KBC Morning Sunrise Market Commentary 09-012-2011

8/4/2019 KBC Morning Sunrise Market Commentary 09-012-2011

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Sunrise Market CommentaryFrom KBC Market Research Desk - More research on www.kbc.be/dealingroom

KBC Bank N.V. - Treasury and Capital Markets Front Office, Market Research 1

Monday, 12 September 2011

Resignation of ECBs Stark sends shock wave through marketsThe resignation of ECBs Stark caused global core bonds to soar and a sell-off on peripheral bond markets. Fears of aGreek insolvency/default or that the clash between Germany and the ECB will result in Greece leaving EMU are higherthan ever.

Panic sell-off hits the single currencyTensions on the EMU debt crisis pushed the euro below key support levels. EUR/USD dropped below 1.3837 andEUR/GBP lost the 0.8611 range bottom. This smells like euro-panic.

Sunrise Headlines

US Equities dropped sharply lower on Friday on fresh worries about thedebt crisis in Europe, which even intensified after the resignation of ECBsStark. The S&P ended 2.67% lower. This morning, also Asian shares tradesharply lower.

ECB Executive Board member Juergen Stark resigned unexpectedly onFriday in conflict with the central banks policy of buying government bondsto combat the euro zones debt crisis. The ECB confirmed that the chiefeconomist would leave for personal reasons.

After weeks of market turbulence, finance ministers and central bankersfrom the Group of Seven industrialised nations pledged a coordinated re-sponse to the global slowdown, but offered no specific steps and differed inemphasis on Europes debt crisis.

Britains banks should shield their retail operations from riskier investmentbanking units and boost capital levels to protect taxpayers from future cri-ses, according to far-reaching proposals that could cost the industry 7 bil-lion a year.

The Greek government announced yesterday that it would impose a two-year property tax to raise 2 billion this year, closing a 1.7 billion budgetgap that the EU and IMF said must be resolved or they would stop makingbail-out payments.

Frances top banks are bracing themselves for a likely credit rating down-grade from Moodys sources close to the situation said on Saturday. Sev-eral sources said that BNP Paribas, Societe Generale and Credit Agricolewere expecting an imminent decision from the rating agency, which first putthem on review for a possible downgrade on June 15.

Chinese inflation is still too high and the country needs to maintain itsprudent monetary policy, the central bank said this morning, adding thatstabilising overall price levels remains the top priority of macro economicpolicy.

Today, the eco calendar is thin with only the Italian industrial productiondata. The BIS holds its bimonthly meeting and Germanys Merkel and EUsBarrosso hold crisis talks.


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Sunrise Market Commentary



Markets: Fixed Income

On Friday, global core bonds once more profited from risk aversion. Germanbond yields dropped by 5 to 10 bps, US ones shed about 6 bps. The market barelyreacted to the speech of president Obama in which he laid down an approx. $450Bplan to help the labour market and get the economy going. Market participants ap-parently wait to see whether the plan makes it through Congress, which is indeed aquestion mark after the bitter fight over the increase of the debt ceiling about sixweeks ago. However, developments in the European debt crisis primed all otherconsiderations. Besides the deteriorating situation of Greeces fiscal situation andthe increasing chances that the rescue operation will fall apart, the resignation ofthe German ECB executive board member, Mr. Stark opened another battle fieldinside the EMU that looks to be disintegrating fast.

The resignation of ECB Stark shows that Germany is rapidly losing faith in theEMU construction. The resignation follows a similar action of Axel Weber, the pre-vious Bundesbank president in February; sharp critique from the current Bundes-bank president, Mr. Weidmann and very critical remarks by the president of Ger-many, Mr. Wulff, which is very unusual. Monetary Germany doesnt accept theECB Securities Markets Programme (SMP) by which it buys bonds of governmentsunder pressure. The SMP was introduced last year in June when Greece was un-der intense market pressure. At that time, the Bundesbank and German ECBmember Stark already rejected the programme. However, it was reactivated in Au-gust of this year, after Italy and Spain became the next victims of the debt crisis.Mr. Trichet knew that buying government bonds was difficult to accept for the Ger-mans and thus dictated to Mr. Berlusconi the austerity measures Italy had to takein exchange for buying its bonds. Mr. Berlusconi bowed and announced the auster-ity measures after an emergency weekend meeting of his cabinet. He howeverbacktracked on his promises later on, putting the ECB and Trichet, who in the

mean time had started buying bonds in a difficult position. More recently, Italy tookother measures to fill the hole in the budget. However, the episode probably hard-ened the position of the German monetary policymakers, who saw their objectionsto the programme confirmed. Indeed, the SMP blurs the line with fiscal policy andtakes the heat off the governments to take measures to heal their finances. TheSMP of course saddles the ECB with a credit risk that, if things go wrong, lead tolosses and eventually force the ECB to go cap in the hand to the political govern-ments for a humiliating recapitulation.

