ECB and Portuguese Deal Keep Euro Firm

The euro continues to surge this morning, trading ahead of $1.49, despite some US short covering against some of the majors and a mixed tone in risk appetite, buoyed by a combination of drivers. For one, many see the risk premium in the periphery fading, at least in the near-term, with the procurement of the 3-year, €78bln bailout of Portugal leading to a sharp decline in the price of most of the euro zone periphery’s CDS price. Portugal’s 5-year CDS price, for example, is down 33bps on the day as the yield on the 10-year dropped 18bps. While the Portuguese bailout includes a goal to reduce the government’s deficit from a planned 5.9% of GDP in 2011 to 4.5% in 2012 and 3% in 2013, the agreement is much favorable that many had anticipated, in terms of size and duration.

BBH CurrencyView

  • Dollar mixed against the majors; ADP and ISM services unlikely to provide support for USD
  • China’s central bank reiterates inflation priority; risk appetite mixed
  • Euro approaches 18-month high ahead of ECB meeting; Portugal strikes €78bln aid deal

Negative risk sentiment abated from the overnight session with many equity markets moving into the black and the USD paring its gains against most major currencies. The euro remains firm though as it approaches an 18-month high following the announcement of the Portuguese bailout, while sterling followed the euro higher, despite another round of disappointing economic data. Asian equities extended Tuesday’s losses, forcing the MSCI Asia Pacific to its biggest loss in three weeks as profit taking accelerated, while European bourses are flat to 0.5% higher. A reversal of intra-euro zone safe haven flows is adding to pressure on bunds (2-year yield up 5bps) as euro zone spreads narrow on the back of the Portugal bailout, coupled with the expectations of a hawkish ECB tomorrow. Weaker than expected services PMIs and retail sales failed to give lasting support, though. Energy prices and gold are flat, but silver continues to tumble, falling over 2% today.

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China’s central bank reiterated that inflation is the bank’s top priority and so markets are preparing for further tightening in China. This is not the first time that PBOC officials have made comments about inflation or another key goal, to reign in property prices, so the purpose appears to be to signal markets of what is to come. Chinese newspaper headlines today included that reserve requirements will be boosted again in May and that property market controls will be extended to additional cities. Chinese stocks were down over 2%, with basic materials the worst performing sector, down 3.8%, and the MSCI Asia index was down 1.5%, as equity markets see tightening resulting in slower growth and lower profits. Chinese stocks are at 2 month lows. Over the last 6 months China has raised rated 4 times and increased reserve requirements to a record 20.5%. Chinese manufacturing PMI for April was weak, on the back of this tightening. Services PMI comes out tonight. Next week China and the US have their strategic economic dialogue. Before such meetings China historically allows for additional CNY appreciation, and in just over a week, CNY has appreciated by 0.5% vs. the dollar, to the current 6.5010. We expect the government to increase the use of an appreciating currency as a tool to slow inflation, and thus see CNY appreciation to pick up to over 5% during the next 12 months, beyond current forward pricing of 2.8%.

The euro continues to surge this morning, trading ahead of $1.49, despite some US short covering against some of the majors and a mixed tone in risk appetite, buoyed by a combination of drivers. For one, many see the risk premium in the periphery fading, at least in the near-term, with the procurement of the 3-year, €78bln bailout of Portugal leading to a sharp decline in the price of most of the euro zone periphery’s CDS price. Portugal’s 5-year CDS price, for example, is down 33bps on the day as the yield on the 10-year dropped 18bps. While the Portuguese bailout includes a goal to reduce the government’s deficit from a planned 5.9% of GDP in 2011 to 4.5% in 2012 and 3% in 2013, the agreement is much favorable that many had anticipated, in terms of size and duration. However, some important details of the deal are unknown (such as the interest rate and details of the expected austerity measures) as the final talks with the opposition are still required. In the end, though, we expect the measures to pass with some minor tweaks possible. The second driving force (which is likely to boost the euro through $1.50 this week) continues to be the policy trajectory of the ECB and in turn the relative 2-year interest rate spread between Germany and the US. Specifically, the 2-year German-US yield spread is roughly 132bps as the spread approaches highs not seen since December of 2008. At the same time, the catalyst for the shift in the ECB policy language and indeed for the shift in overall policy towards normalization has been the combination of higher commodity prices, leading in turn to worries about second-round effects, and strong economic data in the core. In our view, these effects are likely to prompt a hawkish response from Trichet in the post meeting press conference tomorrow and indicate that the next 25bps hike is likely to take place in June or July, with the rates market beginning to lean towards June. With US data likely to be on the soft side this morning a break of the $1.49 level is likely to trigger a run towards $1.51.

