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“Even if the US savings rate stabilises at 7pc, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.”

                           Ambrose Evans-Pritchard

FX Trading – The risk to mere consolidation: euro

As we finished up last week with US Nonfarm Payrolls, we were left with a taste of risk-taking. US stocks breached resistance and the dollar flopped, barely holding on above support.

Now starting this week we wouldn’t be surprised to see some sort of consolidation (pullback, or sideways move) … as major data reports are sparse. There have been and will be, however, central bank meetings and decisions. The Bank of Japan and the Reserve Bank of Australia are already out of the way with barely a ripple in the markets to show for it. The Bank of England and Bank of Canada are on tap later in the week. The Bank of Canada has the most potential to stir things up, at least for the Canadian and commodity dollars.

All that said, last week was emphatically bullish for stocks following previous weeks of clear-cut bearishness and negative macroeconomic sentiment. It’s been noted how the VIX has not responded to the bearish tone to the extent it usually does.

VIX Daily:

Having broken through an old support level, the VIX is testing last ditch support before a
quick drop to April lows is possible. It appears the doors are opening for a rally to

Except the fact that stories regarding Eurozone banks are spooking the currency market
today. In April and May we saw how rapidly Eurozone concerns dragged down all
markets with a steady stream of Sovereign default analysis and commentary (see also
VIX chart above).

EURUSD vs. S&P 500 vs. Emerging Market Stock (EEM)

The bleeding was only stopped in June with the announcement of bank stress tests, the
ultimate goal of which seemed to be managing market perceptions rather than
uncovering the nastiness of banks’ financial positions. Traders and analysts were in synch prior to the stress test development, at which point analysts remained negative on the Eurozone banking system but market sentiment was swayed by the tests.

But as covered here by The Wall Street Journal this week, among the problems with the European stress tests were incomplete disclosures by banks.

An examination of the banks’ disclosures indicates that some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for "short" positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.

The start of the second quarter saw risk appetite rocked by news out of Europe. After a short recovery in risk appetite, fears of global recession 2.0 hurt investor sentiment. The markets seem to have stabilized with the release of various pieces of positive data from around the globe.

One day will not make a trend. But two days might get one started. We’ll watch to see if the market latches on to these renewed Eurozone concerns as this week pushes on. We’ll latch on to it … and here is why: the chart below shows the relative size of European banking compared to the rest of the world. This is why Eurozone banking concerns have been, and will be, so huge when it comes to its “systemic-ness.”
Of the $82.8 trillion bank assets in the G-20, $50.4 trillion (62%) are on the balance sheets of European banks.

Source: International Economy Magazine

And for those of us who like looking at spread charts, it’s not a pretty picture.

Greece 10- bond vs. 10-year German bund:

Ireland 10-year bond vs. 10-year German bund:

Not pretty indeed, as these two in particular are blowing off, signifying the increasing cost to borrow for Greece and Ireland relative to Germany. It goes back to the same fundamental question: Can these countries operate effectively, simultaneously, under a common currency?

Our answer is still the same: no.