The latest plan is for the ECB to lend to the IMF who then lend to the distressed euro members

By Sam Coxhead*:

Last week has seen the markets once again taking their lead primarily from developments in Europe, and in particular the European Government bond markets.

Italian and Spanish debt continues to be of intense focus, and the European Central Bank (ECB) continues to aggressively support their debt in the secondary market.

With the ECB legally unable to lend directly to member Governments, talks are progressing to enable a scheme whereby the ECB lends to the International Monetary Fund (IMF), and the IMF lends to the governments with stressed debt markets.

The theory is this would enable the IMF to maintain a lower cost of funding for the respective governments and avoid any destructive contagion from spreading further.

Whatever their next plan is, the speed of implementation is the key. Sentiment remains very fragile, and uncertainty high across most markets.

The economic data in the US remains a little more positive than forecast, and it looks likely now the US will avoid a return to recession in the coming quarters.

Elsewhere the news remains mixed, with frayed investor nerves maintaining the recent trend of large daily swings in most markets.

Overall the appetite for risk remains low and growth assets under pressure. Adding to the uncertainly is the increasing volatility in the Middle East/North Africa region once again.

Major Announcements last week:

· NZ Retail Sales Q3 2.4% vs +0.7% expected
· RBA minutes reveal lower inflation eased the way for cash rate cut, EZ remains primary concern
· Japanese preliminary GDP Q3 +1.5% vs 1.5% expected
· UK Inflation 5.0% vs 5.1% expected
· German Investor Sentiment -55.2 vs -51.89 expected
· European GDP Q3 0.2% vs 0.2% expected
· US Retail Sales 0.6% vs 0.2% expected
· US Empire State Manufacturing Index 0.6% vs 0.2% expected
· Bank of Japan leaves monetary policy unchanged
· US Inflation 0.1% as expected
· UK Retail sales 0.6% vs -0.2% expected
· US Philadelphia Fed Manufacturing Index 3.6 vs 8.7 expected
· Canadian inflation 0.3% vs 0.2% expected
· Mario Monti interim Italian Prime Minister and Minister of Finance
· Italian and Spanish bond yields remain at stressed levels, even French pushing toward 2% above German yield
· ECB continues to be main support of Italian and Spanish debt in secondary market 

NZD/USD 
The NZD saw sustained pressure from the USD as global risk sentiment soured and a supply of NZD funds hit the market, as the November 2011 NZ Government stock rolled off. Expect to see the risk aversion continue this week for the most part. Adding to the mix is the prospect of the inability of the US congressional  “super committee” to come up with a cost cutting plan for the next decade. This hurdle will no doubt be a unsettling affair, and will further add to the volatility.  The RBNZ inflation expectations survey on Tuesday will be closely watched, but should be of limited impact. In the US, the preliminary GDP number, and Fed minutes on Tuesday will garner attention, along with the durable goods orders data on Wednesday. It can be expected that further US dollar gains will be somewhat harder to make, given the USD appreciation seen last week.

NZD/AUD (AUD/NZD)
The AUD continued to put further pressure on the NZ dollar last week. This came after the stella retail sales number released in NZ last Monday. The rolling off of the November 2011 NZ Government bonds saw excess NZD supply, and this impact was easily seen. The funds in the interest rate market looking for a home also pushed rates quite a bit lower, to a point where a significant chance of the cut to the cash rate is priced in for the March meeting from the RBNZ. Current levels look to represent good value buying of NZD with Australian dollars from a historical basis.

NZD/GBP (GBP/NZD)
The NZD remained under pressure from the GBP throughout the course of last week. The market ignored the positive NZ retail sales number and succumbed to global risk aversion and a healthy supply of NZ dollars thanks to the maturity of the November 2011 NZ government bond. Progress lower by the NZD from current levels should prove to be somewhat slower. The BOE have revised down forecasts for both 2011 and 2012, and further QE is likely from them. However the risk averse sentiment in markets will continue and this should see the NZ dollar struggle to make any meaningful ground. Current levels are inviting for those that have been patiently waiting for some GBP strength.

 
NZD/CAD
This pairing was another to see the NZ dollar suffering. This was a result of the dual forces of lower global risk aversion, and the supply of NZD following the maturity of the November 2011 NZ government bond. The break down through the .7900 level heralds a return to more historically average levels for this pairing. This week sees the focus come on Tuesday when the RBNZ inflation expectations survey results are follow by the monthly retail sales figures in Canada. If the tensions in the middle East/North Africa region keep the oil price elevated, expect the CAD to maintain its pressure this week.

