The currency blog

There is no change to sentiment this morning as the euro remains on the back foot as Eurozone bond yield spreads remain the driver for US Dollar buying. This is sufficient to keep Eurodollar testing 2 - 3 month lows on a daily basis. The sovereign spreads continued to widen yesterday despite the widely heralded financial rescue announced for Ireland and its banking sector. The package did little to dissuade fears of contagion of the Greek/Irish problems into other peripheral nations. Official reaction towards the future of the Euro and Eurozone has remained positive with ECB and EU spokespersons being joined by the Chinese government news agency, Xinhua in encouraging the future of both. The Chinese stated that ‘Contrary to the widespread claim that the Eurozone is doomed to break up, the single currency will not fail’. It did add however that the currency was facing its toughest challenge since instigation.
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So we now know the gory details. First, the main points: the Irish bailout of €85 billion will be made up of external support from the IMF and EFSF of €67.5 billion and domestic funds of €17.5 billion. The Irish contribution comes from the now decimated National Pension Reserve Fund with the UK making a bilateral loan of €3.8 billion as well as contributing to the IMF funds (and you thought the money saved in recent round of UK spending cuts was used for paying down our own debt…). The effective interest rate that the Irish will pay on the loan is reported at 5.8% according to the official document, but private calculations have put the figure closer to 7.25% and this will lead to an astonishing 20 per cent of Irish tax revenues servicing the debt by 2014 according to calculations. The main controversy is the news that senior bond holders in the Irish banks will received no haircut on their holdings – no doubt due to contagion fears as investors dump bank bonds in the event of any short back and sides – and the banks are estimated to need an extra €8bn to get core Tier One capital to at least 12 per cent.
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The Euro remains on the back foot this morning as we draw near the end of a troublesome week for the single European currency.  Sovereign debt concerns continuing to dominate, prompting the single currency to hit two-month lows against the dollar.  The focus of attention has moved to Portugal as reports that Eurozone Politicians are placing pressure on the Portuguese to obtain support from a EUR 750 billion bailout fund. The underlying principle behind piling pressure on the Portuguese government is undoubtedly an attempt by the EU to border contagion effects and in particular to limit the likelihood of having to bail out Spain. Even with these ongoing efforts borrowing costs for the euro region’s most indebted nations are surging. The average yield investors demand 10-year debt from Portugal, Ireland, Italy, Greece and Spain hit over 7.50% yesterday, a record for the Eurozone.
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The Irish 4-year austerity plan was released and contained few surprises. PM Brian Cowen said that a bailout of €85bn has been discussed with EU and IMF officials, though not yet agreed. While a successful conclusion of negotiations on an aid package could help stem some of the recent euro downslide, it is difficult to see a more substantial euro recovery ahead of the budget vote.
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The Dollar continues to advance against the Pound and Euro this morning as the safe haven currencies benefit from the ongoing tensions on the Korean peninsular. A US aircraft carrier is on route to support the South Koreans in a spot of puffing the chest and attempting to look scary in a joint military exercise, with the Chinese also announcing they will look to work with the US to resolve the tensions. With all sides on edge, the Dollar and Swiss franc will continue to hold onto its gains in the coming days. The release of the Federal Reserve minutes last night passed largely as expected, with most members agreed that the benefits of further QE still outweigh the costs and that a monthly purchase scheme was the best option available. The Fed also discussed specific term rate targeting – a departure from the current duel mandate of inflation and employment – and the uber QE option if pursued. This will be worth following going forward since any change in the Feds mandate or stance will likely have large ramifications for the Dollar.
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All eyes will be European markets to see whether Ireland’s reluctant receipt of a financial bailout package will provide its function and ease the pressure on the Eurozone peripheral debt market and thus prevent looming implosion of the region’s financial system. The single European currency has made huge gains over the past few trading sessions however a continued theme looks unlikely. With negotiations between Ireland, the ECB and the IMF over, now the discussions regarding specific backing will not doubt drag for several days, if not go into December, so traders will probably look at current rates to go short on the euro. The theory being that contagion from Ireland is already in place and that interest will now move to Iberia as the next in the firing line for financing difficulties.
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