Data Reports 2011-05-04

Daily Currency Performance 2011-05-04

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2 Comments
  1. Grace Styles says

    The package will fail because it does not address Portugals true problems.

    What is the true situation and what can be done?

    Since joining the Euro Portugal has had the slowest growth rate of the euro zone nations which contrasts her strongly with Greece who was growing (assuming you believe the numbers) at around 3/4% per annum over this period. Portugal has had an average rate of less than 1% over this period. This has been caused by several factors.

    1. There has been a “brain drain” where many educated Portuguese emigrate although because of EU rules it is hard to get exact numbers.

    2. Portugal had and has quite a few industries which are price competitive and these have been affected by the growth of price competitive manufacturing in China and the Far East as well as in Eastern Europe.

    3. Portugal had a privatisation programme for many utilities but it would appear that there has been a form of “soft corruption” where ex-politicians rather than businessman have been appointed to the boards of such firms making them inflexible and the reverse of dynamic.

    4.Portugal has rigid labour laws, which there is little political will to reform and she has one of Europe’s toughest employee-protection regimes.

    There should be concern about the democratic legitimacy of a caretaker government which had its policies rejected in Parliament in effect setting bailout terms for Portugal. This is the job of a new elected government not the job of one which has lost most of its legitimacy.

    http://bit.ly/jUZupM

  2. Grace Styles says

    The package will fail because it does not address Portugals true problems.

    What is the true situation and what can be done?

    Since joining the Euro Portugal has had the slowest growth rate of the euro zone nations which contrasts her strongly with Greece who was growing (assuming you believe the numbers) at around 3/4% per annum over this period. Portugal has had an average rate of less than 1% over this period. This has been caused by several factors.

    1. There has been a “brain drain” where many educated Portuguese emigrate although because of EU rules it is hard to get exact numbers.

    2. Portugal had and has quite a few industries which are price competitive and these have been affected by the growth of price competitive manufacturing in China and the Far East as well as in Eastern Europe.

    3. Portugal had a privatisation programme for many utilities but it would appear that there has been a form of “soft corruption” where ex-politicians rather than businessman have been appointed to the boards of such firms making them inflexible and the reverse of dynamic.

    4.Portugal has rigid labour laws, which there is little political will to reform and she has one of Europe’s toughest employee-protection regimes.

    There should be concern about the democratic legitimacy of a caretaker government which had its policies rejected in Parliament in effect setting bailout terms for Portugal. This is the job of a new elected government not the job of one which has lost most of its legitimacy.

    http://bit.ly/jUZupM

  3. DavidLazarusUK says

    I suspect that the package will fail for the following reasons. The loan deal is too short at less than two years. This means that the same problems could be back in two years time. Why two years and who benefits from the delay? This looks like a kick the can down the road solution.

    The privatisations will bring in less money than expected and result in higher prices meaning a further sqeeze on portuguese spending. A freeze of wages and benefits while there is 3.5% inflation will hurt the poorest hardest. With elections next month I cannot see these being approved by the electorate. Who knows we could get rioting in Portugal as a result. That could send the CDS market into overdrive.

  4. Anonymous says

    I suspect that the package will fail for the following reasons. The loan deal is too short at less than two years. This means that the same problems could be back in two years time. Why two years and who benefits from the delay? This looks like a kick the can down the road solution.

    The privatisations will bring in less money than expected and result in higher prices meaning a further sqeeze on portuguese spending. A freeze of wages and benefits while there is 3.5% inflation will hurt the poorest hardest. With elections next month I cannot see these being approved by the electorate. Who knows we could get rioting in Portugal as a result. That could send the CDS market into overdrive.

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