EUR's Risk and Reward limited until LTRO

It is to be expected that FX price action would be rather subdued ahead of the second 3-year LTRO announcement tomorrow. It will be then, that the first squeeze will occur, either positive or negative. Thus far, investors are playing by the old adage “buy the rumor, sell the fact.” Market consensus is for an allocation around +EU470b. Anything below a sub-EU200b uptake will hurt risk sentiment, while a result above +EU500b would likely support a stronger risk rally and reinforce recent gains in risk sensitive currencies.

That is fine in theory, but, how much pre-pricing liquidity injection is the market taking on? With a threat of a large allocation uptake, the single currency potentially has more to lose. Eventually, this excess liquidity is likely to depress Euro front-end rates further. It is this that should keep the EUR vulnerable outright and against the crosses. If there is such a large uptake, naturally the market will be questioning why Euro-banks are so enthusiastic for funding. It seems to be a rotating exit door when it comes to reasons for shortening the EUR. Mind you, price action over the past five sessions will have tested the ‘metal' of many traders!

The single currency has even managed to shrug off reports that S&P had put Greece into selective default. Certainly not something wholly out-in left-field, however, S&P had said that it is likely to raise Greece's ratings back to CCC after the debt swap. The fact that the German Bundestag had approved the second Greek package with such a large majority has also aided some of the periphery debt auctions.

Large reinvestment flows and the prospect of more cheap ECB liquidity has helped the Italian Treasury to sell ‘the top planned amount of bonds' this morning. Italy issued +€6.25b in 2017 and 2022 bonds. The auctions have allowed Italian 10-year borrowing costs to fall to their lowest level since August. The auction yield fell to +5.50% from +6.08% a month ago. Demand for the 10-year tranche (+€3.75b) totaled 1.4 times, very much in line with last months much smaller issue. The ECB move to shore up funding is allowing lenders to buy European bonds with some confidence. Maybe we are due an underperformance effort soon? Periphery yield linearity is not a norm!

Fundamental data is also taking the EUR's side this morning. Euro-zone economic sentiment rose to 94.4 this month from 93.4 and an excuse to be supporting short term and macro-economic demand for the single currency. Again, the currency's upside remains somewhat limited ahead of a well publicized 1.35 option strike. On the other hand, it should keep investors looking at the EUR crosses for better value. Risk and reward should be rather limited ahead of the LTRO results tomorrow.

Remember, on Wednesday, the ISDA (international SWAPs and Derivatives Association) will decide on whether a credit event has occurred in Greece. If the answer is in the affirmative, then the CDS's are triggered, bringing another large unknown back into the picture!

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