Turbulent week as Draghi makes a stumbling start to tenure by cutting ECB rates whilst the EU ponders a Greek exit from the Euro and US jobs data is mixed

Tom Tong07/Nov/2011Currency Updates

Greece announced late Monday that it would call a referendum on the bailout package. This appears to be a sign that the Greek austerity drive is falling apart. Work stoppages and demonstrations are now part of the habitual Greek scene, and the ruling PASOK party is one or two defections away from losing its majority in parliament, threatening the viability of the Government in Friday’s vote of confidence. The chief of staff of the armed forces has been sacked, left and right are uniting in demanding a snap election in which the ruling party would surely be trounced. It appears that reality is going to catch up with European ineptness even sooner than we expected.

Meanwhile, the steep economic price tag for the ECBs refusal to take the crisis seriously is becoming clearer by the day. To the dismal news out of Spain and Italy last week, we can now add the UK, Chinese and US PMI indices of manufacturing confidence, all of which came in significantly lower than expected. On cue to maximize the egg on Frankfurt’s sadomonetarist faces, the biggest came in the prices paid component, which unexpectedly plunged by more than 10 points in both China and the US. Inflationary pressures are building mostly in Mr. Trichet’s fevered imagination, apparently.

By in large it was a good week for Safe havens as most currencies plunged against your typical safe havens. USD, JPY and CHF.

GBP

At the beginning of the week we saw talk of the UK being the first country to fall back into recession this argument came back to the forefront as the week drew to a close as the National Institute of Economic and Social Research suggested that there is a 50% chance the UK will fall indeed fall back.

At one point in the week it seemed GBP was set for a mini rally against its major counterparts after construction PMI showed a positive reading of 53.9 for October. The markets had anticipated a similar reading to September’s figure of 50.1; however this rally eventually fizzled out. Concern about the strength of the UK economy also dampened demand for the pound following lacklustre figures on UK manufacturing and the services sector earlier in week.

This week we see the Monetary Policy Committee meeting with speculation gathering pace that we may see more easing. This puts the pound at risk of losing recent gains against the Euro and falling beneath the 1.60 mark against the Greenback.

EUR

Last week saw a dramatic shift in the view of Germany and France towards the prospect of Greece’s exit from the single currency. Despite Draghi suggesting that any move was impossible, with no mechanism for exit existing and any legal framework absent, Merkel and Sarkozy seemed to open the door for the possibility. Although, this rhetoric must be taken in context as many EU politicians felt that Greece’s call for referendum was merely a bargaining ploy and that the stance of the European big hitters may be the same. Either way, such political uncertainty much market volatility and saw the Euro lose ground against the majors by the end of the week.

Last week we saw the hopes raised by the ECB decision to cut rates to 1.25% (surprising the consensus, which expected no change) quickly dashed by Mr. Draghi’s plodding, hapless performance at the press conference. Mr. Draghi suggested that the decision to cut rates was prompted by weaker prospects for European growth. However, this appears to be about as far as the ECB is willing to go in acknowledging reality.

Draghi appears to have inherited his predecessor’s eerie detachment from the reality of the financial crisis. Predictably, he was bombarded with questions about the possibility of a Greek exit from the common currency. This has become more likely after Merkel and Sarkozy made it clear that a Greek referendum on the bailout package is in effect a referendum on Euro membership. Mr. Draghi replied, more than once, that he did not consider it a possibility, and suggested that the ECB had made no preparations for the eventuality, because “exit from the Euro is not contemplated in the treaty”; therefore, presumably, it cannot happen.

Draghi was similarly nonchalant when asked, rather pointedly, about the blow up of Italian sovereign rates above 6%, and the ominous inversion in the Italian curve, which means that the market is pricing in a non-negligible chance of default. In fact, one got the clear impression that many of the journalists asking questions had a better grasp of the situation than Mr. Draghi himself.

In summary, we are disappointed but not surprised at the lack of a clear break between Draghi’s leadership and Trichet’s. To repeat ourselves, again: no lasting solution to the Euro crisis is possible without massive ECB involvement. Draghi, like Trichet, insists that such involvement will not happen. We shall have to wait, again, for reality to force the ECBs hand. This is not a positive for the common currency. In the meantime, expect the enormous volatility in currencies to continue as the market now looks to see if contagion spreads to Italy. It is also worth considering the unthinkable that Silvio Berlusconi could actually lose his governing majority ahead of a budget vote at the beginning of the week.

USD

The Greenback enjoyed a great start to the week but allowed some high yielding currencies to push ahead by mid-week. In the FOMC speech Ben Bernanke referred to improving economic data in the 3rd Quarter but also downgraded growth forecasts. The economy is now expected to grow 1.6 to 1.7% in 2011 as opposed to 2.7 to 2.9%, while for 2012 growth is now expected at 2.5 to 2.9% and not 3.3 to 3.7% . The Federal Reserve is looking to extend support for the US economy amid growing fears about another slide into recession; strategists say the prospect of further monetary easing by the Fed in the New Year would weigh heavily on the dollar. Further, Federal Reserve Chairman Ben S. Bernanke said additional purchases of mortgage-backed securities are a “viable option” if the state of the economy warrants further easing.

Mid-week ADP job figures came at 110,000, slightly higher than the expected 102,000 figure. The positive reading marked the 10th month in a row that ADP has showed an uptake in job growth. In normal circumstances this would be a great indication that the job market is heading in the right direction. However, in the months gone by the ADP report has done little to give us any insight into the Non-Farm Payroll report.

Towards the back end of the week the widely anticipated US jobs data provided a mixed picture of the nation’s jobs market. The US Labor Department’s monthly jobs report showed October’s nonfarm payrolls rose 80,000, below market consensus of an increase of 95,000. The unemployment rate fell to 9% from 9.1%, confounding expectations for no change. September and August’s figures were revised upwards. All in all this left the dollar in a position to be the main beneficiary of any safe haven flows as the sovereign debt crisis in Europe continues to play out.

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Written by Tom Tong

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