EUR Surging As FX Repatriation Rears Its Ugly Head Again
Back in October, there were those who were confused how it was imaginable that European sovereign bond yields could be exploding to their highest in a decade, much as the EURUSD keep grinding higher. We clarified it, and said to prepare for much worse down the road. Certain enough, much worse came, and was promptly forestalled as both the Fed expanded its swap lines and lower the OIS swap rate, and the ECB “begrudgingly” ceded to LTRO 1+2 (that this resulted in nominal value gains was to be expected – after all humans delight in being fooled when value levels rise when in reality just the underlying monetary base has expanded). However how did the EURUSD spike fit into all this? Simple – FX repatriation. This was clarified as follows: “the sole cause for the EUR (and hence S&P and global 100% correlated equity risk) surge in the past 9 days is not driven by any latent “optimism” that Europe will fix itself, however simply due to the previously discussed wholesale asset liquidations (as none other than the FT already noted), which on the margin are explicitly EUR positive due to FX repatriation, courtesy of the advertise-sale conversion of USDs to EURs. Which method that the ever so gullible equity market has just experienced one of the largest headfakes in history, and has misinterpreted a pervasive European, though mostly French, scramble to procure liquidity at any cost by dumping various USD-denominated assets, as a risk on signal!” It appears we are immediately back into liquidation mode, and the higher Euro spread surge, the quicker EURUSD will rise as more and more FX is “repatriated.” In other words, as back in the fall of 2011, the quicker the EURUSD rises, the worstr the fair liquidity situation in Europe becomes: a critical regime alter, which will naturally fool the algos who assume every spike up in EURUSD is indicative of Risk On, and send ES higher when in reality, the underlying situation is diametrically opposite.
For those who missed the article back in October 2011, here it is again:
The Largest Market Headfake Ever: Is A Wholesale French Bank Liquidity Run The Sole Cause For The Euro, And S&P, Surge?
Over the past two weeks, there is one simple body that has been bugging skeptical macro observers: namely the paradox of i) just how hideous the European funding and liquidity situations have gotten, on the one palm, confirmed by the blow outside in French bond yields (the French-Bund 10 year spread just hit an all age record yesterday) as well as continuing deterioration in credit spreads across core European nations, yet, on the other, ii) the euro, exceptionally in that critical pair the EURUSD, has seen one of its most explosive rises in recent history, which as Zero Hedge pointed outside yesterday, has really decorrelated with the French-Bund spread, to which it had been firmly ‘pegged’ previously. As a result of ii), equity markets have surged due to legacy correlation arbs, which see Euro strength, and hence dollar weakness, as an empirical signal of equity “cheapness”, which in turn leads all algos to treat a rise in the EURUSD as a buying signal. So how is it that much with the interbank liquidity situation in Europe frozen and getting worse, further keeping in intellect that European banks are immediately expected to (or have already commenced – see yesterday’s go in PrimeX) engage in widespread asset liquidations, that broad market risk is perceived as cheap? Simple. As the following notice by Deutsche Bank’s Alan Ruskin clarifies, the sole cause for the EUR (and hence S&P and global 100% correlated equity risk) surge in the past 9 days is not driven by any latent “optimism” that Europe will fix itself, however simply due to the previously discussed wholesale asset liquidations (as none other than the FT already noted), which on the margin are explicitly EUR positive due to FX repatriation, courtesy of the advertise-sale conversion of USDs to EURs. Which method that the ever so gullible equity market has just experienced one of the largest headfakes in history, and has misinterpreted a pervasive European, though mostly French, scramble to procure liquidity at any cost by dumping various USD-denominated assets, as a risk on signal!
In other words, an internal bank run has somehow been interpreted to be stock positive… And there is your explanation for not only the paradoxical surge in the EURUSD and S&P, however why the correlation between the EURUSD and the Bund-France spread has completely broken down. Expect all of this to promptly, and very violently, fair once the market understands what an idiot it has been in the past two weeks.
