Special Report-Growing threat of intervention
Here are the latest Financial News:
After plunging to a four year low versus the USD in reaction to report Germany has temporarily banned naked short sales of government bonds and default swaps the EUR posted a sharp short covering rebound in US trading session Wednesday. The ban on naked short selling is to try and prevent speculative assaults on German financial markets. German officials believe that speculative assaults, particularly in EU bond markets helped to drive up the cost of funding EU debt and exacerbated the EU debt crisis. Whether the German ban on naked short sales will be successful in discouraging speculative assaults on the German/EU financial markets remains to be seen. So far the ban has added to market panic and skepticism. Traders generally find ways around trading curbs and according to a Bloomberg report Germany took the action to ban naked short selling as a political move to show that the German government is taking action to try to defend the EUR.
The EUR traded at the four year low of 1.2143 in European trade and surged above 1.2350 in the US trading session. One explanation for the sharp rebound in the EUR was a rumor that the ECB is holding an emergency meeting and soon may announce a Euro Zone wide ban on naked short selling. The fact that Germany so far has acted unilaterally in its action to try to discourage excessive speculation in its financial markets generates concern about lack of cohesion among EU nations to tackle the fallout from the Greek debt crisis. A ban on naked short selling across the Euro Zone would be confirmation of greater unity within the EU community. This could increase the credibility of the German and EU efforts to help restore confidence in EU financial markets and the EUR. Investors remain skeptical about the efficacy of the near $1trln EU rescue plan announced earlier in the week for Europe. The plan does little more than buy time for Europe to try to deal with the debt crisis and offers limited solutions to the debt crisis. The same could be said of plans to ban naked short selling. The ban on naked short selling does not address the underlying fundamental problems facing the EU.
The EUR rebound Wednesday was also attributed to rumors of central bank intervention. There was a rumor that the ECB intervened in support of the EUR. There was a rumor that the Fed intervened along with the ECB to support the EUR. And the SNB intervened in EUR/CHF cross. EUR/CHF cross dropped to a record low with the CHF supported by safe haven flows sparked by the EU debt crisis and the German ban on naked short selling. EUR/CHF traded below 1.40 in overseas trade and surged above 1.42 in the US session supported by what appeared to be SNB intervention buying the EUR. SNB officials have consistently stated that they plan to take aggressive action to stop excessive CHF appreciation versus the EUR. Until today the SNB has been intervening unilaterally. G-7 members may be coming to the conclusion that in order to stabilize the global markets the EUR must be stabilized by intervention. There is a growing threat of Forex intervention from the ECB and possibly coordinated intervention with the Fed and other G-7 members.
The threat of intervention or actual intervention may disrupt or interrupt the current short-term trends in FX markets. This means that traders need to consider how intervention may affect Forex price action and their trading strategies. There are three main types of central bank Forex intervention. The first is rhetorical intervention. Rhetorical invention takes place when government officials and central bankers try to influence Forex markets with comments about a specific currency. The impact of rhetorical intervention is usually short-lived and it may be the prelude for physical intervention. Physical intervention is when a central bank buys or sells a currency to try to support a currency or limit a currencies appreciation. There are two types of physical intervention. The first is unilateral. This is when one central bank acts along. The second is coordinated. This is when central banks act in concert. In general, unilateral invention is less successful than coordinated intervention and there have been numerous studies questioning the effectiveness of either type of intervention. Additionally intervention that is not supported by underlying fundamentals will fail to have lasting impact on the direction of a currency. Our study of past currency interventions suggest that it’s easier to slow the rate of appreciation of a currency than to support a currency and the most effective intervention tends to be associated with the element of surprise backed up by underlying fundamentals. When intervention is expected the impact is generally deluded and limited. Most times central banks will refuse to comment on intervention to try to keep currency traders guessing. In contrast, the SNB has made clear its intention to intervene. Maybe other G-7 central banks will follow the SNB’s lead.
The fundamental outlook for the EUR remains negative due to uncertainty about whether the EU rescue plan will contain the contagion risk of the Greek debt crisis. The EUR is also vulnerable to concern that EU austerity measures will to slow the EU recovery and force the ECB to maintain accommodative policy possibly into 2012. The negative fundamental outlook for the EUR means that central bank intervention to support the EUR will likely have limited lasting impact. Central banks sometimes intervene into try to manage currency fluctuations and try and keep a currency within a given range. This is called a smoothing operation. A smoothing operation is designed to stop the rate of acceleration or deceleration in a currency market price direction not to try to change the overall price direction of a currency. Unless something dramatically changes in the fundamental outlook for the EU, intervention at this time will likely be limited to smoothing operations. One factor that may work in favor of ECB and/or coordinated intervention is statement from the IMF that the EUR is nearing equilibrium. According to the IMF’s Lipsky the 18% decline in the EUR since the beginning of the year is positive for EU exports and long-range growth. We noted in a special report Monday that the EUR is approaching major technical support at the 50% retracement level of the record low in the EUR at 0.82 from the record high above 1.60. The 50% retracement of range comes in just above 1.20. Central banks may have temporary success supporting EUR above this level. We suspect that intervention in EUR will be seen as opportunity to sell the EUR at a better value and the threat of intervention will have limited lasting impact.
Note in the graph below the impact of rumored SNB intervention in the EUR/CHF cross.
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