Market Economics | Interest Rate Strategy - BNP PARIBAS ...

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markets to slide, reminding us of the adage: ‘Sell in May and go away’. This means following a risk-off strategy for currency markets, favouring the USD, CHF and JPY in that order. EURUSD and equities: The correlation will return Should equity and other risky asset markets decline, the EUR will be a victim. This finding might surprise given that the correlation between EURUSD and the performance of share markets has collapsed over recent months. However, the correlation has collapsed due to inflows into the EMU bond market weakening at a faster pace than the inflows into European share markets. Financial account data show that the 12-month sum of inflows into European bond markets has collapsed from EUR 285bn to EUR 20bn within the course of a year. But during the same period, foreign investors kept on buying shares and short-dated money market instruments, keeping total portfolio inflows at a reasonably strong EUR 320bn. The combination of weak bond and strong equity inflows led the EURUSD-capital market correlation to decline. However, should the equity markets lose their upward momentum or even turn south, EURUSD will trade sharply lower. The Aussie case Should global liquidity decline, putting risky assets out of favour, we see commodity currencies coming under selling pressure too. Of course, changes to Asian liquidity most notably via China increasing domestic interest rates will impact commodity currencies more compared to liquidity declines due to (i) difficulties within the European banking system developing on the back of the Greek or more broadly speaking European peripheral crisis or (ii) the US introducing tough financial sector reforms. However, once equity markets turn down, investors will not ask what caused the decline. People will just take profits on commodity- and high-yielding currencies. The exposure within this FX market segment is significant, suggesting the first wave of a sell-off would be sharp. Sterling undervalued? Dream on Last not least, we turn again to sterling. A Conservative-led government would no doubt be less damaging to capital markets than another Labour government, but the Institute for Fiscal Studies suggested that all main three party elections manifestos were showing significant budget gaps. These range from GBP 38bn in the case of the Liberal Democrats to more than GBP 52bn for the Conservatives. We cannot repeat often enough that the over-leveraged British economy will find it difficult to grow out of its problems (leverage is always deflationary in a country unless debt is monetised) suggesting the government will either have a higher tax take or lower revenues. The Sunday Times newspaper reported that BoE chief Mervyn King Chart 7: EUR: Net Financial including Bond flows have collapsed Source: Reuters EcoWin Pro, BNP Paribas Chart 8: There is no yield in core Euroland Source: Reuters EcoWin Pro, BNP Paribas privately admitted that sterling rates will have to stay low for several years, implying that the sterling forward curve is wrongly priced. Whichever way we look at it, sterling remains a clear sell. Either it will trade lower as investors lose trust in the country’s ability to reduce its debt and deficit levels or it will decline due to the impact of budget consolidation on growth. One could argue that budget consolidation gives greater scope for the private sector to invest as rates and yields should fall due to lower public borrowing, creating a ‘crowding-in’ effect. Unfortunately, it will not work this way in the UK. Money market rates are already low and the crowding-in effect will not develop: there was no crowding-out effect when UK deficits were rising as the BoE counterbalanced any possible effect through its quantitative easing policy. The BoE has stopped buying gilts, at least for now, suggesting that the deficit may have to be completely funded via the capital market. This means that 2010 and 2011 will see more net capital demand from the public sector than 2009 – even if the deficit reduction process turns out to be successful. Hence, crowding in is not going to happen. Sterling is the only variable the UK can manipulate to create the positive growth impulse that will sorely be needed to compensate for the loss of public demand. Hans Redeker 7 May 2010 Market Mover, Non-Objective Research Section 64 www.GlobalMarkets.bnpparibas.com
