New Momentum

Lack of Liquidity and Market volatility

Liquidity is a key parameter in the currency markets and the hour during which neither of New York and Tokyo traders is properly active has always been a critical time for investors, who usually avoid trading if possible. This phenomenon, happening between 5pm and 6pm (NY Time), was this time exacerbated by a public holiday in Japan and, most importantly, by the Apple News which drove investors to the Yen.

At the start of the Asian session, the yen temporarily surged, taking more than 3.6% against the dollar at 104.87 yen, its highest level since March. Facing the euro, it gained 4% and rose to 118.71 yen, a level last seen in April 2017.

This flash crash was not only due to the Apple warning and lack of liquidity in the foreign exchange market but also came as a confirmation to analyst’s fear on the recent worldwide economic slowdown. Indeed, the move was not confined to one or two currency pair and, as we have seen above, also concerned the Australian dollar and some other emerging countries’ currencies.

The Yen is usually a Safe Haven for investors

As a safe haven, the Japanese currency tends to appreciate in times of political or economic uncertainty. It gained this status due to the stability of the Nippon economy (although its inflation has been anemic in the last years) and political stability. The country also accounts with a large number of investors holding money overseas and thus willing to rush back into domestic values in times of high volatility,

This tendency also spreads to Gold and Bond markets, also considered as safe havens by traders. Indeed, Bonds of G7 governments have had their best December in the last ten years according to a Bank of America Merrill Lynch index. For instance, the U.S Treasury yields have dropped 60bps since the beginning of November, while the German 10y yields are around their lowest in 26 weeks. On its side, Gold price hit its highest level in 6months at 1.292,42 dollars.

Lasting trend?

The yen has been surging at a 5% rate in the five last weeks, its biggest increase in 2 years.  In the meantime, the Dow Jones suffered its worst weeks since 2008, down by 11,4% over the month on mounting worries over the direction of the global economy.

USD/JPY 1 Months Chart (01/04/19)

Source: Bloomberg

What are the reasons for such moves? Investors are generally worried over global eco slowdown (particularly in Europe and China), and Political risks (shutdown in the US, Brexit in the UK, etc.). To that fear recently summed up the first real effects of trade war on companies’ earnings (e.g. Apple) and the announcements of the Fed on more moderated than expected interest rate hikes.

Global fear has only been confirmed during the first days of 2019 with the release of economic statistics: the euro area PMI has reached a low for several years, following a sharp decline in the Chinese PMI at its lowest point in 19 months. In the US, the manufacturing activity indicator (ISM) saw its largest decline in a month since 2008, to reach a low for two years, suddenly lowering the dollar.

Whether this market trend will last will then highly depend on next months economic figures and whether a growth slowdown is confirmed or not. This will automatically depend on a various range of factors including US-China trade talks, Brexit or Central bank policies.

Côme Vigoureux

Sources: Bloomberg, Reuters, Financial Times

On the EU side, a target deficit equal to 2.4% is considered to be excessively liberal with respect to the path that has been set previously, allowing a deficit around 1,6% over the GDP, with the aim of progressively reducing it in the future. However, on the other side, the League-5 Star Movement coalition has clarified that it would not even consider the possibility of reviewing the plan. Their belief is that, being Italy a sovereign State, any decisions concerning the economy should be taken internally without any other external influence. Nonetheless, the EU Commissioner in charge of the euro, Mr. Valdis Dombrovskis, invoking the principle of trust and the agreed rules on which the European Union poses its bases, wishes for an “open and constructive    dialogue” with the Italian authorities, as hoped by the Prime Minister, Mr. Giuseppe Conte, as well.

As for markets’ reaction, after the EU Commission’s rejection, the FTSE MIB, the main Italian stock index, fell by more than 5% with the banks’ stocks registering the worst results. In the following days, the stock market has rebounded partially recovering what had been lost.

As for the fixed income market, a significant sell-off of Italian Government bonds occurred leading to rising yields due to a higher risk premium required by investors. As a matter of fact, the yield on 2-year sovereign bond jumped from 0.79% to 1.25%, whereas the one referring to the 10-year Italian government bonds increased from 2.91% on Thursday evening to 3.25%. The spread over the 10-year German Bund has been put under pressure as well, breaching 340 bps before getting back below 320 bps. In addition to what has been said already, the downgrading inflicted to Italy by Moody’s, that cut the rating from Baa2 to Baa3, has worsened the turmoil on the markets.

What are the next steps now? Well, assuming that the Government will keep its word and will not intervene to change the budget, the EU would open an “excessive deficit procedure” that, in 2019, could result in pecuniary sanctions. Nonetheless, it seems quite unlikely that these sanctions will ever come into force because they could just bolster the populist sentiment in the country, increasing people’s preference for the coalition already in place.

As for investors, they should watch closely the future events related to Italy, since they could put under pressure the Euro and other European countries, which now represent a solid alternative investment to Italy, especially dealing with corporations of safer countries like Spain and France.

Paolo Barbusca

References:

• La Repubblica
• Ilsole24ore
• Financial Times
• Corriere della Sera

Starting from the first half of May, the two Parties who got most of the votes, the 5-Star Movement and the League, have negotiated, through their leaders Di Maio and Salvini, to draft a “contract” that would include all the changes that will be pushed forward with for the next years by this totally unexpected coalition.

Eventually, on the 27th May, a list of Ministers was presented to the President of the Republic Sergio Mattarella by the PM-designate Giuseppe Conte. However, due to the presence of the Eurosceptic economist Paolo Savona as Minister of Economy, the President vetoed the proposal so as not give a bad signal to the markets, namely a possible “Italexit”.

As a consequence, a political crisis followed and markets reacted promptly by massively selling Italian Government Bonds, leading the spread to the highest levels since 2013. Indeed, for the 10-year bond, the spread overtook the threshold of 300 bps, up to 320 bps, then reaching 273 bps on the 31^st May. At this point, three possible scenarios were considered: the first one saw new national elections in autumn with a “transition” Government led by the former PM Gentiloni; the second one dealing with the chance of having a political Government led by the League and the 5-Star Movement and, finally, the formation of a technical Government that could guide the country until new elections in July.

