Sunday, December 20, 2009

FX Briefing : Euro Losing Ground

  • Greece shatters confidence in the euro
  • Last long-term tender floods money market
  • Fed gradually moving towards exit mode

EUR-USD remains under pressure. During the course of the week, it dropped to almost 1.43, partly due to investors’ increasing concern about the credit ratings of some of the eurozone countries. High demand for the ECB’s 12-month tender could also have had an impact. Furthermore, the Fed’s statement after the FOMC meeting was relatively hawkish. And, with the end of the year approaching, increased profit-taking might also have played a part. However, at the end of the week, after the release of the ifo business climate, which showed further improvement, thus indicating a sustained economic recovery in the euro area, the euro strengthened again somewhat.

Greece has promised to take radical steps to reduce its deficit to 3% of GDP by 2013, and other EU country representatives have expressed confidence in the Greek government’s plans. Nevertheless, the markets remain sceptical. On Wednesday, S&P followed rating agency Fitch and downgraded
Greece’s long-term credit rating from A– to BBB+. Austria also stepped into the spotlight when it emerged that the bank Hypo Alpe Adria had been nationalised: there were rumours – later denied – that the financial supervisory authority had put a large Austrian bank under special observation.

On Tuesday, the ECB offered its last 12-month tender. Even though the interest rate will be linked to the ECB’s main interest rate, the total bids amounted to €96.9bn, which were allocated in full. Thus €614bn have been injected into the money market via 12-month tenders, and these funds will mature at the beginning of July at the earliest (€442bn). Given that banks’ liquidity requirements are currently estimated at just under €590bn, this liquidity supply alone would be ample. Moreover, a further €55bn from other long-term refinancing operations are also in the market, €16bn of which will mature in January and €25bn in February. And an additional €50- 60bn will be provided via the weekly tenders.
This excess liquidity in the money market is likely to remain pronounced for some months to come. However, the ECB’s latest press release stated that, given the improved conditions in financial markets, not all the liquidity measures would be needed to the same extent as in the past. Therefore, the possibility of action being taken in the coming weeks and months to mop up liquidity cannot be ruled out entirely either. The ECB governing council meeting on 14 January could reveal more.

There were basically two changes in the FOMC statement on Wednesday evening: firstly, the committee’s assessment of the economic situation was slightly more favourable again. The Fed mentioned particularly that the deterioration in the labour market was abating and that the housing market had shown some signs of improvement. Secondly, it underlined the ongoing improvement in the functioning of financial markets. That is why the statement no longer included the phrase that the Fed would “employ all available tools to promote economic growth”. Most of the special liquidity facilities will expire at the end of January, and the others at the end of March or the end of June. Thus the Fed is also gradually embarking on an exit from quantitative easing. As regards interest rate policy, however, it did reiterate its standard statement that “economic conditions are likely to warrant exceptionally low levels of the fed funds rate for an extended period”.

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