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Euro Rallies Ahead of ECB on Strong Bond Auctions

Last updated 1/12/2012 5:54 AM ET (GMT -5) 0 Comments - Add your comment

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Boris Schlossberg

Director of Currency Research, GFT

Top Stories

• Strong Italian and Spanish auctions lift EUR/USD
• UK data misses
• Nikkei down -0.74% Europe up 1.20%
• Oil at $101.75/bbl
• Gold above $1650/oz.

Overnight Eco

• JPY Eco Watchers Survey: Current (DEC) 47.0 vs. 46.3
• EUR German Consumer Price Index (MoM) (DEC F) 0.7%
• GBP Industrial Production (MoM) (NOV) -0.6% vs 0.1%
• GBP Manufacturing Production (MoM) (NOV) -0.2% vs. 0.0%

Event Risk on Tap

• USD Advance Retail Sales (DEC) expected at 0.2%
• USD Retail Sales Less Autos (DEC) expected at 0.3%
• USD Initial Jobless Claims (JAN 7)
• USD Continuing Claims (DEC 31)

Price Action

• USD/JPY still under 77.00
• AUD/USD rallied to 1.3050 on better risk flows
• GBP/USD jumps to 1.5345 despite woeful IP data
• EUR/USD better auction help spur rally to 1.2750

Strong Spanish and Italian debt auctions helped to lift EUR/USD to fresh session highs as yields on 10 year Italian bonds dropped markedly by more than 40bp in the wake of solid investor demand for periphery paper. Spain was able to sell more than twice of its 3 year bonds raising 9.98 Billion euros versus 4 Billion expected.  Italy was able to fund its 1 year paper at yields of 2.735% - sharply lower than the period prior.

Today’s positive results in Spanish and Italian auctions indicate that ECB’s LTRO strategy is starting to work, as European banks borrow at ultra-low 1% rates and invest the proceeds in short term periphery bonds with relatively high yields, thus earning carry trade profits. However, the true test of the LTRO strategy will come later in the year when both Spain and Italy seek to refinance longer term debt. Given the limitations of the 3 year term on LTRO loans the key question is whether European banks will be willing to assume longer credit risk maturity under those conditions.

If the longer term auctions prove to be less attractive to investors, Club Med members may have to resort to refinancing their debt on shorter term maturities – a tactic that could leave them much more vulnerable to any potential spike in rates. As we noted earlier, the ECB’s LTRO strategy may have succeeded in kicking the can down the road but only by making very short passes.

The EUR/USD  reacted positively to the news rising to 1.2750 in the aftermath of the auctions, but any further progress is likely to be limited until traders heard from Mario Draghi later today at the ECB press conference. As we wrote earlier, “The consensus view is that today will be essentially a maintenance meeting with no new policy proposals from Mr. Draghi, but given yesterday’s warning from Fitch ratings the pressure on the EZ monetary policymakers is intense and investors could voice their disappointment if the ECB  does not offer any fresh initiatives.”

Elsewhere in UK the eco data proved disappointing with Industrial Production declining -0.6% versus -0.2% eyed while Manufacturing Production contracted by -0.2% versus 0.0% eyed. The steep fall in output suggests that production in Q4 will decline sharply and will have a negative impact on GDP. Cable however ignored the news, as the positive risk sentiment of the European auctions trumped the disappointing results and sent the pair 50 point higher to 1.5350 in mid-morning London trade.    

Aside from the ECB all eyes in FX will be on the US Retail Sales numbers due at 13:30 GMT. The market anticipates a rise of 0.3% which as our colleague Kathy Lien noted is an “extremely modest gain especially since the International Council of Shopping Centers reported a 4.5 percent annualized rise in store sales. The holiday shopping season was a strong one, thanks in large part to heavy discounting and longer hours – according to a spokesman for ICSC, “the last few weeks of December helped to lift full-month performance above our earlier expectation.” However a similar report on chain store sales from Johnson Redbook showed a 2.1 percent decline in spending in the first five weeks of December from November, which is of course at odds with the rosier results seen in the ICSC report and explains why there is both upside and downside risk to today’s report."

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About The Author

Boris Schlossberg began his Wall Street trading career more than 20 years ago at Drexel Burhnam Lambert. There, he traded nearly every type of financial product on the market in the U.S., from equities and options to stock index futures and foreign exchange. His innate ability to analyze market information and use it to trade has helped him become an industry-recognized, “go to” trading professional.

These days, whenever the markets move, many organizations turn to Schlossberg for his take on the situation. He is a weekly contributor to CNBC's Squawk Box and a regular commentator for Bloomberg radio and television. His daily currency research is widely quoted by Reuters, Dow Jones and Agence France Presse newswires and appears in numerous newspapers worldwide. Schlossberg has written for publications like SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is also the author of Technical Analysis of the Currency Market and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Kathy Lien. He joined GFT in 2008.