After this, on the 1^st June, finally an agreement was reached to form a political Government with Conte as PM and Savona moved from the Ministry of Economy to that dealing with European Affairs. As far as the two leaders are concerned, both Salvini and Di Maio have been nominated not only vice-PMs, but also Minister of Internal Affairs and Minister of Labour, respectively. After this news, the spread on the 10-year bond fell by 24 bps, from 257 bps to 233 bps, meaning that it was fairly appreciated by the markets, looking for a bit of calm after the storm.

Will it last? It is not easy to say, because it will strongly depend on how the new Government will act, especially regarding the relationships with the European Union, that has always represented a “delicate” matter for the two winning political parties. In addition to this, it should also be considered what is currently happening to the surroundings, especially Spain. Indeed, after the Parliament’s vote in favor of no-confidence towards the ex-PM Rajoy, on the 1^st June, and the appointment of the socialist Pedro Sanchez (PSOE), the spread for 10-year bonos has gone through pretty volatile hours, but it is now stabilizing again below the 100 bp threshold, after even breaking the barrier of 130 bps.

What are the takeaways for the investors? Calm and cautiousness are key. Generally speaking, the outlook for the Eurozone is very good. So, even in these times of volatility, it is useful to look at fundamentals: both Italy and Spain are rich countries and with good economic growth perspectives. Having said that, it seems safe to state that investing in these countries is always a good option, even in difficult times, since, due to this positive economic momentum, companies are always willing to invest in their growth and future.

Paolo Barbusca

References: La Repubblica / Ilsole24ore / El Pais

Notwithstanding, there is one topic that is rightfully considered crucial for the market’s becoming, i.e. the heterogenous strategies written on central banks’ agendas. Why are they so important? Because they significantly drive the path of relevant factors, such as inflation and interest rates.

Starting from the Eurozone, during the press conference, held on 25th January, at the end of the ECB meeting, Draghi’s words have been aligned to market expectations one more time. Indeed, as anticipated by market actors, the ECB left unchanged its plans. As a matter of fact, the QE has not been reduced and it might rather be prolonged if needed, in order to sustain the inflation rate, whose ideal value is close but not higher than 2%; the level of interest rates remains stable at -0.40% for the deposit facility, 0.00% for refinancing operations and 0.25% for marginal lending facility. In addition, according to the President’s speech, they could be maintained at the current level even after having ended QE, keeping unaltered the forward guidance.

EUR/USD February 2017 – January 2018

Source: Bloomberg

As for the EUR/USD exchange rate, it went up during and immediately after the speech, hitting +0.67% while Draghi was pointing out his worries due to the strengthening of the unique currency during the last days, and how this behavior might increase uncertainty about the immediate future.

EUR/GBP February 2017 – January 2018

Source: Bloomberg

Similarly, the Euro gained 0.27% against the GBP, lightening the pressure undergone at the beginning of this week. Moving on to the bond market, right after the announcement, German 2yr and 10yr bunds have seen their yields go down at -0.591% and 0.577% respectively, losing about 2-3bps. As far as Spanish and Italian 10yr bonds are concerned, they presented, at first, an opposite behavior. The former went down, in terms of spread over the related bund, by 7-8bps, whereas the latter increased its spread by 7bps. However, they went back to their previous values and eventually set at 1-2bps higher than their initial level.

On the contrary, in the US, there is something different going on. Overseas, the Fed keeps following the path of rising interest rates traced in December 2016. Currently, after the last hike in December 2017, the fed funds rate has a target range of 1.25%-1.50%. On 23^rd January, the US Senate confirmed Jerome Powell as new Governor, succeeding Janet Yellen, in charge starting from February 2014. According to the expectations, the new head of the Federal Reserve should not walk away from the current policy, therefore, new hikes are expected to take place over the next months. These decisions have immediately had a significant impact on US bonds’ interest rate curve. However, not all the maturities have been equally affected, since, usually, the shorter maturities are those undergoing a more relevant impact due to policy changes.

Daily Treasury Yield Curve Rates

Source: US Treasury website

In fact, looking at the Treasury Yield Curve Rates chart, it seems safe to state that the curve is flattening, due to the marked rise of rates for shorter term maturities, while those of longer maturities have slightly decreased. Currently, the spread between 1-month bond and 30-year bond rates is lower than 170bps. On January 2016, i.e. eleven months before the first hike by the Fed, the spread was consistently higher, at 255bps. As a consequence, it is possible that this contingency might lead to higher savings and investments in money market instruments and credit-deposits, as profits for short-term and safer products are increasingly growing.

In conclusion, considering the present situation, in the US, Government bonds seem to represent a good compromise between return and risk, even at shorter term maturity. On the contrary, having examined what is happening in the Eurozone, investors, who are striving to capture proper remuneration on the market, seem to be willing to accept to invest in alternative products, walking away from traditional instruments that, for now, are not paying out.

Paolo Barbusca

References:

• https://www.reuters.com/article/us-usa-fed/fed-raises-interest-rates-keeps-2018-policy-outlook-unchanged-idUSKBN1E70IX
• Bloomberg

As a starting point, markets did not react as expected as the Spanish risk premium (the spread between the interest rates of a 10-year Spanish government bond and a 10-year German bund) has decreased to under 120 basis points. Moreover, the economy minister, Luis de Guindos, has ruled out that investors are fleeing from Spain as a result of the political tension. According to him, the scenario that investors are considering is one where Catalunya will remain a part of Spain. However, the Spanish financial regulators don’t seem too calm regarding the future of markets over the next months. The regulators in Spain, known as the CNMV, have warned that, over the medium term, the prolongation of the Catalan crisis could have a significant impact on economic activity and markets overall. They explained that there could be a tightening of the conditions required to get funds and a loss of trust that might bring down valuations and outbreaks of volatility. However, Spain remains the fastest growing economy in the Eurozone with a 3.1% increase in GDP over the second half of 2017 and one of the most attractive countries in the Europe for investments.

Spain’s Risk Premium compared to Germany

Source: countryeconomy.com

Spanish risk premium

On the 23^rd of October the regulators in Spain published an indicative stress index of the financial markets corresponding to the 3^rd quarter 2017 and October. The index had a minor upward movement which was attributed to the crisis in Catalunya, but the level remains low.

Until now, the highest level of stress remains within the fixed income segment, due to the increase of volatility as much as to the worsening of liquidity. Furthermore, if we focus on the Catalan region we see a strong effect caused by the sovereign crisis given that the yield of the Catalan bond violently jumped as Catalunya’s president Puigdemont came before the parliament where the declaration of independence was expected to be announced. In only one week the Catalan bond yield maturing in June 2018 went up from 2% to 3.6%. These yields are not normal for securities of less than one year in the eurozone. Also, the spread between the Catalan region risk premium and that of Spain reached 300 basis points.

