27th of October 2011 - Fundamental Forex Market Overview

DAILY MARKET COMMENTARY
27 October 2011 – 8:00 GMT
Thursday

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Market Analysis Desk
Foreign Exchange Research: www.fibosignals.com/5585/resources.html
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FUNDAMENTAL ANALYSIS at 0800 GMT

USD
The euro and risk assets rallied overnight as clear developments emerged from the EU summit. The most important outcome of last night's marathon summit seems to be reaching an agreement with the IIF that a 50% face value haircut would be accepted 'voluntarily'. This means in all likelihood that the ISDA will rule that the restructuring does not amount to a credit event and CDS payout is not triggered. On the EFSF, further details were lacking but a range of options, including a special purpose vehicle and/or credit enhancement, will aim to leverage the fund 4 to 5 times, boosting it to around EUR1 trn. On bank recaps, the capital position of banks will be expected to increase to 9% of core Tier 1 by the end of June 2012. While many doubts remain over the program, the short-term reaction of markets has been favourable and risk currencies, including the euro, will likely continue to perform for now. Elsewhere, The BoJ left the official target rate unchanged but decided to conduct more easing via JPY5 trn worth of more JGB purchases. Also, the RBNZ kept the policy rate unchanged at 2.5%, and left the policy guidance unchanged, retaining its explicit tightening bias. EURUSD traded in a range of 1.3825-1.4000 and USDJPY 75.89-76.32.

EUR
The EU summit ended overnight with clear signs of progress. French President Nikolas Sarkozy outlined the following points:

1. PSI: An agreement that should secure the decline of the Greek debt to GDP ratio with an objective of reaching 120% by 2020. Euro area Member States will contribute to the PSI package up to 30 bn euro. The nominal discount will be 50% on notional Greek debt held by private investors. A new EU-IMF multiannual programme financing up to 100 bn euro will be put in place by the end of the year. Reaching an agreement with the IIF that a 50% face value haircut would be accepted 'voluntarily' means that in all likelihood ISDA will rule that the restructuring does not amount to a credit event and CDS payout is not triggered. This provides significant questions to the CDS market going forward but removes the immediate problem of a credit event. The EU, ECB and IMF now have to decide amongst themselves how to wear the 30 bn loss between them. IMF has de facto preferred creditor status, meaning that the ECB may have to take a hit on its holdings of Greek bonds. If ECB refuses to take a loss then EU governments will simply write off 30 bn of the loans they have already advanced to Greece, which will not be looked upon favourably in several countries. Further details will be forthcoming on this however.

2. EFSF: There will be significant optimization of the EFSF resources, without extending the guarantees underpinning the facility. The options agreed will allow the EFSF resources to be leveraged up to 4 or 5x, which would yield around 1 trillion euros. Further details are limited but it might include a special purpose vehicle construction and/or credit enhancement. With the EFSF chief in China, potential sovereign interest will keep hopes alive for a comprehensive solution, even though many will remain skeptical, given the lack of details.

3. Bank recaps: The capital position of banks will be expected to increase to 9% of Core Tier 1 by the end of June 2012. This was in line with pre-summit . The EBA announced its estimates for how much the banking systems of various countries would need in fresh capital: French banks need EUR 8.8 bn, German EUR 5.2 bn, Portuguese EUR 7.8 bn, Greek EUR 30 bn, Spanish EUR 26.2 bn, and Irish banks none. In total, as signaled previously there is a EUR 106.45 bn capital shortfall.

While many doubts remain over the program, the short term reaction of markets has been favourable and risk currencies, including the euro, will continue to perform. However, with the ECB likely to cut rates, we remain skeptical over the longer-term viability of the euro at these levels and would look to enter fresh short positions once the market has priced these outcomes in..
JPY
The BoJ left the official target rate unchanged but decided to conduct more easing via Yen 5 trillion of more JGB purchases. The size of this program is quite timid, amounting to a JPY 5tn increase to the size of an existing JPY 50 trn asset purchase facility. Increases in this ceiling have occurred several times in the past and we note that any easing of this sort would likely only have a very minor and short-lived effect on USDJPY.

Finance Minister Azumi said that Japan will take bold action on the yen if necessary, and that he wants to keep monitoring FX moves during Tokyo trading on Thursday. Intervention risk remains high.

NZD
The RBNZ kept the policy rate unchanged at 2.5%, and also left the policy guidance unchanged, retaining its explicit tightening bias. If "global developments have only a mild impact on the New Zealand economy" then "future OCR increases" may be needed.


A. White
Analyst at Fibosignals.com


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