Friday, 5 July 2013

Euro-Pound Sell-Off as Central Banks Vow to Keep Rates Low

Ralph Shell, Excel Analyst

Both the Bank of England and the ECB have vowed to keep rates low, hoping easy money is going to revive their moribund economies.  Since this was the first policy meeting presided over by the BOE's new superstar central banker, Mark Carney, keeping the status quo was to be expected.  The news, though, was enough to knock the GBPUSD down over 200 pips.

The EURUSD, likewise, dropped over 200 points, following ECB President Draghi's comments.  He said the lack of recovery means the ECB bank rate, a record low, 0.5%, will continue, and may even be reduced.  Today's comments by Draghi are similar to those made at his June 6th press conference.  Then, however, the market was encouraged  by his outlook.  He said:

"Euro area economic activity should stabilize and recover in the course of the year, albeit at a subdued pace."

Following these comments, the euro rallied from under 1.31 ro the top side of 1.34 for a brief trade there.  Today, the pair went the other way.  The support has disappeared at 1.30 handle.  We are now recovering after taking out the 1.29 handle.

Once again, problems in the eurozone are arising.  There are reports Greece needs write down more loans, to arrive at IMF goals.  Portugal is tired of austerity, and the government is on the verge of collapsing, and Ireland is back in a recession.  In Germany, all of these issues take back seat to Frau Merkel's election.

Rates for government borrowing have been rising, the result of Bernanke's hints of tapering.  This is putting pressure on the peripherals, especially Italy, the third largest issuer of sovereign debt.

Understanding another country's politics, always difficult, is even more so in the case of Italy.  Remember in the last election, the biggest vote getters were a comedian who was unable to hold office because of manslaughter charge from a fatal accident, and a former PM facing charges of having sex with an under-age prostitute.  The Italian situation, if the stories are true, is now getting more bizarre.

Back in 1999, when Italy was preparing to enter the euro zone, the debt load was to high to qualify according to the Maastricht Treaty.  At that time, Mario Draghi was head of the Bank of Italy.  Various derivative contracts were entered into to deceive the true debt level.  Then, in 2008, during the banking crises, they need to be rolled forward, and this cost to Italy went up.

According to Zero Hedge, quoting a story from The Financial Times: 

"Italy risks potential losses of billions of euros on derivatives contracts it restructured at the height of the eurozone crisis, according to a confidential report by the Rome Treasury that sheds more light on the financial tactics that enabled the debt-laden country to enter the euro in 1999. A 29-page report by the Treasury, obtained by the Financial Times, details Italy’s debt transactions and exposure in the first half of 2012, including the restructuring of eight derivatives contracts with foreign banks with a total notional value of €31.7bn."

Traders are in fashion, like bankers.  We both make mistakes, but, unlike bankers, we do not get promoted.  It seems to me the final chapter in this saga has yet to be written, but the possibility does exists that traders may again doubt the value - or possibly the future - of the euro.

Click EURGBP Daily Chart to Enlarge

We now suspect that, versus the USD, the euro will find resistance around the 1.30 handle, but we prefer to see today's Non Farm Payroll (NFP) before venturing into that pair. Instead take a look at selling the EURGBP.  This pair has been stuck in a narrow range for months.  The British economy is not great, but it beats most of those on the Continent.

As always, mind your money.
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