rates
For much of this year, relatively high interest rates gave international
investors an incentive to hold European fixed- income assets even as the
threat of more bailouts rose.
Trichet’s increases in April and July pushed the ECB’s main refinancing rate to
1.5 percent from 1 percent, helping drive yields on two-year German bunds to
1.31 percentage points more than U.S. Treasuries of similar maturity on May
4 from 0.2 percentage point in January. The euro appreciated as much as 16
percent in that period. Since then, the gap has shrunk to 0.09 percentage
point, and the euro has depreciated about 10 percent.
The two-year Treasury-German note spread has “been the most statistically
significant” driver of the euro-dollar exchange rate “over time,” strategists at
New York-based Citigroup Inc. said in a Dec. 9 report to clients.
Europe’s common currency fell 0.9 percent to $1.3272 at 10:25 a.m. London
time. It dropped 0.6 percent to 103.25 yen and weakened 0.2 percent against
the pound to 85.25 pence.
Europe Blueprint
European leaders unveiled a blueprint last week for a closer fiscal accord to
save the currency, adding 200 billion euros ($268 billion) to their bailout fund
and tightening rules to curb future debts. They also will start a 500 billioneuro rescue fund next year and diluted a demand that bondholders shoulder
losses in rescues.
The measures failed to spur the ECB, which has bought 207 billion euros of
sovereign bonds since May 2010 to curb a rise in borrowing costs, to commit
to purchasing more securities. Yields on Italian five-year securities jumped as
much as 65 basis points, or 0.65 percentage point on the day of the Dec. 8
ECB meeting, rising above 7 percent the next day.
“There’s an element of disappointment in that much more could have been
done,” Samarjit Shankar, a managing director for the foreign-exchange group
at Bank of New York Mellon Corp. in Boston, said in a Dec. 9 telephone
interview. “The tolerance of investors has been severely tested and there’s a
general expectation that a lot more needs to be done.”
Euro Flows
Cumulative outflows from the euro last week were twice the average in the
same period last year, according to BNY Mellon, the world’s largest custodial
bank, with more than $26 trillion in assets under administration. The firm
doesn’t provide specific figures.
Bets against the euro are at about a record high, suggesting that any positive
news may cause traders to unwind those trades, sending the currency higher,
according to Pierre Lequeux, head of currency management at Aviva
Investors.
“The market is already positioned for a collapse of the euro and therefore
there’s not much room for them to add to the existing position,” Lequeux,
whose firm manages about $420 billion, said in an interview at his office in
London on Dec. 9. The single currency may rebound to as high as $1.50 next
year, which would be “driven by a credible solution,” he said.
Hedge funds and other large speculators held a net 95,814 contracts at the
Chicago Mercantile Exchange as of Dec. 6 anticipating a drop in the euro,
from 104,302 a week earlier, according to the Washington-based Commodity
Futures Trading Commission. In May, there were 99,516 contracts wagering
on a gain.
Historical Levels
The last time there were about as many contracts betting on a decline was in
2010, just before the euro began a rise from $1.1877 in June to as high as
$1.4282 that November.
For all the concern that the euro may break up, the currency is about 11
percent above its average since being created in 1999. That’s a sign that
traders see little chance of a collapse. The currency will end March at $1.30,
the weakest quarter-end level next year, based on median quarterly estimates
of strategists surveyed by Bloomberg News.
Last week’s EU summit sets Europe on the path to a “lastingly stable euro,”
German Chancellor Angela Merkel told reporters. “The breakthrough to a
stability union has been achieved.”
Slower Growth
Growth in the euro area’s economy next year will probably slow from a
projected 1.6 percent in 2011, while U.S. expansion may accelerate in 2012
from 1.8 percent this year, according to Bloomberg surveys of economists.
Stress in Europe’s financial system, coupled with slower growth, prompted
Standard & Poor’s on Dec. 5 to say Germany and France may be stripped of
their AAA credit ratings as it put 15 euro nations on review for possible
downgrade.
A slumping economy may prompt the Frankfurt-based ECB to cut its main
refinancing rate a further 0.25 percentage point to 0.75 percent by March,
shrinking the difference between the Federal Reserve’s target rate to 0.50
percentage point, separate surveys show. The gap would be the smallest
since 2008.
Bets that the euro will drop against the dollar increased in the options market.
Traders paid 3.6 percentage points more on Dec. 9 for the right to sell the
euro against the dollar than to buy it, up from about 1.2 percentage points in
January. The so-called three-month 25-delta risk reversal rate rose 0.17
percentage point on Dec. 9 after EU leaders agreed at the summit to enforce
stricter debt and deficit limits.
Dollar Funding Costs
Dollar funding costs for European banks increased after the summit amid
concern the measures won’t be enough to stem the crisis. The three-month
cross-currency basis swap, the rate banks pay to convert euro payments into
dollars, ended last week at 122 basis points below the euro interbank offered
rate, from 117 basis points the day before. The measure reached 163 basis
points on Nov. 30.
Looser policy from the ECB “may accentuate the process and continue to
force the euro lower in due course,” Geoffrey Yu, a currency strategist at UBS
AG in London, said in a telephone interview on Dec. 8. “The market is
reaching a consensus that there aren’t going to be many upside factors for
the euro at this stage and if Draghi is thinking of further rate cuts, it just adds
to pressure on the euro.”
To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at
lmnyanda@bloomberg.net; Catarina Saraiva in New York at
asaraiva5@bloomberg.net
To contact the editors responsible for this story: Daniel Tilles at
dtilles@bloomberg.net; Dave Liedtka at dliedtka@bloomberg.net