European debt crisis (II)

Tom Tong01/Nov/2011Currency Updates

Bank of Japan intervenes; Euro crashes below pre-summit levels; Ebury gloats (a bit)

It is not often that one’s contrarian views are validated by markets as swiftly as ours were today. Italian-German spreads blew out to an all-time high above 400 bp, and the Euro gave up all of the post-summit gains that had puzzled us so much last week. At the other end of the world, the Ministry of Finance also fulfilled our expectations and intervened shortly after the Yen reached all-time highs against the dollar. The currency promptly depreciated by 4%, although it drifted somewhat higher after Tokyo went home. Yes, what you hear in the background is the sound of us slapping ourselves in the back…

It looks like markets are taking an increasingly dim view of Eurocrats’ efforts to solve the crisis. In particular, consensus seems to be coming around to our view that no lasting solution is possible without massive involvement from the ECB. As long as German hard-money fixation prevails, the Euro will lurch from one crisis to the next. The next meeting of the ECB on Thursday is absolutely critical. The disastrous Trichet era will come to an end, and Mario Draghi will become the new head of the ECB. Draghi has made all the ritualistic pronouncements against looser policy that Germans demand of any candidate for the post. Though we hope that all this was for show, and Draghi is actually a dove at heart, though we have no particular reason to think so. The rate decision on Thursday and the press conference afterwards will give us much information about the future course of the ECB and hence the survival of the common currency; we expect dramatic volatility both during and after the ECB meeting, so manage your risk accordingly.

As for the Yen, we have finally discovered the pain threshold for Japan’s export-oriented economy: 75 Yen per dollar. The Swiss National Bank proved that a determined central bank can prevent its currency from appreciating beyond a certain point. The Japanese are now following their lead, and we think that a floor has been firmly established for the USD/JPY rate. However, we expect that the Euro crisis will keep risk markets on edge for a while, and the resulting flows into safe havens should prevent the Yen from depreciating significantly, thus keeping this rate anchored around current levels for a while.

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Written by Tom Tong

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