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In the ECB's Wake, Euro Looks Free of its Crisis-Mode Market Dynamic

In the ECB's Wake, Euro Looks Free of its Crisis-Mode Market Dynamic

2013-10-03 10:05:00
Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- Italian PM Letta retains power, but support in the Senate weakens; governance issues not solved at all.

- ECB stance very hopeful for growth and cautious about excess easing – Bundesbank influence evident.

- US government enters day 3 of shutdown with no end in sight; debt ceiling hit in 14 days.

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(vs USD)








Dow Jones FXCM Dollar Index (Ticker: USDOLLAR): 0.00% (-0.80%prior 5-days)


The Dow Jones FXCM Dollar Index continues to teeter around its September lows but no break has transpired with a Doji candle having thus far formed on the daily chart. The stabilization in the US Dollar comes as the Euro has retained its post-ECB gains, while the Japanese Yen has fallen back slightly amid a generally strong stream of data across Asia and Europe; strong growth data is a solid check against crisis fears.

The Euro now finds itself in the envious position of having a central bank that is cautiously confident in its region’s economic recovery – something the British Pound has enjoyed the past several months, allowing it to rally in absence of purported ultra-dovish Governor Mark Carney’s latest iteration of QE, and something the US Dollar has not enjoyed as evidenced by the Federal Reserve refusing to taper QE3 in September.

I had been looking for the European Central Bank to come out and make the case for another LTRO in the coming months – predicated around weak growth, soft inflation, and low excess reserve levels at banks. While all those may be true which ECB President Mario Draghi acknowledged, he outlined one stark difference between conditions now versus in late-2011 and early-2012: the Euro-Zone is no longer in a crisis.

With crisis conditions having abated, the dynamics of low excess reserve levels – essentially capital that banks have on hand – has changed and become a less critical concern. Accordingly, the ECB has pivoted to a stern “wait-and-see” mode, as it allows the region to work through the fits of weaker credit growth in the near-term as organic growth conditions continue to try and accumulate.

The caveat, of course: if another crisis arises, the ECB will act accordingly. If loan growth remains weak, but another crisis does not come into play, then the ECB might experiment with a BoE-style Funding for Lending scheme, targeted at small- and medium-sized enterprises. While the impact of the BoE’s FLS was limited in the immediate months following its installment in July 2012, it is clear that the UK business environment has improved dramatically, considering the UK service sector just had its best quarter in 16 years, and the BoE itself has officially stepped away from the QE throttle.

EURUSD 5-minute Chart: October 2 to 3, 2013 Intraday

In_the_ECBs_Wake_Euro_Looks_Free_of_its_Crisis-Mode_Market_Dynamic_body_Picture_1.png, In the ECB's Wake, Euro Looks Free of its Crisis-Mode Market Dynamic

Taking a look at European credit, the generally improved tone of the PMI reports has provoked higher yields and a stronger Euro – a rare occurrence over the past few years given the tendency for higher yields to equate to increased financial stress. But with the ECB in “wait-and-see” mode, and definitely not in a hurry to introduce another LTRO barring the uprising of another crisis, it is positive that yields have edged up in support in the Euro as it comes on improved data – something that would transpire in more ‘normal’ conditions.

The Italian 2-year note yield has increased to 1.691% (+1.3-bps) while the Spanish 2-year note yield has increased to 1.420% (+3.5-bps). Likewise, the Italian 10-year note yield has increased to 4.363% (+0.6-bps) while the Spanish 10-year note yield has increased to 4.258% (+2.0-bps); higher yields imply lower prices.

Read more: Dollar Down as Government Closes; Abe Tax Drops USD/JPY Under ¥98


In_the_ECBs_Wake_Euro_Looks_Free_of_its_Crisis-Mode_Market_Dynamic_body_x0000_i1028.png, In the ECB's Wake, Euro Looks Free of its Crisis-Mode Market Dynamic

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--- Written by Christopher Vecchio, Currency Analyst

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