FxPro Daily Forex Brief | Euro shrugs off Moody’s blues

Yet another example yesterday of the single currency failing to respond negatively to bad news - another sign that the quality of the price action is very different these days. Despite Moody’s adverse pronouncement on the outlook for eurozone sovereign debt ratings, the euro preferred to focus on other developments. Spanish and Dutch auctions went well and the German ZEW economic sentiment index for February was significantly above expectations. Indeed, the ZEW remarked that the current reading suggests that the recent slowdown is unlikely to last very long, and growth could pick up in the second half. After falling to 1.3125 early in the London session the euro recovered to reach 1.32. More short-covering and sovereign wealth fund-buying were behind the move. These days, the euro seems to really struggle to sustain lower levels, which must be encouraging for the bulls. We wait to see what, if any, effect the postponement of the Eurogroup’s meeting to ratify Greece’s austerity measures - that was scheduled for today but has now downgraded to a conference call – will have on the single currency.
Commentary


Moody’s is slowly catching on. Rather belatedly, Moody’s has finally recognised that the AAA debt ratings of both France and the United Kingdom cannot reasonably be defended. Sifting through the rationale for its decision on France in particular, one is left with the distinct impression that Moody’s will follow through with an actual downgrade at some point. Especially critical is its analysis of the deterioration of France’s government debt metrics, which Moody’s rightly describes as “among the weakest of France’s Aaa peers”. Government debt continues to climb to the point where it is now as heavily indebted as both the United Kingdom and the United States. Also, France’s ability to support this huge debt stockpile is complicated by the fact that it is not the “single risk-free issuer of debt denominated in its own currency”. Moody’s also questions the ability of French politicians to deliver medium-term austerity and thereby stabilise its growing public debt-load. Also disturbing is that the French government will be required to provide further financial assistance to help ailing European sovereigns and to shore up its banking system. Frankly, it is very difficult to justify an Aaa debt rating for France right now, and a downgrade (from Moody’s and/or S&P) looks inevitable at some point this year. Likewise for the UK, defending its Aaa debt rating is also becoming more problematic. Moody’s seems particularly vexed by the worsening growth picture and the potential for this to derail efforts to consolidate the government’s finances. According to Moody’s, public debt/GDP will stabilise later and at a higher level than projected by the government and, moreover, this debt-load will be quite elevated relative to its Aaa peers. As Moody’s summarises: “The combination of a rising medium-term debt trajectory and lower than expected trend economic growth would put into question the government’s ability to retain its Aaa rating”. As Moody’s correctly explains, there are a number of factors that continue to support the UK’s debt rating, including a diversified and “highly competitive” economy, a flexible labour market and a banking sector that is much more highly capitalised these days. The UK also benefits from various structural reforms that will help growth over the medium term. The long maturity of the public debt increases the shock-absorption capacity of the government, the UK has its own currency and an independent central bank that has strong international credibility. Also, the government has a strong commitment to fiscal consolidation, in contrast to some other European countries. On the debt rating front, France has more to worry about than the UK, but neither can expect to remain on the top rung for too much longer.


UK inflation heading in the right direction. With justification, it can now finally be pronounced that UK inflation is definitely heading downwards. Consumer prices fell 0.5% in January, aided by very sharp declines in footwear and clothing (-4.9%), furniture and household goods (-2.2%) and transport (the cost of air fares plunged 28.4% after a 40.9% increase in December). In YoY terms, inflation is now 3.6%, a 14mth low. Core consumer prices fell even more sharply, down 0.8% in January. In the past nine months, the core CPI is only up by 0.6%, which ought to be tremendously comforting for the BoE’s policy-makers. Indeed, the Bank expects inflation to decline to below 2% by the fourth quarter and, judging by these figures, it is definitely on track to achieve this. The high street is in the grip of intense deflation as consumers remain reluctant to spend amidst fiscal austerity and a crippling decline in real incomes. Import prices are decreasing, unemployment is rising and gas prices are falling in response to the very mild winter. Bank of England Governor King will be delighted, if only because his perpetual letter-writing to the Chancellor after the regular inflation disappointments will soon cease.  
Healthy doubts about Greek PSI deal. Germany’s Handelsblatt reported yesterday that some European central bankers have doubts that the PSI deal (due to be announced later today) will deliver the EUR 100bln reduction in Greek government debt. This is because the uptake from private investors will not be sufficient, which will force the government to pass legislation binding all investors to the terms as long as 50% agree. Naturally, this will result in massive lawsuits by the affected parties, contributing once again to uncertainty regarding the Greek debt position.



A huge injection of love from the BoJ. In recent weeks, many commentators felt that the MoF was preparing to unleash another massive round of intervention in order to reverse yen strength. As such, yesterday’s announcement from the BoJ that it was adding another JPY 10trln (GBP 82bln) to its asset purchase program was a surprise, with USD/JPY back up above 78 once more. Separately, the BoJ also declared an explicit inflation target of 1%. With the economy declining by an annualised 2.3% in the final quarter of last year, the BoJ was under pressure to respond. These days, quantitative easing is the policy de jour for the major global central banks. The BoE has just announced a third round of asset purchases, the Fed has intimated that it may also be prepared to implement another dose of QE, and the ECB is rapidly expanding its balance sheet by providing Europe’s troubled banking sector with access to unlimited funding. Although investors and traders alike are (rightly) deeply troubled by this deliberate currency debasement in the western world, it is unfortunately an unavoidable consequence of balance sheet-deleveraging. We had better get used to it. There is plenty more where that came from.  



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