Autonomous Community of Catalonia Bond 06/2018

Source: Bloomberg.

EURO

The euro has not looked away from the Catalan crisis. During the first weeks of October, the European currency lost position against the USD decreasing by as much as 0.5% in one day. However, the markets felt relieved when the central government decided to bring back normality by using article 155. This is yet another situation where the exchange rates have demonstrated to be highly influenced by the international political-economic circumstances.

EUR/USD October 2017

Source: Bloomberg.

As for equity markets, on the 4^th of October, the IBEX-35 went down as much as 2.8% in one day, being the biggest registered fall since BREXIT. Over the next days, this fall has started to stabilize as two of the key Catalan banking players, Sabadell and Caixabank, announced that they will move their headquarters out of Catalunya.

IBEX-35 October 2017

Source: Bloomberg.

The independence movement is struggling to find a way forward after the regional leader fled out of the country and is now seeking asylum in Belgium. As of today, only 33% of the people in Catalunya are supporting the independence process. Two things are for certain, markets have shaken off any negative effect caused by this political uncertainty as tensions are dissolving, and it seems that the central government has pulled off its strategy to invalidate Catalunya’s shout of independence. Also, there is a trend in currencies where political and economic scenarios are the most influential power in volatility nowadays, which is why it is important to focus on these areas when assessing an efficient risk management strategy before moving on to the fundamental analysis.

Rafael Neira

References and sources:

http://www.abc.es/economia/abci-cnmv-advierte-crisis-cataluna-puede-tener-consecuencias-notables-sobre-mercados-201710231851_noticia.html

http://www.expansion.com/empresas/banca/2017/09/27/59cb9ace22601d56248b456b.html

http://www.ideal.es/economia/reacciones-mercado-financiero-20171027124356-nt.html

In fact, the FED makes decisions regarding the Federal interest rates based on the conditions of the labor market and the U.S. core inflation rate. While the first has gone up significantly as of today, the second one is still weak. The FED inflation target over the long period is 2%. In order to comply with this objective, taking into account overshooting, the short-term inflation should be at a level near 3%. The data of July show a core inflation rate of 1.7%, well below the target rate. The data released by U.S. authorities today, 13^th of September, seem better, but not conclusive.

President Yellen, inside the FED board, is the principal supporter of a cautious policy of tapering, waiting for the inflation rate to reach target level. In various statements, Mrs. Yellen argued that inflation will eventually materialize given the continued improvement in the job market.

Some critics of the Fed president argue that it is not so sure that core inflation will rise near FED’s target in the short period. This is because a long period of low inflation (up to now it’s five years of core US inflation rate below the FED expectations) creates expectations for more of the same, and so consumers are not concerned about buying today if they can wait some years. For this reason, they sustain that it is meaningless to wait for a higher inflation to raise the Federal interest rates for the simple reason that it is possible that the inflation will be as low as now for many years.

But what are the effects of low interest rates on the economy? The interest rates have a strong impact on the bond, equity and on the FX market (USD).

As the easy money policy is reaching his 10-year anniversary, the equity market is still booming. There are concerns about the equity market has finally got used to these extraordinary measures, but the consequences of this assumption could be disastrous. A future clear path of tapering could in fact bring the equity market to collapse, with effects similar to those of the financial crisis of 2007, that led to the economic crisis of 2008.

Another effect of persistent low Fed interest rates is felt on the level exchange of the USD. The US currency exchange rate, without the implementation of a clear tapering policy, will likely remain low versus other currencies like Euro and Pound. Many observers argue that the Fed and the US Government want to keep the dollar competitive on the FX market, and this could be another explanation for persistent low Fed interest rates.

As Ms. Yellen will end her mandate on February 3^rd 2018, and it is quite sure that she won’t be nominated for another mandate, the next Governor will have to decide whether to continue with the cautious policy of Yellen or begin a hawkish tapering policy. This choice will have a huge impact on the bond, equity and FX market, and in general on the US and World economy.

Filippo Bernardi

1. Core inflation reflects the long-term trend in a particular price level. It is a measure of inflationthat excludes certain items that face volatile price movements because in finding out the legitimate long run inflation, short-term price volatility and transitory changes in price must be removed. Core inflation is most often calculated using the consumer price index (CPI), which eliminates products — usually those in the energy and food sectors — that can have temporary price shocks because these shocks can diverge from the overall trend of inflation and give a false measure of inflation.

FUENTES: www.financialtimes.com  https://data.bls.gov/timeseries/CUUR0000SA0L1E?output_view=pct_12mths

Shareholders and non-privileged debt holders will also contribute for 4.3 billion, with a strong protection for the mis-selling debt holder that will receive their money back (approximately 1.5 billion). On the 5^th of July, the CEO of Montepaschi Marco Morelli has announced a five-year plan for the bank, with huge structural and staff cuts (up to 5.500 workers until 2021) and the dismiss of 28.6 billion of non-performing loans at the end of the plan. The forecasts are of a net profit of 1.2 billion and a ROE of 10,7% by 2021.

This rescue presents a completely new structure compared with the previous ones. Only ten days ago, the Italian government approved a plan that can cost up to 17 billion to the State to facilitate the sale of Banco Popolare di Vicenza and Veneto Banca to Intesa San Paolo (it must be said that the situation was unsustainable and a rescue similar to MPS was impossible). MPS rescue plan mix the bail-out (Monte dei Paschi has been substantially nationalized) with a light version of the bail in (there is a substantial contribute of shareholders and non-privileged debt holders), with a full reimbursement to the mis-selling debt holders. The Italian minister of Economy Pier Carlo Padoan has said that this operation represents a milestone in the consolidation of the Italian banking system, and the government will continue its efforts in this sense. He also added that the intervention of the State will be temporary.

Despite the obvious differences regarding this case, the Italian government struggled and it’s still struggling to get rid of Alitalia, the flight company that received the first government aid in 1974. At first sight, the rescue plan doesn’t seem like a big deal for the centre-left Gentiloni government.