NZD/EURO (EURO/NZD)
The EURO put pressure on the NZ dollar throughout the course of last week. The debt inspired risk aversion continues to weigh on growth assets and this can be expected to continue this week. The NZD supply that came with the maturity of the November 2011 NZ government bond, may continue this week, to what extent remains to be seen. The RBNZ inflation expectations survey on Tuesday, is unlikely to garner too much reaction given the stronger forces currently at play. The focus will remain on the state of the European bond markets and the associated funding pressures.

 
NZD/YEN (NZD/YEN)
The increased risk aversion continued its trend last week and this obviously pushed the NZ dollar lower against the safe haven YEN. Adding to the pressure was the increased NZD supply as the November 2011 NZ Government bond matured. The wider market risk aversion does not look like abating this week, but further progress from current levels should be harder fought for the YEN. In the absence of any top tier data in either economy this week, again the winder market risk appetite will be the primary driver for this pair.

AUD/USD
The Australian dollar was under sustained pressure from the US dollar last week. The risk aversion was almost unabated and this trend does not look like changing in the short term. However, given the recent moves, progress from current levels should prove harder to make for the US dollar. The uncertainty surrounding the congressional negotiations to reduce costs in the US will also add the mix this week. There is little in the way of top tier data due for release in Australia, so again, the majority of the lead for this pair will come from the wider market appetite for risk.

AUD/GBP (GBP/AUD)                            
After a reasonably stable start to the week, this pairing saw the wider market risk aversion increase and the AUD come under some pressure from the GBP into the end of the week. This pairing is now getting down towards levels where we should see some support appear for the Australian dollar. The GBP has performed pretty well considering the market appears to accept there will be further quantitative easing from the BOE. In the absence of any significant data in Australia this week, expect the BOE meeting minutes on Wednesday and final GDP numbers for the 3rd quarter on Thursday to be closely watched in the UK.

 
AUD/EURO (EURO/AUD)
After a stable start to last week, the wider market risk aversion increased and this saw the EUR put renewed pressure on the AUD. Given the current market sentiment in place the current bias to the downside should continue for the AUD. There is an absence of data in Australia this week, so the lead will almost entirely come from developments in Europe. The possibility of negative sentiment from the flaring up Middle East/North African turmoil would only be AUD negative. For those looking to transfer EURO’s into Australian dollars, loading order can be advised as the last two retracement from the .7200 (1.3890) levels has been swift.

GBP/USD
The Pound Sterling lost ground to the US dollar last week as the risk aversion increased. The likelihood that the BOE will need to initiate further quantitative easing, further lends support to the downside for the GBP in the short term. Having said that, the current levels provide reasonable value buying of GBP, so further US dollar progress will no doubt be harder fought. In the US Preliminary Q3 GDP numbers and Fed monetary policy meeting minutes on Tuesday provide initial focus, ahead of durable goods orders on Wednesday. In the UK BOE monetary policy meeting minutes on Wednesday will be closely watched ahead of the final Q3 GDP number is released on Thursday. 

GBP/EURO (EURO/GBP)

This pairing remained in familiar territory throughout the course of last week. Major concerns continue in Europe, but the UK economy is still suffering stagnant growth. The prospect of further quantitative easing in the UK will certainly be subduing the potential GBP appreciation over the EURO. In Europe this week, the focus will continue to be dominated by the state of the respective bond markets. As yields fall, the EUR will outperform and vice versa. In the UK the BOE monetary policy meeting minutes on Wednesday are followed by the final Q3 GDP numbers on Thursday and these will be both closely watched.

Market commentary:

Last week has seen the markets once again taking their lead primarily from developments in Europe, and in particular the European Government bond markets. Italian and Spanish debt continues to be of intense focus, and the European Central Bank (ECB) continues to aggressively support their debt in the secondary market. With the ECB legally unable to lend directly to member Governments, talks are progressing to enable a scheme whereby the ECB lends to the International Monetary Fund (IMF), and the IMF lends to the governments with stressed debt markets.  The theory is this would enable the IMF to maintain a lower cost of funding for the respective governments and avoid any destructive contagion from spreading further. Whatever their next plan is, the speed of implementation is the key. Sentiment remains very fragile, and uncertainty high across most markets. The economic data in the US remains a little more positive than forecast, and it looks likely now the US will avoid a return to recession in the coming quarters. Elsewhere the news remains mixed, with frayed investor nerves maintaining the recent trend of large daily swings in most markets. Overall  the appetite for risk remains low and growth assets under pressure. Adding to the uncertainly is the increasing volatility in the Middle East/North Africa region once again.