To accept the euro, Germany had two big conditions that found their way into theTreaty: the no bail-out clause and the independence of the ECB (including theprohibition of the direct financing of governments). Both have now been violated,which means that many in Germany come to the conclusion that the euro projecthas no big value any longer.

The ECB reacted with the best intentions to the debt problems and came with in-ventive solutions to safe the system. It argued that the SMP did fit in its mandate,as it was needed to offset problems with the transmission of its policy towards thereal economy. Lowering government bond yields did make its monetary policyworkable again. While one may discuss the issue and arguments for both the ECBand the German position are available, it is obvious that the ECB has stretched itsmandate quite extremely and doing so against the will of the biggest and strongestcountry of the area was extremely risky, as recent events bore out. Last Thursday,Mr. Trichet sharply lashed out against the big countries and especially Germany bysaying that they were at the origin of the current problems because they had defacto put the Stability pact out of work. Was this the trigger for Mr. Starks resigna-tion or will we get later today the announcement that the ECB had bought last

week an enormous amount of Italian and Spanish bonds?


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Markets were already very sceptical versus the EMU due to the debt problems andthe German ECB rift will only exacerbate the scepticism. The endgame has nowstarted in earnest (see also the Greek saga below). We suspect that capital pres-

ervation will become ever more engrained in investors behaviour. In this regard,German and its satellite bonds will continue to thrive, regardless of yield considera-tions.

This means that the ECB will have to make an impossible choice: if it stops buyingmassively Spanish and Italian bonds, these countries will end up in the same situa-tion the peripherals arrived, notably yields that are too high to carry and thus theinability to finance them in the market. If the ECB on the contrary continues buyingbonds, German may pull the plug from the EMU construction. So, risks on a soreend are increasing. In Germany, chancellor Merkel might still be in the game ofsaving the EMU project, but she might soon find herself politically isolated. Ofcourse, governments wont put too easily the EMU project on the line and thus anew far-reaching plan is still possible, but the window of opportunity is closing fast.

Peripheral yield spreads widened on Friday as the resignation of ECB Starkcaused another shock wave on financial markets. PIIGS bonds were sold enmasse and intraday graphs seem to indicate that the ECB needed to intervene inSpanish and Italian bond markets to keep yields in check. In the end, Ger-man/Greek 10-year spread increased by 53 bps and the Italian, Spanish and Por-tuguese spread widened 23 bps. With Starks resignation, rumours that Greecewould soon leave the euro zone took centre stage. Germany also keeps upping itsrhetoric on the matter. German Economy Minister Roesler said that an orderlybankruptcy could no longer be ruled out; FM Schaeuble has ordered preparationsto be made for a Greek bankruptcy according to Der Spiegel and a separate reportsuggested that the German government was readying a plan to recapitalize itsbanks in the event Greece did default. Over the weekend, Greek PM Papandreoumade an (ultimate?) attempt to convince people that he would do whatever it takes

to avoid a default and keep Greece in the euro zone. Yesterday, FM Venizelos an-nounced that 2B extra austerity measures were approved to close this yearsbudget shortfall. EU Rehn welcomed the steps ahead of the return of the Troika toconclude their review. The budget shortfall was more than likely the reason whythe Troika suddenly interrupted their review last week but question remainswhether this will convince Greeces official creditors to release the next aid tranche.Spreads will continue to increase this week on Greek insolvency fears and on thegrowing possibility that the clash between Germany and the ECB on the SMP-programme (see above) will eventually push Greece out of the euro zone.