However, the opposite could be true given a set of facts that should be considered. Gentiloni has learnt from the Banca Etruria experience of his predecessor Matteo Renzi, where the mechanism of the bail-in was fully applied. The two main opposition parties in Italy, the Movimento 5 stelle and the Lega Nord, have been extremely critical on the operation claiming that the government had left the investors alone. After that experience, the Movimento 5 stelle and its recognized leader Luigi Di Maio publicly declared the preference of the party for the bail-out system. Even the exuberant leader of Lega Nord, Matteo Salvini, seems not to be so critical about the MPS rescue. In this sense, the political repercussions of the operation for Partito Democratico appear to be limited.

Regarding the repercussion on the stabilization process of the Italian banking system, this operation presents huge risks. First, because it moves exactly in the opposite direction with respect to the European directive of bail-in. The European Union is trying to shift the bank’s failure risk from states to investors, but in this case the greater amount of the risk has fallen on the Italian government. Secondly, this can represent a danger precedent to future critical situations, with Italian regional banks full of non-performing loans. The big question is whether the State can transform MPS into a profitable bank, and then sell the bank on the market within a few years.

In any event, it will be fundamental for Italy to best manage the Monte dei Paschi di Siena rescue, because a potential failure could have a disastrous impact overall the Italian banking system.

Filippo Bernardi

Sources: ilsole24ore.com

2017 is a decisive year for the future of Europe with these different presidential elections. In March, we will assist of the election of the Netherlands, before the Germain election in this autumn. France will elect its new president on 7^th of May 2017. These elections are decisive for the whole Europe and the CAC 40. With its partners, the future presidents of these countries will decide about the new trajectory of Europe, which is currently facing several crisis.

In a global way, Europe growth is confirmed but it is not accelerating. For example, in France, the end-of-year accounts for 2016 show an upturn for most major French companies. Nevertheless, the discount of European large-cap and mid-caps compared to the US is measured with a difference of more than three points of the multiple of capitalization of profits. This 20% delay could be reduced by the confirmation of economic trends, but it is politics that will have the greatest impact on the future of the economy.

As for the French elections, Front National candidate leads all polls. From February 20 to 24, Marine Le Pen remains in the lead in the first round despite the affair of the parliamentary assistants of the FN. However, it lost ground in the second round after starting the week at its highest level. The case of the “Penelope gate” has dropped the right candidate, Mr. François Fillon. Currently, France and more globally the world fears a rise of populism and a fear of Europe. Marine Le Pen advocates an exit from the Monetary Union if elected.

Let us take a point to illustrate the case of France. If Mrs. Le Pen is elected as president, France will be forced to change money; The question of debt will arise. If France were to return to the Francs, she would have to pay her debt in the new currency to her creditors. In fact, forced conversion into French francs will be detrimental to French creditors because the new currency will lose its value compared to the euro. Some analyst talk about two possible scenarios, the devaluation of the state or the attack of the markets against this currency.

The possibility of the election of Le Pen scares foreign investors in the French debt. They prefer to turn to a value called “refuge”, the German debt, which is considered safer. This is at its peak. The German treasury raises the question of increasing its debt to meet market demand. In recent weeks, the rate of German debt collapsed down to negative. The German rate is currently around -0.96%. Even the ECB buys its German debt with pleasure over short or medium periods.

Moreover, the evolution of the euro is correlated with the French political context. After going down on the 22^nd of February, the announcement of M Barou to join the centrist M Macron put the euro back on the rise. The financial markets, financial analysts and other countries of the world keep a suspicious eye on the French political situation and fluctuations in voting intentions.

References:

http://www.touteleurope.eu/actualite/election-presidentielle-2017-quelle-place-pour-l-europe.html

https://www.challenges.fr/finance-et-marche/marches-financiers/l-election-presidentielle-en-france-pese-sur-la-bourse_455080

http://www.lesechos.fr/elections/marine-le-pen/0211826787758-la-france-peut-elle-convertir-sans-probleme-sa-dette-en-francs-comme-le-jure-le-fn-2067677.php

http://abonnes.lemonde.fr/economie-mondiale/article/2017/02/22/l-euro-remonte-face-au-dollar_5083957_1656941.html

http://www.leparisien.fr/economie/election-presidentielle-les-investisseurs-se-desengagent-de-la-dette-francaise-21-02-2017-6698517.php

http://www.lesechos.fr/finance-marches/marches-financiers/0211832341792-proches-de-la-penurie-les-emprunts-detat-allemands-victimes-de-leur-succes-2067861.php

Taking the USD/MXN and the EUR/MXN as a reference, there has been a clear depreciation of the Mexican currency when the presidential elections saw Trump leading over Clinton. From this point on, the polls became a reliable reference of the MXN performance. We should also consider that the EUR/MXN has suffered considerably from the OIL CRUDE depreciation over the last 2 years, and the domestic conditions in Mexico are accentuating this effect.

Moreover, the US elections and the peso have been flirting with each other, evidencing a correlation between fluctuations in the MXN and official presidential polls. Then, the presidential debates started and, after a weak performance of Mr. Trump during the first debate, the Mexican market felt relief. The EURMXN went back to the 21.0000 level (-1.67% change in one day after the second presidential debate). It is evident that the U.S election barometer gives a clear picture of how the MXN reacts to changes in the presidential race. Since the first debate most of the US citizens agreed on the fact that Clinton took the lead over Trump and it continues this way even after the final debate. The MXN is facing a violent correction now that Clinton’s policies will most probable be the next US economic and social policies by 2017, which are not as harsh to the Mexican economy as Trump’s proposals.

However, the currency that everyone is suddenly talking about (MXN) isn´t just getting crushed because of Donald Trump. The peso was still lagging its regional counterparts well before Trump’s rise in the polls. We should note that the peso has weakened by more than any other major emerging market currency, except for the Argentine peso, which has suffered from the country’s inflation. Also, Mexico is facing the risk of credit rating downgrades if it fails in cutting back spending next year and shrinking its deficit.

 Source: Capital Economics

During 2015, the state-owned oil giant Pemex was facing short term financial difficulties after reporting a $32 billion full-year loss. Additionally, some analysts argue that Mexico’s “chronically weak productivity growth” is also to blame for the weakness in the MXN because Mexico’s industrial production has stagnated since early 2015. But after considering all these political and economic effects on the MXN, is it a good time to buy MXN?