In New Zealand better than expected spending related  from the Rugby World Cup saw the 3rd quarter retail sales numbers substantially beat expectations. However the market discounted this good news as the negative sentiment from Europe continued to weigh on the NZ dollar. Compounding issues for the NZD, was the rolling off of the large November 2011 NZ Government bonds. The 8.8billion NZD of bond funds came back into the market and the influence was felt throughout the week. This had the dual effect of pushing interest rates significantly lower, as some funds were reinvested into the interest rate market, and pushing the NZ dollar lower on almost all cross rates, as some funds were repatriated back into foreign currencies. Whether or not the influence continues to be seen this week will be of interest. With only the RBNZ conducted quarterly survey of inflation expectations due for release this week, expect the bulk to the lead to come from the wider market sentiment driven by bond yields in Europe, and the possible hangover from the NZ Government bond maturity.

In Australian last week the main focus was the release of the meeting minutes from the previous Reserve Bank of Australia (RBA) monetary policy meeting, where it cut the cash rate by 25points to 4.50%. The minutes showed it so, because of the lowering of inflationary pressure and the building concerns about the situation in Europe, and the way it may unfold. However there was no clear commitment that they would cut at the next meeting on December 6th, albeit that remains a possibility. Therefore further data watching remains on the cards from here. Unfortunately this week, the main focus will be offshore, with a lack of top tier economic data due for release in Australia. The European bond yields will be the primary focus, but the budget debates in the US will also be closely watched.

The United States looks to have avoided a return to recession in the short term, with the economic data continuing its upswing. A potential hurdle to investor sentiment will come this week in the form of the “super committee” progress on negotiations to cut 1.2 trillion in spending over the next 10 years. This Congressional committee is unsurprisingly struggling to make progress according to all reports. Whether or not this comes to influence the European focused market remains to be seen, but the situation has be acknowledged. Tuesday sees the release of preliminary GDP numbers for the 3rd quarter and the expectation is for a 2.5% number. Forecasts for 4th quarter growth have also been increased with the data improvement, with JPMorgan revising their growth forecast from 2.5% to 3.0% and Morgan Stanley from 3.0% to 3.5%. Tuesday also sees the latest Fed monetary policy meeting minutes released, and the “large ticket” durable goods order number comes on Wednesday. Until we see some respite from the fears in Europe, expect the US dollar to continue to see demand.

In the UK, the bright point last week was the welcomed retail sales number. Against expectation of a -.2% number for the month, the market was buoyed by the +.6% increase. Unfortunately the Bank of England (BOE) growth forecasts for 2011 and 2012 have been revised down to just 1% and this indicates the likelihood of further quantitative easing measures from the BOE are likely. Against the Australasian currencies, the GBP continues to claw back ground as the growth currencies underperform because of the ongoing issues in Europe. This week sees the release of BOE monetary policy meeting minutes on Wednesday, and final GDP numbers on Thursday.

In Europe the focus remains on the performance of the bond markets. Aside from Germany, bond yields have pushed higher over the last week. This directly correlates to the risk aversion seen in the wider market. Italian and Spanish yields continue to teeter close to the 7% level in the 10 year bond. To put this in context, just five months ago the Italian 10 year bond yield was around 2.0%, and unnervingly just above levels where French yields closed on Friday. The idea that the ECB fund lending of the IMF to debt stressed Euro-zone members is gaining momentum, even if it is a circular solution. The Spanish election results,  and ongoing meetings between the new Italian and Greek leaders and other European heads of state, will mean politically charged headlines will come thick and fast this week. This situation has already affected global growth in the second half of 2011. There is potential for the debt contagion to spread further afield and this is why it is so important that a credible solution be established quickly. Until this happens, focus will remain steadfastly on Europe and its effects on the global outlook.

In Canada Fridays slightly higher than expected inflation number will be giving further encouragement to Canadian dollar fans. This coupled with the elevated oil price should keep underpinning the form of the CAD over the coming week. The domestic focus for the week comes in the form of Canadian retail sales numbers on Tuesday, with the market expecting +.4% for the month.

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Sam Coxhead is a currency analyst with DirectFX You can contact him here >>