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Currencies:On Friday, EUR/USD extended the post-ECB decline. There was also no reason at allto change tactics. The EU policymakers dont give the impression to come closer to acomprehensive solution for the debt crisis. On the contrary. In addition, the euro hadlost one of its main assets against most other majors, being (the prospect for) addi-tional interest rate support. At Thursdays meeting, the ECB made clear that the proc-ess of normalisation of policy rates has been put on hold. In this respect, a further re-positioning out of the single currency should be considered as logical. During the day,sentiment on risk even deteriorated further. EUR/USD dropped already below the key1.3837 support before noon in Europe. Later in the session, there were rumours in themarket that Mr. Stark was to leave ECB because of a conflict over the banks bondbuying plan. This added to the overall uncertainty and pushed EUR/USD further southof the key 1.3837. The news of his resignation was confirmed later in the session. Atthe same time, there were al kinds of other rumours, even on Greece defaulting thisweekend. It was difficult to assess the correctness of these rumours. However, it is

clear that the tensions are mounting on all kinds of issues and that Germany is becom-ing ever less clement on Greece. This kind of political risk and chaos made the euro aneasy victim. The single currency was heavily sold and EUR/USD closed the session at1.3656, compared to 1.3882 on Thursday evening.

Today, the calendarof eco data is thin. However, this is no precursor for a calm trad-ing session. On the contrary. The key question is whether there is still enough politicalwill in Germany to give further support to Greece (and to other countries). The Greekproblem obviously is the most imminent one. Over the weekend, the country took addi-tional measures to reduce its budget deficit. The question is whether they will be con-sidered enough by its sponsors. However, the rift on the ECB bond buying programmeillustrates that Germanys unease is much more profound. Germany is on collisioncourse with a big part of the EU and some if its core institutions like the ECB. As longas there is no sign on a solution of this problem, the euro looks extremely vulnerable.In this respect, it will be interesting to see the reaction from Germany on the amount ofbond buying as announced by the ECB today. There is still plenty of event risk. In thisrespect, markets might still be spooked by rumours on a downgrade of the Italian sov-ereign debt rating (from Moodys). In the same context, there is also speculation on thedowngrade of the major French banks due to their exposure on Greece. This smellslike an outright euro chaos. So, there is absolutely no reason to row against the euronegative tide. The sell-off might continue at a fast pace.

Global context. Since the EU summit on July 21, EUR/USD held within a remarkablytight sideways trading range. The outcome of the meeting was unable to prevent fur-ther contagion on the EMU government bond markets. On the contrary, Italy came alsoin the fire line. In theory, this should have been a negative factor for the euro. However,markets still saw a balance of weakness between the euro and the dollar as the news

flow from the US was also far from inspiring. The eco data indicated that the US mightbe at the brink of a double dip recession and the outcome of the US budget debate il-lustrated that US policymakers have no comprehensive plan to address the debt situa-tion. S&P downgrading the US AAA-credit rating reinforced this feeling and weighed onthe dollar. The Fed committing to extend an extremely accommodative policy at leastuntil 2013 was also no help for the US currency. So, EUR/USD hovered sideways in arange roughly between 1.4050 and 1.4550 in August. However, two weeks ago, senti-ment on the euro turned for the worse as the EMU debt crisis came again in the spot-lights. EUR/USD started a correction off from the range top. Last week, the news flowon the euro turned further negative. At the ECB press conference, the bank indicatedthat it changed tactics. There is even a risk of the ECB again cutting rates in the future.This removes an important support for the euro. On Friday, EUR/USD dropped belowthe key 1.3837 level (12 (July low). Already for quite some time, we indicated that abreak below this level might be an indication that some kind of euro panic is building. Itlooks that we have reached that stage now. The targets of the triple top formation(neckline 1.3968) are seen at 1.3381, at 1.3240 and at 1.2996. We wouldnt be sur-prised if there targets would be reached rather soon.

Technicals EUR/USD

Support comes in at 1.3499 (Re-action low), 1.3447 (Equality C-wave), at 1.3408 (50% Retrace-ment 2010) and at 1.3381/75 (1

st

target off 1.3968/Weekly enve-lope).

Resistance stands at 1.3622(Reaction high), at 1.3688 (Bro-ken daily Boll Bottom), at1.3733/47 (Daily enve-lope/Weekly envelope), and at1.3836 (STMA) and at 1.3872(STMA).

The pair is in oversold territory.