Probably not, since it is important to recognize all other drivers for the second actively traded emerging market currency besides US politics. Factors such as macroeconomics, domestic political forces, and the general risk appetite have powerful influence over the peso. In any way, European and American exporters should acknowledge the fact that the current market scenario is putting Clinton as the next president of the US. which could make the MXN appreciate even more against the dollar. In any case, volatility in FX market will be a major concern for international corporations for the upcoming years and efficient hedging strategies should be put in practice to prevent negative impacts on financial results.

New Momentum will keep tracking the FX market ahead of the U.S. presidential elections on the 8^th of November 2016.

Sources:

http://www.bloomberg.com/news/articles/2016-09-27/this-is-how-wall-street-is-scoring-round-one-of-clinton-vs-trump

http://www.businessinsider.com/marc-chandler-says-do-not-buy-mexican-peso-2016-10

http://finance.yahoo.com/news/trump-fears-fade-other-risks-193357057.html

https://www.dailyfx.com/usd-mxn

https://www.fxstreet.com/rates-charts/usdmxn

By Todd White
(Bloomberg) — For all the investor frenzy over a possible
Brexit, pound bears need a decline of about 2.4 percent to make
money through options should Britain choose to exit the European
Union.
A trader will cover the cost of an option premium if
sterling falls to $1.4186 over the next month, from $1.4537 at
10:33 a.m. in London, according to broker quotes compiled by
Bloomberg.
That pricing suggests that either traders are more sanguine
about the risks of Brexit, or they see less of an effect on the
currency than some banks and money managers who have predicted
the pound will lose as much as 20 percent of its value if the
U.K. quits. A smaller move, or a gain, will see a trader lose
all the upfront premium they paid for the put option.
The run-up to Britain’s unprecedented vote on June 23 has
driven brokers to price in the highest one-month implied
volatility since 2009. They’re seeing the pound liable to swing
higher or lower by an annual 22 percent. That’s boosted the cost
of options, particularly the one-month contracts expiring after
the referendum’s results are published. Even so, downside
protection is still not prohibitive, according to some
investment advisers.

Cheap Hedge

“Considering this is the biggest volatility since Lehman
Brothers’ bankruptcy, the hedge is still cheap to make if you
really think Brexit can happen,” said Bruno Atlan, a former
currency trader who’s now chief executive officer of New
Momentum Consultant SL in Madrid, an adviser to corporations on
investments. “I don’t think Brexit will happen, but hedge funds,
corporates and other players are speculating on it.”
The U.K. currency has had a tumultuous start to the week as
opinion polls gave conflicting messages about the likelihood of
an EU exit. It fell by as much as 1.1 percent on Monday, and
gained as much as 1.5 percent the following day. On Wednesday,
it fluctuated and fell as low as $1.4501.
For money managers, options are an integral part of
managing risk, with a daily average turnover of $104 billion in
the U.K. alone, according to Bank of England data. The current
level of volatility is raising the cost of seeking such
protection. The pound’s implied volatility compares with a 10-
year average of 9.3 percent, and a current level of 9.6 percent
for the euro.

Preparing for Aftermath

As Brexit risks become more imminent, traders and market
operators around the world are preparing for the decision.
Margin requirements are getting raised, bank traders will be
working overnight in London, and investors from Thailand to
Boston are waking up to how their positions may be affected if
Britons choose to leave the trading bloc they’ve been in since
1973.
Investors and analysts are forecasting turmoil if a Brexit
occurs. Adrian Lee, the founder of Adrian Lee & Partners, which
oversees $9 billion of foreign-exchange investments for money
managers, predicts sterling would fall 20 percent on a vote to
leave the EU over the course of two to three days, with much of
it on day one.
A Bloomberg survey of economists in February showed 29 out
of 34 economists in a Bloomberg saw it sinking to $1.35 or below
within a week of a vote to leave — levels last seen in 1985.

–With assistance from Tanvir Sandhu, Itay Dafna and Vassilis
Karamanis.

During the general elections on December 20, Spain understood that the alternation of power between the Popular Party and Socialists had come to a possible end. They now find themselves challenged by the new rising parties of ‘Podemos’ and ‘Ciudadanos’, a far-left party that came third in the general elections and a centrist party that came fourth, respectively. It was indeed one of the most closely-fought legislative polls that Europe has seen in the last decade, and now Spain is experiencing uncertainty since the Popular Party lost its absolute majority and it’s now forced to form an alliance with other party in order to govern.

Since Spain welcomed a new government led by the president of right wing ‘Popular Party’ (PP) in 2011, the country has had major changes in its economy after suffering from the impact of one of the biggest financial crisis the world has experienced. Mariano Rajoy’s administration has intended to put Spain on a new path towards economic recovery by establishing new reforms. The prime minister had positioned himself as the head of state who managed to drag the country away from economic collapse. However, unemployment remains substantially high at more than 21 percent and, during the last political campaign, Rajoy’s rival parties also made emphasis on the increasing inequality that the country is suffering from, brought on by the Popular Party’s drastic spending cuts, tax rises and health reforms. But how does Spain’s economy really look over the last years of the Popular Party administration? How would a government led by the socialist party PSOE, assisted by far-left wing government ‘Podemos’, affect the economic landscape of Spain in the short and long run?

Economic policy under PP has remained static due in part because the party’s administration has already seen a substantial improvement of the economy in terms of less unemployment and more GDP growth than other EU countries. Nevertheless, economists agree that there is a lack of action by the current government and that improvements in the form of innovative reforms should take place right now in order to keep boosting the economy. But Rajoy’s administration is reluctant to intervene with more reforms because they see progress with those imposed back in 2011 (mainly fiscal and labour reforms). In this sense, if the decisions they have made since 2011 have improved the economy, why should they try new things? Some would say that a lack of intervention by the government will keep the economic recovery going, in fact, the Popular Party is waiting for the economic cycle to do its job and bring things back to normal like they were in 2006 before the crisis hit.

We should start by giving a detailed look at how the Spanish economy has evolved after the crisis of 2008 under the command of the Popular Party, and then we’ll move on to analyse the possible economic scenarios under a probable left wing administration led by ‘Podemos’ party.

