The Euro-zone outlook will remain weak in the short term with further concerns surrounding the recession threat, especially with fears surrounding the peripheral economies. There has been some decline in bond yields which will help stabilise conditions to some extent. The depth of recession and deflation pressures will, however, be extremely difficult to reverse. There will also be continuing fears surrounding the sovereign-debt outlook and severe vulnerability within the banking sector. There will be pressure for the ECB to cut interest rates further over the next few months. Even if this salvages the Euro, the currency is liable to be generally weak over the next few months.
There was still a high degree of unease surrounding the Euro-zone banking sector, especially as Italian banks’ dependence on the ECB for funding increased sharply for December. There was also a record amount of funds parked at the ECB which continued to suggest very little confidence in the sector.
The latest German auction for six-month bills registered healthy investor interest. The main feature was that yields were actually negative for the first time. Although there was a technical change, the fact that investors were prepared to pay to hold German securities also illustrated the break-down in trust.
There were comments from ratings agency Fitch that the ECB needed to do more to prevent a cataclysmic collapse of the Euro which pushed the Euro sharply lower and there were further rumours surrounding a French credit-rating downgrade by Standard & Poor’s in rumour-driven trade.
There were well-received bond auctions from Spain and Italy ahead of the ECB meeting which provided underlying Euro support as peripheral yields fell sharply with the Euro recovering from lows below 1.27.
As expected, the ECB left interest rates on hold at 1.0% at the latest council meeting following cuts at the previous two meetings. Bank president Draghi stated that there was tentative evidence that the massive liquidity operations were having some success in easing credit conditions. Draghi also stated that there were signs that economic activity was stabilising. There were no suggestions that the bank was looking to cut rates again in the very short term, but markets continued to expect further action.
There was further unease surrounding the Greek situation with continuing obstacles to a debt-restructuring deal. Two senior members of the German governing CDU party also stated that a Greek exit from the Euro area could be manageable.
Yen
Underlying confidence in the Japanese economy will remain weak with continuing doubts whether there will be a sustainable improvement in conditions, especially if there is a downturn in regional demand. There will be pressure for the Bank of Japan to intervene and weaken the currency, particularly if output levels deteriorate. There would be further US opposition to sustained yen selling which would limit its effectiveness. There will still be caution surrounding the global economy and this will help protect the yen with a reluctance to commit substantial capital outflows while repatriation will remain an important element. Near-term yen losses could, therefore, still be limited.
The dollar failed to make any significant headway against the yen over the week and was generally trapped below 77. Main attention focussed on the crosses as the yen reached a fresh 11-year high against the Euro beyond 97.50 before a limited correction. The weaker than expected US retail sales data had a negative impact and pushed the currency weaker as the dollar failed to gain any additional yield support.
Global risk appetite has been able to stabilise which may curb aggressive yen support, but sentiment remains very fragile and there is a reluctance to push funds out of Japan while repatriation from Europe also remains a threat.
Markets remained on high alert for comments from the Bank of Japan given the possibility of intervention to weaken the yen and the latest speculative positioning data will be watched very closely over the weekend. |