From Deutsche Bank:
In the at the end hardly any days there has been talk that European bank repatriation of capital may be behind EUR strength. Setting aside the timing of asset sales, and the reduced universe of potential bidders for these assets, it is worth considering what happens when a European bank sells USD assets. European banks in aggregate are regarded as having a still sizable shortfall of USD liabilities. The BIS has done some of the most comprehensive employment on the USD shortage (see in particularly working paper: www.bis.org/publ/work291.pdf ). The most recent data for the end of 2010 (see the latest BIS annual report sheet 104), suggested the funding shortage had declined by at least half compared to before the 2008 crisis. More recently. the dependence on cross currency funding has gone up again, with the decline in US money funding. (DB’s Bill Prophet showed EUR region CDs of 7 of the 10 largest US money funds fell by over $70bn from May through September). Given this collapse, it is likely that European banks that do successfully sell USD assets, will try maintain the corresponding USD liability to mitigate against USD term funding that may not be rolled in the prospect. If a European bank sells a USD asset, it probably reduces the European Bank shortage of USDs by the sales amount. A smaller ‘USD shortage’, at the margin reduces the risk of a small USD squeeze of the sort seen in 2008, and to that extent is a minor USD negative, and EUR positive. It also fits with the EUR cross currency basis swaps coming in slightly of late, although this nearly certainly has more to do with global risk appetite. This marginal USD negative, EUR positive impact, should not however be confused with a foreign exchange transaction whereby USD’s are converted into EUR.
Much Deutsche Bank is scratching its head to clarify the dichotomy between the funding market and common risk. They do, however, provide the only absolute explanation, as opposed to the widely trumpeted by market cheerleaders ridiculous explanation that this is merely the latest “hope” rally. Ridiculous, since if that was the condition, one would see a thawing of interbank liquidity and defaults spreads. As Zero Hedge readers know, 100% the opposite has happened.
Notice also that the EUR is going in the opposite direction to much purer gauges of EUR tensions in the bond market. The collapse in OATS today is a major tale. This is not least since France is experiencing the negative side of its (still) AAA status and being a member of the core - the fiscal transfers are going toward the periphery and away from the core in terms of ability to tap the EFSF for bank recaps, and possibly bond insurance/guarantees. In the past, we have noted that the periphery flows fleeing toward the core has tended to leave the EUR trading like a closed system to the outside earth, which is one explanation for surprising EUR resilience to periphery travails. The latest French balance of payments data (http://www.banque-france.fr/gb/statistiques/economie/economie-balance/ec… ) again shows large French portfolio inflows that are very surprising, although the large errors and omissions do suggest the data is incomplete. (In the prospect, Target 2 balances will be another vehicle to employ to check the degree to which inflows are being concentrated in Germany solely). In any event, instability in the French bond market has the capacity to significantly reduce points of refuge for risk averse funds at the EUR’s (shrinking) core, and adds to DB FX team’s doubt about the sustainability of the EUR’s rally…
And so on.
Naturally, the Eurocrats will be delighted to associate the run up in risk assets and the European currency as a confirmation that the market is interpreting further lies, innuendo, and confusion as a risk on indicator, and is encouraging their behavior, when nothing is further from the truth. However, the largest beneficiary of the recent go is none other than the insolvent French banking system, whose very own liquidity run has caused asset values to soar, on an epic misinterpretation of underlying market signals, and thus sell much more into market strength, when in circumstance the market should be selling alongside France…
As for unwind catalysts for this most insidious market go, we are confident that the inability of the G20 to come up with any resolution over the weekend in Paris, nor the Eurozone Summit in one week to really present any relevant details vis-a-vis the continent’s bailout, or the EFSF’s expansion into some multi-trillion Bailoutstein monster, will not be met also happily by a market which has just realized it has been thoroughly fooled by the cash-crunched French banking system.
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