After the housing crisis and subsequent employment crisis, domestic demand in Spain decreased substantially, for this reason the country needed to become more competitive in the global markets and so the Popular Party decided that decreasing labour costs was the best option, because this would in turn allow Spanish exporters to reduce their prices and foreign companies to settle businesses in Spain, thus creating more jobs. More specifically, Rajoy enacted a monumental labour reform in 2012 with the Royal Decree Law 3/2012, which consisted in reforming the collective bargaining aspect of Spanish labour and adjusting the employment protection legislation. These reforms were aiming at reducing Spain’s labour costs and wrest power from its employees. In this sense, businesses could hire and fire employees without incurring high costs. The fact that a company was less profitable was reason enough to lay off a certain number of employees. With this flexibility, corporations were more eager to hire people. This in fact had a major impact on the unemployment rate, which supports the idea that the reforms imposed by the Popular Party appeared to have achieved a mechanism of decreasing unit labour costs and increasing productivity.

On the other hand, left wing party Podemos is proposing a substantial increase in public spending (96.000 million euros in four years) which most analysts agree would bring consequences to the Spanish economy. A boost in public spending could hit company profits and thus lead to a reduction in private investment and economic growth. This could also increase inflation and, since firms are less certain investment will be profitable, unemployment and inequality could rise in the long term. The anti-austerity measures by the left party include an increase in spending on health, education, dependency and social protection, and an investment fund that will be used for energy transition, which will intervene and nationalize the electricity market. This is a crucial point in Podemos administration since people are more aware of climate change and how important a transition from traditional energy sources to clean renewable energy is for the economy. There can’t be a growth model in this century that neglects the challenge of climate change. Consumption and production subsidies for fossils fuels that damage the environment are serious obstacles to a new green growth model, and this is where the Popular Party and Podemos differ. Spain is still subsidising domestic coal production for power generation (traditional means of energy) and there is limited taxation on fossil fuels, which do nothing to promote the transition to new sources of renewable energy. If the Popular Party keeps its policies away from renewable energy and innovation, the costs for Spain’s economy could be even higher in the long run.

Moving on to the government budget, Spain has had a notable reduction of the deficit since Mariano Rajoy took office in 2011. However, even though the economy has been put on a new path towards substantial recovery, the European Commission estimates that the deficit in 2015 was about 4,8% in 2015, compared to a 4,2% that they had as their objective, and it’s probable that the deficit will stay around 3,6% this year, compared to an objective of under 3%. These numbers are important to consider because Spain could see a coalition of both socialist party ‘PSOE’ and far-left wing party ‘Podemos’, which could take the deficit even higher due to the amount of increasing spending that both parties proposed in their campaigns. But how will the economy react to this? Firstly, not complying with the deficit limits imposed by the European Commission would lead to a conflict between the Spanish government and the Commission in Brussels, this in turn could result in an increase in interest rates as Spain would become a riskier investment, especially if there was a risk that the ECB would stop buying Spanish government bonds. However, this scenario is less probable given that an increase in government bond rates will generate pressure on both parties and will eventually make PSOE and Podemos back off from its public spending decisions, which are key pillars of their political campaigns.

Overall, it seems that the Popular Party has imposed the appropriate fiscal and labour policies, this is evident in the reduction of the unemployment rate and the GDP growth that the country has enjoyed during 2015. However, there is a conflict between meeting the European Commission’s deficit objective for Spain (which is one of the main goals of the Popular party) and meeting the needs of many Spaniards who strongly want to see changes in health, labour, education, and innovative solutions for the younger generations and the environment, which are the investments that PSOE and Podemos are really committed to do.

In brief, Spain’s economy is at a stable position waiting for a final agreement between the parties, unemployment and economic growth are at stake, and it seems that a coalition between parties will still result in conflict and will negatively affect the economy. The Popular Party has done things right but the economy needs new and innovative reforms if Spain wants to boost its economy to the levels it enjoyed back in 2006 before the crisis. In any case, one thing seems to be crystal clear, the two ancient parties, the old left and the old right, won’t have power anymore. For now, a vast number of the population wants to see drastic changes.

References:

http://www.businessinsider.com/afp-spain-faces-struggle-to-form-government-after-historic-polls-2015-12

http://www.expansion.com/economia/2016/02/15/56c24964e2704e18548b45bf.html

http://www.studentpulse.com/articles/921/3/the-spanish-financial-crisis-economic-reforms-and-the-export-led-recovery

http://negocios.com/noticias/propone-iva-25-lujo-subir-irpf-hachazo-sicav-15022016-1303

http://www.bloomberg.com/news/articles/2015-03-08/spain-s-post-franco-elite-under-attack-from-podemos-rise

http://www.studentpulse.com/articles/921/2/the-spanish-financial-crisis-economic-reforms-and-the-export-led-recovery?utm_expid=22625156-.jO__KIIlQVuEPc9uLGsmiQ.0&utm_referrer=http%3A%2F%2Fwww.studentpulse.com%2Farticles%2F921%2Fthe-spanish-financial-crisis-economic-reforms-and-the-export-led-recovery

The next day an incipient rally was undone by the news that American stocks of crude oil and petroleum products had reached 1.3 billion barrels, a new record. Firms are hunkering down. BP this week announced hefty job cuts; Petrobras, Brazil’s state-controlled oil firm, slashed planned investment.

Some blame factors other than supply and demand for turning increasingly bearish. For instance, Standard Chartered, a bank, said oil might need to fall as low as $10 a barrel before speculators concede that “matters had gone too far”. But it’s mostly guesswork. Such is the level of uncertainty that American derivatives contracts tied to deliveries in April imply an oil price of anything from $25 to $56 a barrel, according to official number-crunchers.

Neil Atkinson of the International Energy Agency (IEA), a forecasting outfit, finds lots in the physical oil market to be bearish about—particularly regarding consumption, which was one of the few factors supporting prices last year. The sell-off in oil in the past fortnight has occurred concurrently with a slide in the Chinese stock market and the yuan, which some investors think reflects weakness in China’s economy and hence in demand for oil. Though Mr. Atkinson acknowledges that possibility, he thinks this risk is overplayed: figures on January 13th showed China imported a record 6.7m barrels a day (b/d) of oil in 2015.

The trouble, though, is that apart from India and a wobbly China, demand is not looking promising anywhere this year. Europe is unlikely to see a repeat of its relatively strong oil-demand growth in 2015. Although America’s economy continues to grow, tightening fuel-efficiency standards cap the upside. Drivers in the Middle East, where fuel use rose last year, are more likely to keep their cars off the road after their governments raised petrol prices or eliminated fuel subsidies altogether to shore up public finances. “There are now considerable uncertainties about oil-demand growth globally,” Mr. Atkinson says.

