Tuesday, July 27, 2010

EUR - a turd no more?

As regular readers will know, Team Macro Man fully subscribes to the view that the obvious trade is more often, than not, the right trade. And for TMM, at least, it is seeming increasingly likely that the mighty (or not so mighty) EURUSD grinds higher over the course of the summer. If the EU Stress Tests were not a real stress test of the EU banking system, the past seven months have certainly been a stress test for the Euro itself, becoming the instrument du jour for expressing bearish views about Europe, after the headless chickens in Brussels powers that be decided to ban shorting of just about everything else. We have had the whole framework of the Eurozone called into question, and while policymakers were late to the party (though perhaps not as late as Hank & Ben in 2008), somehow, against all the odds they seem to have pulled it off... at least in the near term. And while TMM's concerns over the medium term remain, they are struggling to think of reasons why the short-squeeze in Eurozone assets cannot continue over the coming months.

Taking stock, the Eurozone now has a Sovereign safety net - in the form of the EFSF, it has managed to negotiate the July debt issuance "hump" without any problems (hell, even Greece managed to sell some T-Bills to foreigners...), it seems to have either fooled or calmed market concerns about bank solvency - at least, judging by the reaction in EU bank CDS and Equity prices (see chart below; white - EuroStoxx Bank Index, orange - EU Senior Financial CDS Index), and the implementation of fiscal austerity programmes across Europe have helped to calm market concerns about sovereign solvency - Greece's progress both in halving its budget deficit and moving into current account surplus is a notable example of these measures beginning to show signs of success.

As the analyst community pointed out yesterday, with the Stress Tests out of the way, and transparency in terms of exposures (if not realism about actual capital requirements) now available, markets will move to focus on the macroeconomic conditions going forward as these will drive loan losses and thus contingent capital calls upon the Sovereigns. TMM is very sympathetic to the argument that should the Eurozone economy begin to show serious signs of slowing down that a feedback mechanism between Sovereigns and banks will be ignited, and in such a scenario it is likely that the Euro gets trashed (along with a few other things, not to mention Sarko's re-election prospects). But for the time being, at least, as we pointed out yesterday, the European growth picture is looking reasonably good, as Germany & France have picked up the growth baton. Now TMM expect the data in Europe to eventually roll-over (as a lagged response to the US slowdown and fiscal tightening), but this is not likely to occur for at least a couple of month, and in the meantime the divergence of EU and US data surprises (see chart below; orange - US economic data surprise index, white line - EU economic surprise) is merely a tailwind for the Euro.

Team Macro Man have a long-held theory that the best trades arise when three conditions are met: (i) changing fundamental newsflow, (ii) valuations are attractive, and (iii) momentum/technicals are aligned. And here it definitely looks as though the newsflow has changed for the better and, although on long-term metrics such as REER (see chart below), EURUSD is pretty much fairly valued...

... on a shorter-term financial asset-based model (see chart below) based upon 2yr Interest Rate Swap spreads and the EMU Eonia-UST OIS Asset Swap Spread (which provides a Sovereign-credit input), the Euro looks as though it has a lot of room to rally......as it does based upon the ratio of European Bank to US Bank equity prices (hat tip to TMM's mate RightField):Finally, in terms of momentum/technicals, EURUSD seems to have comfortably broken its 100day moving average and punters, in general, still seem to be pretty sceptical of its 9% rally from the June lows.

Now TMM thinks this turd is just as smelly as it was back then, but surely the obvious trade is for it to grind higher over the dull summer months...


Charles Butler said...

The issue never was principally the state of eurozone banks or even states, anyway. It was the perceived structural inability of the EU/ECB, and various member countries, to do anything about the situation - even from people who should know that most everything here works in spite of, not in accordance with, the veneer of written rules.

Exactly how wrong was that take!

Result? Three years of unremitting nonsense from the anglo press.

Bob_in_MA said...

Michael Pettis, among others, has predicted that the U.S. will bear the brunt of the current slowdown because we are the importer of last resort. So, Germany and northern Europe will be insulated from the fall in consumption in the south, by increasing exports out of the Eurozone.

The surprise indices are interesting, but I wouldn't read too much into the high level of Europe's. Look where the U.S. index was in August 2008. ;-)

cpmppi said...

Yes, it always comes down to policymakers - same story in the US/UK in 2008, but they (well, Paulson...) had already unleashed a new shock (Lehman) before they actually came up with a policy response that was sufficient to draw a line.

Yes that is a reasonable view, though I have seen some evidence recently of rebalancing in Germany (in terms of domestic demand) - the current account surplus contracted sharply last month, with imports the main driver, and the orders components of the surveys seem to suggest that domestic orders vs export orders are at decade highs...

Regarding the surprise indices, yes, like everything they are but one tool in the box. However, to be fair, I seem to remember things were looking pretty good in Aug 2008 - it was only after the FRE/FNM seizures and Lehman bankruptcy that these cratered.


MKGI said...

The one mystery to me is Greek bonds. If all is (sort of) well again in the Euro area, why is the Greek curve pretty much flat at 10% from 2s to 10s? Perhaps an unhedged cash buy of a Greek two year could be a nice way to go a little long EUR?

FX said...


Personally I think we've missed the boat, who really thought ECB was going to sterilize,coinciding with USD growth diff re-adjustment, in a big way, obviously in Fxland.

Our third team in the second-half aren't missing this opportunity either, that gives me more confidence when it starts to top(intraday,not long now) to double up short, why?, well their form speaks for it self , doesn't,

Everything they touch turns to shit.