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On Friday, trading in the EUR/GBP cross rate was also driven by the euro side of thestory. So, EUR/GBP to a very large extent tracked the price swings of the EUR/USDcross rate. The UK PPI data were no factor of importance for trading. The ru-mours/news on ECBs Stark leaving the ECB pushed EUR/GBP for a test of the key0.8611 area. The level was extensively tested, but contrary to what happened inEUR/USD, a break of this key level didnt (yet) occur. The pair closed the session at0.8600, compared to 0.8698 on Thursday.

Today, the eco calendar in the UK is again empty. So, the EMU debt crisis will alsobe the dominant factor for EUR/GBP trading. In this respect, the pair dropped thismorning clearly below the 0.8611 support. This is also an important event forEUR/GBP trading as it makes the technical picture negative. However, later thisweek, the UK eco data are interesting too. We especially watch out for the labourmarket data and the retails sales. A poor outcome of these series might be seen aspushing the BoE for more QE in the near future. It is not sure that this will stop thedecline of EUR/GBP if the panic on the euro-zone debt crisis persists. It will be inter-esting to see the market reaction.

.

EUR/USD: panic selling as pair drops below 1.3837 support.

EUR/GBP: dropping below the 0.8611

Technicals EUR/GBP

Support comes in at 0.8529 (Reac-tion low), at 0.8476/73 (Weeklyenvelope/76% retracement), at0.8455 (62% retracement), at 83.85

(Irr C) and at 0.8285 (Year low).

Resistance is seen at 0.8591 (Bro-ken Boll Bottom), at 0.8632 (Daily,envelope) and at 0.8687 (STMA).

The pair is slightly overbought terri-tory.


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Global picture. The EUR/GBP cross rate reached a new high for 2011 at 0.9083early July, but renewed uncertainty on how European policymakers would handle thespreading of the EMU debt crisis pushed EUR/GBP to the 0.8700 area. The 21 July

agreement was no big support for the single currency as contagion also hit the Italianbond market. EUR/GBP reached a correction low at 0.8643 early August. However,the key 0.8611 level stayed out of reach. The ECB buying Italian and Spanish bondseased the tensions on the intra-EMU bond markets and the euro entered calmer wa-ters. Regarding the UK side of the story, there is still a decent chance that the BoEwill enlarge its program of asset purchases in case UK economic growth remainsweak. The risk of more QE in the UK of late capped any gains of the UK currency.We had a LT EUR/GBP bullish view as we expected the BoE to keep its policy loosefor a prolonged period of time while the ECB was trying to bring its policy rate to amore normal level. However, the ECB normalization process is obviously put onhold sine die and even a rate cut might again come on the agenda. This clearlychanged the balance between the BoE and the ECB. The flaring up of the EMU crisisis currently pushing EUR/GBP below the key 0.8611 range bottom. This obliges us tochange our strategy in this cross rate. Euro panic clearly outweighs uncertainty on

more QE and on the UK currency. So, we can not but cut EUR/GBP long exposure.It might look far at this stage, but 0.8285 (year low) is the next high profile target onthe charts


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CalendarMonday, 12 Septem-ber

Consensus Previous

Japan01:50 BSI Large All Industry (QoQ) (3Q) - - -22.001:50 BSI Large Manufacturing (QoQ) (3Q) - - -23.301:50 Tertiary Industry Index (MoM) (JUL) 0.2% 1.9%01:50 Domestic CGPI (MoM) (YoY) (AUG) -0.2%/2.7% 0.2%/2.9%

Italy10:00 Industrial Production (MoM) (YoY) (JUL) 0.2% / - - -0.6% / 0.2%

Portugal11:00 CPI EU Harmonized (MoM) (YoY) (AUG) - - 0.1% / 3.0%

EventsBimonthly Meeting of Bank for International Settlements

01:50 BOJ to Publish Minutes of Aug. 4-5 Board Meeting

11:00 EU General Affairs Ministers Meet in Brussels12:00 Gemanys Merkel and ECs Barrosso hold talks on Crisis15:30 ECB Calls for Bids in 7-Day Main Refinancing Tender15:30 ECB Calls for Bids in 1-Month Tender15:30 ECB Announces Bond Purchases22:00 Fed's Fisher Speaks on Monetary Policy in DallasGermany Bubill Auction (4B Mar2012)US 3-Yr Notes Auction ($32B)

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This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot beheld liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute arecommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee theaccuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

KBC Morning Sunrise Market Commentary 09-012-2011

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