Euro Dives • The euro is collapsing across the board with a break through major support levels on most crosses suggesting that an acceleration of the downtrend is now unfolding • EURUSD is currently accelerating the downtrend following the break below major support with the bottom end of the six month channel being tested • EURJPY has collapsed breaking below the February low, opening the way for further significant losses over the medium term • EURGBP now approaching major medium term support, a break of which will turn the longer term outlook bearish The euro has accelerated its recent decline, with losses across the board triggering important bearish technical signals suggesting that further significant downside potential is now developing. Indeed, it is interesting to note that the euro is already the weakest currency year-to-date among the majors, with losses of over 11% against the USD. The current collapse is confirming the medium term bearish outlook for the euro. Indeed, EURUSD has accelerated the major downtrend through the key support at the 1.2890 level to confirm the longer term bearish technical picture and the bottom end of the six-month descending channel at the 1.2595 level is now being targeted. A further break below here will open downside potential back to the 1.2330 lows seen in October 2008. Longer term, the structure of the decline seen since the 1.5145 November 2009 high implies an eventual break below the 1.2330 support. Such a break lower confirms the long term bearish outlook for the euro, putting the focus on the 1.1645 November 2005 lows. The overall bearish picture is consistent with the negative signals currently being generated by technical indicators, which suggest that bearish momentum is set to be sustained in the coming weeks. However, one of the most bearish technical signals currently being generated by the euro is on EURJPY, where the long term pivotal support at the 119.70 level has been broken. This break lower has now turned the longer term EURJPY outlook bearish and losses are expected to target the 115.95 level initially, which represents the bottom end of the sixmonth descending channel. Over the medium term, the 112.10 January 2009 low is also expected to be targeted. Longer term charts suggest that the EURJPY trading activity seen since the beginning of 2009 is corrective and that the down trend from the 169.95 July 2008 high is set to be resumed target 100.35. Chart 1: EUR/USD – accelerating the downtrend EURUSD is accelerating the down trend with the break below the 1.2890 level confirming the medium term bearish outlook. We now expect a test of the channel support at 1.2595, with a further break below here targeting the 1.2330 lows of October 2008. 1.5060 1.51 1.5144 1.4842 1.46 1.4582 1.4630 1.4480 1.41 1.4219 1.36 1.3435 1.31 1.3815 1.3270 1.3690 1.26 14-Sep-09 11-Nov-09 08-Jan-10 09-Mar-10 06-May-10 Source: BNP Paribas Ian Stannard 7 Mayl 2010 Market Mover, Non-Objective Research Section 65 www.GlobalMarkets.bnpparibas.com
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Market Economics | Interest Rate St
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UK: all eyes on the election US: re
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Event response The ECB is being ove
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Eurozone Periphery: Compare and Con
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over 20% in Q1) and, last but not l
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Market Stress Charts • Signs of s
Page 13 and 14: Chart 7: Greek Bank CDS* 900 Greece
Page 15 and 16: • The plan also contains a number
Page 17 and 18: Germany: Downs and Ups • The impa
Page 19 and 20: Retail sales data from month to mon
Page 21 and 22: On inflation, the statement was als
Page 23 and 24: quarterly average of 2.7% in the fi
Page 25 and 26: US Credit: Still the Recovery’s B
Page 27 and 28: Japan: Rising Chance of Sales Tax H
Page 29 and 30: BNP Paribas Surprise Indicator •
Page 31 and 32: UK headline After surprising to the
Page 33 and 34: US: Supply Could Affect Swap Spread
Page 35 and 36: steep curve is typically associated
Page 37 and 38: decline. We continue to maintain ou
Page 39 and 40: Chart 12: 90-119 Day Dlq for FRE 90
Page 41 and 42: the gamma sector for some time now.
Page 43 and 44: EUR: Limited Nervousness at ECB Ten
Page 45 and 46: with the big redemption (EUR 17.7bn
Page 47 and 48: measures are not promptly taken to
Page 49 and 50: Table 1: BNP Paribas' Inflation For
Page 51 and 52: Table 3: BNP Paribas' Inflation For
Page 53 and 54: Table 1: BNP Paribas Carry Analysis
Page 55 and 56: What’s the call? It is relatively
Page 57 and 58: Update on FIN SEN and FIN SUB 5/10y
Page 59 and 60: Germany 10y: Within MT falling wedg
Page 61 and 62: Judging Currencies by Liquidity •
Page 63: type of regulation would reduce mon
Page 67 and 68: Currency Spot Trade Recommendations
Page 69 and 70: Economic Calendar: 7 - 14 May (cont
Page 71 and 72: Key Data Preview Chart 1: US Payrol
Page 73 and 74: Key Data Preview Chart 5: UK Manufa
Page 75 and 76: Key Data Preview Chart 9: French GD
Page 77 and 78: Key Data Preview Chart 13: US Indus
Page 79 and 80: Treasury and SAS Issuance Calendar
Page 81 and 82: Central Bank Watch Interest Rate EU
Page 83 and 84: FX Forecasts* USD Bloc Q2 '10 Q3 '1
Page 85: RESEARCH DISCLAIMERS: IMPORTANT DIS
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