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EUR: Don't Expect Much From G8

Kathy Lien, Director of Currency Research, GFT





  06/20 Meeting 07/31 Meeting
NO CHANGE 60.0% 60.0%
CUT TO 0 BP 40.0% 40.0%
HIKE TO 50BP 0.0% 0.0%



It has been an extremely tough week for the EUR/USD. On Monday, one euro was worth 1.29 U.S. dollars and during the early European trading session, the value of one euro dropped to as low as 1.2641. The currency pair came within a whisker of its year to date low and if not for the excitement of the Facebook IPO in the early NY trading session and an end of the day push higher, that level would have probably been broken. Contagion has been in the air throughout the past week as the chance of a Greek euro exit increased. Moody’s downgraded Italian and Spanish banks driving the 10-year bond yield of both countries above 6 percent. LCH has now requested higher margins on Spanish bonds. It is against this backdrop that the leaders of the 8 major industrial economies will convene at Camp David.  On the top of their agenda is Europe’s debt troubles and the region’s ability to contain the crisis. There is an overwhelming feeling in the market that the crisis is getting out of hand and European officials either don’t have the power to or don’t want to take additional steps to shore up confidence. Everyone is pointing fingers at each other, calling for more austerity but austerity comes with severe consequences for growth that make it difficult for these countries to rise from the ashes. This is the main reason why Francois Hollande, France’s new President has been such a big advocate for austerity measures to be accompanied by pro-growth policies. He is not alone. Aside from German Chancellor Angela Merkel, most other G8 leaders will share the view that austerity alone is not enough.  At the same time, there is still a feeling that this problem is one to be solved by Europe alone. Therefore no economic policy decisions (large or small) are expected to be made at this weekend’s summit but the EUR/USD could rally if Merkel appears more conciliatory. Either way, don’t expect much from the G8 meeting especially after Obama moved the meeting from Chicago to Camp David to give it a more informal feel. As much as Europe will be a focus, this will also be an introductory meeting for G8 leaders as it will be the first time for Francois Hollande and Japan’s Yoshihiko Noda.

With no major decisions expected over the weekend, the market will continue to be haunted by Greece and Spain’s.  Analysts are divided on whether Greece will opt to leave the euro because most Greeks want to remain in the Eurozone. The odds are probably 60-40 at this point with a 60 percent chance in our opinion that they will abandon the euro. In fact, there was even talk today that Merkel proposed to Greece that their election should include a referendum on the euro, which was later denied. Unfortunately the problem has never been about Greece alone. A Grexit would be bad for the markets but most banks and investors have had plenty of time to prepare for this possibility. U.S. banks for example have cut two thirds of their Greek debt exposure over the past 2 years. They have not necessarily had the same time to discount a blowup of Spain. Banco Santander U.K. reported that depositors pulled out GBP200 million on Friday. Although this represented only 0.02 percent of deposits, approximately 30 percent of their customers apparently came in to pull deposits today. If European officials act quickly and allocate Greek bailout funds to increasing the region’s firewall, a 2008 style global financial market sell-off could be avoided. Yet don’t expect the EU or the ECB to announce any additional measures until Greece makes a decision about staying in the euro, which won’t be until the June elections. In the meantime, Eurozone PMI numbers and the German IFO report will be released next week, providing us with greater insight into whether Germany has sustained its growth into the second quarter.


With Europe back in the headlines, investors around the world piled into the U.S. dollar this week. At the beginning of the year in our 2012 outlook, we said deleveraging is this year’s greatest risk and the biggest beneficiary would be the U.S. dollar. Although the U.S. is not without its own problems, some of which came to light this past week, the attractiveness of U.S. Treasuries has kept the dollar in demand. Yesterday’s surprisingly weak Philadelphia Fed survey awakened speculation for QE3. While the Federal Reserve has kept the door open to additional easing, we don’t believe that the decline in the Philly Fed survey is enough to push the central bank over the edge. The national ISM manufacturing index has recently diverged from regional indices and with the Empire State survey rebounding, the pullback in industrial activity in Philadelphia may not be indicative of manufacturing activity across the nation. More importantly, jobless claims remain low. The high level of unemployment has been the source of the Federal Reserve’s concerns and the latest report showed very little change in claims. In fact, so far jobless claims have been consistent with a slightly stronger May non-farm payrolls report. In other words, while another round of Quantitative Easing remains a possibility, we still believe that the Fed will abstain from introducing more stimulus for the time being. Like central bankers around the world, they want to see how Europe and Greece’s problems play out first. U.S. stocks have already been dragged down significantly by Europe’s sovereign debt troubles and an escalation of uncertainty could lead to a sharper slide that could necessitate swift and decisive action by central banks. At that time, QE3 would a much more significant impact on risk appetite.