Adding to the gloom, producers are not turning off the taps as fast as people expected. The latest rout stems from an OPEC meeting in early December in which the producers’ cartel abandoned output quotas. Saudi Arabia, which used to curb output to rescue prices, now refuses to play that role, and instead is bent on driving high-cost producers out of business. Saudi officials privately say that they expect the price of oil to rebound late this year or early in 2017 as global output begins to lag behind demand. The natural decline as fields are depleted saps production by at least 5% a year, they argue, even before accounting for the effects of reductions in new drilling by embattled oil firms.

But there remains huge uncertainty about how much Iran will export when UN sanctions are lifted, possibly in coming weeks. What is more, Mr. Atkinson says, production continued to rise last year from high-cost wells in the Gulf of Mexico and Canada’s tar sands because, however much oil prices fell, operating costs were lower. “The habit of the industry is to keep producing for as long as you can. Anyone who blinks first is handing a lifeline to their competitors,” he says.

To be sure, production in America is falling, thanks chiefly to cutbacks by struggling shale-oil producers. With oil prices at $30 a barrel, America’s oilmen will have an even tougher task shoring up output by drilling new wells, and will face further pressure from their bankers to reduce borrowing. AlixPartners, a consultancy that advises troubled firms, says more will go bankrupt this year. It forecasts a funding gap of $102 billion this year between American oil firms’ projected cash flows and their interest payments and capital spending, up from $83 billion in 2015. It said the downturn “could be one of the most severe and prolonged ever”.

But however big the cutbacks, they are not yet enough to reduce the glut. Global inventories are at record highs, the IEA says. The Energy Information Administration, an American government agency, predicts they will rise a further 700,000 b/d before supply and demand begin to balance out in 2017.

It adds that storage at Cushing, Oklahoma, which can hold 73m barrels, is at record highs of 64m barrels. Brian Busch of Genscape, an industry data gatherer, says it’s a similar story in China, with ships carrying oil spotted waiting at anchor out at sea because storage tanks appeared to be full. Based on the high level of stocks, Mr Busch thinks it could take up to a year and a half before the bear market ends. The only certainty is, the quicker the oil price falls, the sooner that day will come.

Several influential Governing Council members argued that the ECB’s balance sheet was still relatively small, especially compared to the U.S. Federal Reserve while Denmark’s deeply negative deposit rate illustrated that there was still room to reduce rates, one source with knowledge of the discussion said.

Instead of delivering the wait and see message the market expected, Draghi opted for one that was more dovish and crystal clear, keeping with the ECB’s tradition of building a consensus and putting to shame the Fed, which has fumbled with its communication at a critical juncture.

“It needs to be understood: there is consensus at the ECB Governing Council,” a rate-setter, who asked not to be named, said. “A move in December is likely.”

“Inflation is just not moving higher, there is a risk of falling into a Japanese-style liquidity trap,” the Governing Council member said.

With inflation in negative territory, the ECB is far from its target of getting price growth to near 2 percent and its 60 billion euros ($66 billion) a month asset buys have proven insufficient as lower energy prices and slower growth in emerging economies have worked against it.

Meeting in Malta, the Governing Council discussed a wide range of possible measures and the general view was that instead of one or the other, a combination may be effective, the sources said.

With the Fed postponing its rate hike, Draghi’s comments also had the desired effect of weakening the euro, a key result as the exchange rate is an important channel for policy transmission, another Governing Council member said.

Although increased asset buys could further squeeze liquidity in the market, one source with direct knowledge said concerns over market supplies were overdone as the ECB could move into new instruments and had plenty of room to maneuver even with government bonds.

The ECB could consider corporate debt or equities while there was also room to buy more supranational instruments. Sovereign debt was plentiful due to high net issuance and the ECB could always release debt to be held until maturity, the source said.

There is a constraint about having to buy national instruments in proportion to how much share each country has in the ECB, but substitution rules also provide some flexibility.

Still, another insider warned that the market may have overreacted to Draghi’s words and waiting until December, when the ECB releases fresh inflation forecasts, was normal.

And with monetary policy already ultra-accommodative, room to do more may be limited.

“It’s hard to do much more monetary stimulus than this,” said French Finance Minister Michel Sapin, who has no direct say in policy but who less than a year ago was one of the loudest voices urging the bank to do more.

“Draghi said there is still scope to respond to certain situations if needed, so there is still a possibility to do more but we’ve already come a long way.”

The consensus from almost 60 economists in a poll conducted by Reuters after Thursday’s meeting shows there is an 80 percent probability of the ECB easing at the next policy review on Dec. 3.

COMMUNICATOR

Draghi has been a masterful communicator, repairing the reputation of the ECB, which is run by a 25-member Governing Council that sometimes speaks with as many different voices, leaving the market guessing.

From promising to do “whatever it takes” to save the euro at the height of the bloc’s crisis in 2012 to delivering an unexpectedly large 1 trillion euro plus quantitative easing (QE) program this year, Draghi has become an expert in understanding what the market needs to hear and delivering more.

“The ECB really has become masters of communication: leading the market along, and then over-delivering,” UniCredit chief economist Erik Nielsen said in a note. “I think Draghi more or less gave it away on Thursday: QE2 (in size, composition, duration) and (unfortunately) a rate cut. Remember, they are not in the habit of under-delivering.”

Draghi’s clear stance is now in stark contrast to the Fed, which meets on Tuesday and Wednesday.

Markets have been confused by top Fed officials sending conflicting signals and rate hike expectations have been pushed into next year even as Fed Chair Janet Yellen said she expects that a hike will be needed by the end of this year.

“It is never a good thing when the vice chairman of the FOMC and the vice chairman of the board are saying two different things at a critical juncture for policy,” former Fed research director David Stockton said.

“When comparing the communications of Draghi and Yellen, it is important to remember that Draghi has been dealing with a crisis,” said Stockton, now with the Peterson Institute for International Economics and Macroeconomic Advisers. “Yellen has been in a much different environment, one in which careful nuance has been more important than dramatic statements.”

WORDS NOT ENOUGH

Draghi’s problem now is that he must deliver and the entire world will be watching as market moves induced by the ECB reverberate across the globe.

“If you don’t meet words with action, the market backlash could be quite big” said one Japanese policymaker on condition of anonymity.

