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Fundamental Morning Wrap: ECB Draghi, Dijsselbloem and credit crunch

FXstreet.com (Barcelona) - With the ECB meeting ahead tomorrow, this morning’s institutional reports analyze what is happening in the Eurozone’s approach to the crisis and what is to come.

EUR

Besides of the BoJ, the ECB meeting will attract much attention tomorrow as investors want to know what President Draghi has to say about recent events in the Eurozone. “We do not expect any change in monetary stance and also expect President Draghi to state clearly the ECB view that Cyprus was very unique and that type of banking sector bailout deal would not be repeated elsewhere in the euro-zone”, wrote Derek Halpenny, European Head of Global Markets Research at the Bank of Tokyo Mitsubishi UFJ, seeing downside risks to economic growth and while Draghi will state that inflation risks are broadly balanced, Halpenny believes that assessment is stretching credibility now. In terms of a change in the monetary policy, TD Securities analysts said that the IFO survey was strong enough to mitigate the tracking for the Eurozone until March surveys universally disappointed, so there is nothing yet to drive a case for the ECB to flag downside risks just one month after making new forecasts. “So if the data is bad enough over the next month, this could trigger a response, or at least flagging the risks for June”, wrote analyst Richard Kelly, expecting a refi rate cut and narrowing of the corridor as the likely move in such scenario.

In regard to the “unique” case of Cyprus, and despite preparations to allow the €700bn European Stability Mechanism (ESM) to inject capital directly into distressed banks, the Dutch finance minister and Eurozone Finmin Chairman Jeroen Dijsselbloem scared investors with his fundamentalist approach, saying taxpayers should not have to contribute any further to bank bailouts, with “bail-ins” to become a mainstream policy response. Nomura research Institute Chief Economist Richard Koo believes that unless it is quickly made clear in an official capacity that the authorities’ response to future financial crises will follow the ESM approach and not the Dijsselbloem approach, the turmoil among large depositors will continue: “That, in turn, would force banks to become more conservative, since they cannot lend if there is a risk of large depositors taking their money elsewhere. That suggests the Eurozone’s ongoing credit crunch may worsen, aggravating an already severe recession”, he wrote. “I find it surprising that Europe, which is home to so many social democrats, adopted these policies at the worst possible time while the US, where market fundamentalists hold greater sway, moved quickly to rescue the broader banking system”, he concluded.

JPY

The decision from the BOJ will be key and certainly notable steps will have to be taken in order to meet current high expectations, wrote Derek Halpenny, European Head of Global Markets Research at the Bank of Tokyo Mitsubishi UFJ, saying that it is crucial for the direction of the yen that Japanese investors respond by exporting capital into foreign markets, or accepting greater foreign currency risk through a reduction in current hedge ratios.

“Indeed, Japanese investors repatriated from both foreign equity and bond markets while foreign investors were heavy buyers of Japanese equities. In the four weeks to 22nd March, Japanese investors sold JPY 1,888.5bn worth of foreign equities and JPY 1,067.8bn worth of foreign bonds. Foreign investors bought JPY 1,595.6bn worth of Japanese equities but sold JPY 1,650.6bn worth of JGBs. Hence, there was an overall net portfolio inflow to Japan of JPY 2,901.3bn over the four-week period”, wrote Halpenny, seeing scope for change as foreign investors sold Japanese equities last week while Japanese investors could well turn to foreign bond buying after sustained net selling through most of February and March. The key though will be changes to hedging, and Halpenny sees that life Insurance companies for example currently hold JPY 51 trillion in foreign securities, or 15.4% of total assets as of January according to data incorporating the top 43 life insurers, which equates to USD 545bn at today’s USD/JPY rate. If these entities decide to reduce hedge ratios by 10ppt, this would imply potentially over USD 50bn worth of yen selling.

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