The Daily Prophet: Does Draghi Know He's at War With FX Traders?

Connecting the dots in global markets.

Foreign-exchange traders have a reputation for going to extremes. Fundamentals are thrown out the window when they set their minds on seeing how far they can drive a currency before policy makers push back, and not in some mealy-mouthed way. How else to explain the euro's rally Thursday?

One of the biggest surprises in markets this year has been the strength of Europe's common currency. The Bloomberg Euro Index has risen 9.06 percent in 2017, already making this the best year on record. Against the dollar, the euro has surged to as high as $1.2070 in recent days from $1.0341 in early January. Some traders are saying $1.25 is in sight. The rally has been blamed for halting the rise of European stocks in recent weeks as exporters become less competitive. It's keeping inflation subdued, something the ECB doesn't want to see. So how did Draghi address the situation at a press conference Thursday that followed the central bank's monetary policy meeting? Aside from saying the exchange rate’s “volatility” is problematic, he declined to talk about any possible action to reverse course, according to Bloomberg News' Alessandro Speciale. That's blood in the water to the currency sharks.

In actuality, there's little more than Draghi can do besides trying to jawbone the currency lower, as no one expects the ECB to intervene in the market because such moves if not done in coordination with other major central banks have only a temporary effect. "I very much agree with the notion that the market is going to keep pressing until it finds the true pain threshold,” Ned Rumpeltin, the European head of currency strategy at Toronto-Dominion Bank, told Bloomberg News.

The market for catastrophe bonds, which are essentially securities designed to protect insurers from payouts for natural disasters by passing on the risk to investors, who are effectively betting against natural disasters happening, was largely spared from Hurricane Harvey. That's because most of the policies backing the bonds aren't tied to flooding. Hurricane Irma won't be so forgiving. Barclays Plc estimates Irma will inflict as much as $130 billion on insurers in a worst-case scenario, making it the most expensive storm in U.S. history. S&P Global Ratings says Irma poses a risk to 13 catastrophe bonds totaling at least $1.23 billion. So-called cat bonds have rewarded investors: The Swiss Re Cat Bond Total Return Index hasn't had a down year since its inception in 2002. The gauge's 6.94 percent gain in 2016 was more than three times that of the benchmark Bloomberg Barclays Global Aggregate bond index. Bloomberg News' Oliver Seuss reports that issuance of the debt broke a record last quarter, with more than $6.38 billion brought to market, based on data compiled by the reinsurance broker of Aon Plc. The market’s total value is about $86 billion.

Remember the good old days when the thinking was that a Trump administration and its abhorrence to regulations would be a boon to banking stocks? Well, that lasted for a couple of months until a little thing called the Federal Reserve disrupted things just a bit. The unexpectedly low levels of inflation have caused policy makers to take a more dovish tone. That has created demand for longer-term debt, narrowing the yield curve. Remember that banks make their money by exploiting the gap between short- and long-term rates, and that when the difference narrows, profits get squeezed. Wedbush Securities has just put its 2017 and 2018 earnings estimates for regional and mid-cap banks under review to be cut, in part because of a narrower yield curve, according to Bloomberg News' Heather Burke. Wedbush is also concerned that banks aren't seeing the pickup in loan demand that they had projected as borrowers continue to take a "wait-and-see approach" about whether the Trump administration can get any of its major proposals passed to spur economic growth.

The market for short-term corporate IOUs reached a minor milestone, with the amount of commercial paper outstanding rising above $1 trillion for the first time since before the U.S. elections. Traditionally, the CP market has been viewed as a decent barometer of corporate activity. Companies normally load up on short-term debt to expand or get projects off the ground before the debt can be swapped for longer-term bonds. It just so happens that the Federal Reserve’s latest Beige Book report, which was released Wednesday and covered the months of July and August, noted that along with consumer spending, "capital spending also increased in several Districts." A Morgan Stanley index of capital spending has risen to levels not seen since 2007, which the firm's economists said in a research note "is additional evidence that a cyclical, more durable pickup in equipment investment is underway." Maybe there's hope yet for the bulls who have taken a hit betting on bank stocks.

The rally that’s seen base metals dominate commodities markets this year is wavering, leaving traders and analysts to fret about whether gains are at an end or if this is just a pause that refreshes, according to Bloomberg News' Samuel Potter and Mark Burton. Of the six industrial metals that make up the London Metal Exchange LMEX Index, three fell on Thursday as the others fluctuated, threatening another drop for the index when it updates at the end of the day. The wobble comes after year-to-date gains that have already surpassed all of 2016’s. Global economic growth, a weaker dollar and official moves that disrupted supply in China have stoked the six metals that make up the index, and it’s up about 22 percent this year through Wednesday, beating 2016’s 21 percent advance. “We’ve been advising clients to take profits since the end of August, and if anything my position on that has hardened,” said Guy Wolf, global head of market analytics at Marex Spectron Ltd. Crispin Odey, whose London-based Odey Asset Management oversees about $6 billion, has warned about “partying” markets and is shorting metal stocks in anticipation of slowing economic growth in China.

Perhaps the biggest surprise of the week in markets was the interest-rate increase by the Bank of Canada. The monthly jobs report Friday will either have investors saying the central bank was right in boosting rates or expose policy makers to criticism for being too hawkish. Canada's economy likely generated 15,000 jobs last month, the ninth straight increase and, according to the median estimate of economists surveyed by Bloomberg News. While that would be up from the 10,900 jobs created in July, it would fall below the average of 31,000 in the first half of the year. “There remains some excess capacity in Canada’s labor market, and wage and price pressures are still more subdued than historical relationship would suggest,” the central bank said in a statement Wednesday explaining its decision to raise rates.

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