Recap 2015-03-23: On the EUR

Commentary:

I’ve been very busy with some research projects the past week. I am optimistic that those efforts will bear fruit, but in the meantime, future updates will likely be intermittent. On the other hand, I will hopefully have a bit more to say when I do write.

Market action the past week has been quite interesting. I wrote a few weeks ago that there appears to be a large ‘duration squeeze’ following the ECB’s start of the QE program. I was too early in anticipating stabilization; it appears the squeeze is continuing. The chart below shows the US 30y Treasury yield vs the average 30y EUR sovereign yield. (the 4 largest countries)

What’s new over the past week is that for the first time this year, the yield differential has tightened. While that certainly does not mean that the duration squeeze is over, it does suggest that the intensity of the squeeze is slowing.

The other new item is that for the first time in several quarters, oil prices appear unable to break to substantive new lows. (oil in green below, EUR in white, 30y spread from chart above in orange, and the SPX vs Eurostoxx ratio in purple) This is pertinent because despite the fact that US oil imports have fallen dramatically, the world continues to run a USD to EUR trade balance via the OPEC countries, which tends to invoice in USD and spend in EUR. As a result, the EURUSD cross continues to exhibit decent correlation to oil.

The combination of a stabilization of both oil prices and yield differentials is notable in that they occurred in conjunction – the first time they had done so in recent months except for a few days at the end of January.

In addition, it is quite likely that the bulk of the move in both these factors is over. Obviously oil can’t fall another $50, and with the ECB QE broadly priced in, a further 100bp widening in the US-EU 30y yield spread is improbable.

Given that this backdrop is occurring in the context of a historically extreme move in the currency cross, (see my 2/13 note) there is a significant possibility of a continuation of this recent corrective move. I’ve noted that historical corrections in the EURUSD with this technical backdrop have been roughly 10 figures over the course of a couple months or so. The pace of the move this time suggests that the correction may be both stronger and shorter. We are only a couple weeks and 5 figures in so far; historical precedents suggest another few weeks and another 5 figures or so.

Such a move is likely to be quite pertinent for the US vs EU equity performance differential. A large part of the EU equity outperformance YTD has been pinned to the EUR, and EU equity overweights are currently extremely popular, according to surveys from both BAML and Barclays, among others.

Separately, some interesting points from Goldman on lower expected Neutral Rates:

  • Since reaching a local high in early 2014 after the ‘taper tantrum’ of 2013, our estimates for the neutral level of short rates have been falling both in the US and the Euro area. They are now around 3.25% in the US (on the latest available survey, taken in December 2014, they stood at 3.50%, while in June 2014 they were at 3.70%) and 2.5% in the Euro area. The gap in neutral rates estimates between the US and the Euro area is at the highest level post the global financial crisis.
  • By these metrics, the market’s estimate of neutral rates in the US is around 50bp lower than both the FOMC’s median longer-run federal funds rate and our US economists’ forecast.

To obtain a measure of term premium embedded in the curves, we subtract from the 5-year 5-year market yield the expectations of the 6-to-10 years short-term rates calculated as we described above. The latest numbers show that:

  • The term premium in the US is currently negative to the tune of around 70bp and is now at a historical low. For comparison, during 2012, it stood at around negative 50bp.
  • In the Euro area, the `blended’ term premium is at its historical minimum of negative 150bp.

My own estimate of the Neutral Rate is ~3% in the US and ~2% in Europe. As a result, I do not think yields are quite as mispriced as Goldman or the Fed, though still historically quite unusually low. The flow effects from the QE programs suggest that shorts should be placed at more extreme levels given that a full retracement is less likely.

Pretty funny:

http://www.telegraph.co.uk/news/worldnews/the-pope/11488383/They-are-going-to-eat-him-nuns-stun-Pope.html

Notable:

  • EU Consumer Confidence improved to -3.7 vs -5.8 exp and -6.7 prev. This is the highest print since July 2007
  • US Existing Home Sales rose 1.2% MoM vs 1.7% exp
  • Tsipras has warned Angela Merkel that it will be “impossible” for Athens to service debt obligations due in the coming weeks if the EU fails to distribute any short-term financial assistance to the country. The warning, contained in a letter sent by Mr Tsipras to the German chancellor and obtained by the Financial Times, comes as concerns mount that Athens will struggle to make pension and wage payments at the end of this month and could run out of cash before the end of April.
  • the Syriza gov’t is ratcheting up an investigation into the head of the country’s statistics agency over charges he inflated Greece’s deficit figures to justify the current bailout. The action will likely draw the ire of troika officials who are demanding a politically neutral head of statistics to ensure accurate and transparent numbers. WSJ
  • 7.4% was the slowest expansion rate of the Chinese economy in 24 years according to Credit Suisse

Upcoming:

  • Mon : Japan Markt PMI, China HSBC PMI
  • Tue: EU PMI, UKCPI, USCPI, US Markit PMI, New Home Sales
  • Wed: German IFO, US Durable Goods
  • Thu: German Consumer Confidence, EU Money Supply, UK Retail Sales, US Jobless Claims, US Markit Services PMI, Japan Jobless rate, CPI
  • Fri: UK House Prices
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4 thoughts on “Recap 2015-03-23: On the EUR

  1. One thing I think should keep in mind is that both these forces, have created or have been indicative of surplus savings. Lower energy, improve trade balance, lower price level, gets distributed to either output or assets. ECB money shock similarly distributed overwhelmingly to assets given credit demand, output responds to cheaper credit with lag. I think now we’re seeing some sign that lower rates are being met by lower savings and that atleast the initial overshooting in FX could be behind us. This means EUR up, USD down, and perhaps vol down. Also expect energy prices can recover w EM demand more resilient w stronger FX. Whether this just a pause or the end, i expect the USD retracement to be far reaching across much priced in USD terms.

  2. Very interesting! I had noticed the correlation between WTI and EURUSD before but I thought it was a spurious one. Could you point me to any reference materials that explain your trade balance thesis in more detail?

    Thanks

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