The second round of quantitative easing is always less effective than the first one while the consensus in the Governing Council may also be at risk as more easing means lower borrowing costs for governments, which some central bankers see as de facto monetary financing since the ECB is making it cheaper for governments to borrow.

Governments are also not always doing their fair share to boost growth and accommodative policies by the ECB take pressure off governments to enact long-term measures that may be politically costly now but would support growth over the long term.

(Reporting by Frank Siebelt, Balazs Koranyi, and Francesco Canepa in Frankfurt, George Georgiopoulos in Athens, Leigh Thomas in Paris, Howard Schneider in Washington and Leika Kihara in Tokyo; editing by Susan Thomas)

The market seems consolidating the current level around 1.0500-1.0700 which gives us the opportunity to analyze the situation.

What has changed in the EURUSD market which can explain this spot acceleration?
We can easily find arguments to demonstrate that what happened was predictable but without back trading consideration lets summarize some facts.
At the countries levels, Europe has to manage social tensions and political crisis. Greece, Ukraine, France (extreme right party increase) are elements which can explain the lack of trust in European countries to manage those issues. Terrorism represents as well in Europe a threat particularly imminent. European institutions have, by consequences, to deal between urgent threats with heavy political process and unlikely consensus making any solution very slow.
At the financial level, Central banks seem more and more isolated with a bigger distance with real problematic and finally a panel of solution quite limited to fix the economic situation. The SNB PEG release has been the perfect demonstration of this situation. By unexpected decision EURCHF collapsed from 1.2000 to 0.8500 in less than one day, making the FX market much more volatile and strengthening the trust issue in those institutions. All CHF exporters have seen their margins considerably reduced by that decision jeopardizing the Swiss economy. Even if the PEG was probably very expensive to maintain and unilateral decision created an extra tension to a situation already uncomfortable. In Europe, ECB decision to unleash QE seems to convince less than in the others countries due to the fact that it is difficult for nineteen Europeans nations to do the same thing. In New Momentum, we saw a lot of our customers (corporates and Institutional) believe finally in a limited centrals banks impact on the economic world.

What are the market anticipation and why the idea of breaking the parity is more and more credible?
One of the best way to have the market feelings about a trend is reflected in the market prices and more particularly in the FX options pricing. Why those products particularly because every parameter is priced: the level of volatility given by the implied volatilities and the smile which included the asymmetry between the upside or downside level (given by the Risk Reversal or RR).
The implied volatilities for example moved from the lowest levels ever this summers at a level almost three time higher (3 Months implied volatility moved from 4.88% the 30june14 to 11.31% actually (Bloomberg source)). The acceleration of the move is as important as the current level itself because it traduces the market tension with the current situation. All the elements explain in the previous part contributed for sure for a good part of it but the technical level of the current spot around 1.0500 very close of the psychological level of the parity maintains a high level of uncertainty. Let´s relativize a bit those levels, in capital market world, FX remains an asset with the lowest volatilities. For example Lehman crisis brought EURUSD 3 Months implied volatility at 23% when the VIX reached more than 45%. Last point, does an asset with 25% move in few months is worth 11% vol Implied? The ratio seems to us still interesting even if the best level of the last summer seems definitively gone.
The smile component completed this analysis by the information regarding a trend. The 3 months 25d RR is quoting 2.10% PUT EUR over, it means that a PUT EUR 25d (strike 1.0165 with 1.0600 spot) will have a volatility 2.10% higher than CALL EUR 25d (strike 1.1003 with 1.0600spot). In other word the market is paying more to buy a hedge in the downside than the upside. Higher is the extra cost, more the market is ready to pay for the downside. To translate that with the market data the 3 months 25d RR moved from 0.55% PUT EUR over this summer at 2.10% currently, or almost 4 times higher.

The Graphic above shows the 3 Months Implied volatility and 3 Months 25d Risk Reversal, confirming all the elements explained above with first an Implied volatility much higher and Risk reversal paying more for PUT EUR (-0.55% to -2.10%). The green curve reflects the spread and we see that during the last summer we were in a configuration where volatility and smile were the cheapest. It traduces a very interesting idea probably more explicit in the graphics below that PUT EUR 25d was on its cheapest level.
 
Between this summer and today, the PUT EUR 25d increased from 5.30% to 12.67%. This reflects all the ideas expressed above, the market prices the bearish trend much more than 8 months ago. An interesting exercise can complete this demonstration, let´s consider the current spot 1.0600 (to be able to compare the volatility and smile effect we will assume a constant spot at 1.0600) and let´s take the 01july2014 market data and the current one:
01july2014 : EUR PUT 25d with Spot at 1.0600 would be equivalent to a strike of 1.0415
17march2015 : EUR PUT 25d with Spot at 1.0600 is equivalent to a strike of 1.0202
What does that mean? If we had the July market data today, the strike would be closer than the current spot. The fact that we see more than 200pips between the two strikes reflects that today the market anticipates a much bigger potential on a downside movement. A corporate exposed to a EURUSD lower will have to pay a more expensive premium to get a hedge at a similar strike.
The previous elements finally have shown that the market anticipates all the current events as a serious and credible risk for EUR against USD (or others currencies). It would be probably interesting to quantify that risk and get some answer about a potential timing. Once again a part of the answer will be given by the market pricing but instead of considering vanillas options we will focus on One Touch options which reflects the price during a maturity to touch a certain level. On a spot ref of 1.0600, a 3 Month One Touch 1.0000 is priced 28% and a 6 Months One touch around 50%. In other words, the EURUSD Spot has 50% to reach 1.0000 in 6 months regarding the market anticipation.
Beside the mathematics, what would change a break of the parity?
Let´s consider another effect very important and probably underestimated by the market, the psychological impact of a EURUSD below the parity. In New Momentum, we see a lot of customer under hedge on a level below 1.0000. That fact mixed with the bank risk aversion is creating a perfect situation for an acceleration below the parity. It means that the market is probably long EUR and will contribute to a panic situation when everyone will run behind their exposures. A lot of market experience disappears from the banks with the new bonus regulation, making the market with less memories than before. The recent EURCHF movement can give us a good idea of what can be a market panicking. Even if for the moment we believe in a consolidation of the spot (if any politic announcement or critical event happens), however we are firmly convinced than below the parity all the negative effects will accelerate the trend.