The U.S. economic calendar is light next week leaving Europe as the market’s number one focus. All of the data due for release are second tier including existing and new home sales and durable goods. The Senate also confirmed 2 new members for the Federal Reserve Board of Governors this week, brining the board to 100 percent capacity for the first time since 2006. Little is known about the views of the 2 new members but one is from academia and the other is from the private sector. Jeremy C. Stein is an economist at Harvard while Jerome H. Powell is an investment banker and lawyer. Both men have extensive experience in financial regulation, having formerly worked with the Treasury. As they fill their posts, we will be listening to their speeches closely to see whether they fall in the dove or hawk camp because these men could be the deciding voice in an otherwise divided central bank.


The British pound was among the better performers today, rising against euro and the US dollar. As safe haven flows eased out of the greenback, the GBP/USD pared some of its losses bouncing back from the 1.58 handle. Despite signs of improvement in UK economy, sterling has been weighed down by Europe’s debt crisis. The deteriorating situation in its neighboring single-currency bloc could have a significant impact on struggling British economy. In its Quarterly Inflation Report, the Bank of England cut its estimate of economic growth over this year to 0.8 percent from 1.2 percent. As a result of the worsening outlook, Bank of England policymaker Adam Posen said he may have been premature in dropping call form more quantitative easing. "I still think the weak data somewhat overstates it but given the revisions to the construction data, given the downward moves in the business surveys, the underlying strength of the economy is weaker," he said. Posen’s comment came after another MPC member Paul Fisher said more QE may not be needed given the high level of inflation rate. The difference in opinion could be settled by next week’s economic reports. Consumer prices are scheduled for release on Tuesday and with producer prices easing and shops surveyed by the British Retail Consortium charging lower rates, CPI growth could have receded. However with annualized CPI still running at 3.5 percent and core CPI at 2.5 percent, inflation is still a very big problem. In addition to CPI, the Bank of England minutes, retail sales and first quarter GDP are also due for release. Although the central bank was less dovish at their most recent monetary policy meeting, the less optimistic tone of the Quarterly Inflation Report suggests that there is more skepticism than optimism within the central bank.


The Canadian, Australian and New Zealand dollars continued to decline against the greenback. For the past few weeks, concerns about Europe have put extreme pressure on the high beta commodity currencies. The selling pressure has been so strong that AUD/USD broke below parity with both AUD and NZD falling to 6 month lows against the dollar. The global uncertainty has prompted some market participants to factor in a higher probability for another rate cut by Reserve Bank of Australia. According to interest rate futures, the market is pricing in 35 basis points cut by the central bank in June.  Canada was the only commodity producing country to release economic data but unfortunately hotter inflation failed to lend much support to the Canadian dollar. Consumer prices grew 0.4 percent in the month of April with core prices rising by the same amount. This brought the annualized pace of growth to 2.1 from 1.9 percent. The uptick in inflation supported the Bank of Canada’s view on raising the interest rate sooner. Bank Governor Mark Carney hinted on April 18 that it “may become appropriate” to tighten bank’s monetary policy.  Solid job growth last month will only put more upside pressure on inflation and unfortunately the Canadian dollar has not provided any help. While the BoC is the only major central bank talking about monetary tightening, like many other high beta currencies, the Canadian dollar succumbed to risk aversion in recent weeks. As a result, Governor Carney could take a wait-and-see approach as long as contagion concern remains front and center. As leaders from Group of Eight meet this weekend, containing the crisis will be the main focus. Looking ahead we have inflation expectations and the trade balance from New Zealand and retail sales from Canada this coming week.


With U.S. stocks extending their slide, the Japanese yen traded higher against all of the majors with the exception of the euro. Contagion fear in the eurozone has kept traders on their toes and has made the Yen a particularly attractive harbor of safety.  Unfortunately for the Japanese, this demand has driven USD/JPY to a fresh 3 month low. 78 is the level that we are watching for intervention. If USD/JPY slips below 78, we could see additional action by the Bank of Japan who will use this week’s monetary policy meeting as an opportunity to warn the market that they are watching currency values very carefully. Despite the yen’s renewed strength, the Japanese economy showed more signs of resilience in Q1 as GDP printed better than expected this week. A surge in private consumption and reconstruction efforts have boosted the pace of recovery. Furthermore, Japan’s government upgraded its economic assessment for the first time in nine months. The Cabinet Office raised its evaluation of consumer spending, exports, corporate profits and employment in the May report. This upbeat assessment is similar to that given by the Bank of Japan in its monthly report.  "Japan's economy is expected to return to a moderate recovery path as the pace of recovery in overseas economies picks up, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake disaster gradually strengthens,” BoJ said. However, yen’s recent strength against the greenback presents more challenges as recovery struggles to gain firmer footing. In the government’s latest effort to contain yen’s rise, Finance Minister Azumi stepped up his rhetoric - "We currency authorities will watch the foreign exchange markets with a greater sense of caution and act appropriately when necessary." While Japanese authorities vowed to fight any “excessive” speculation, investors are not likely to lose their interests in yen as long as Greek saga persists. Looking forward, G8 leaders will meet this weekend to discuss more fiscal reforms, which are the hot topics in Europe. Next week, we expect trade balance and consumer price index from Japan. Moreover, BoJ is expected to remain unchanged on its stance as policymakers meet next Tuesday.

NZD/JPY: Currency in Play for Next 24 Hours

Our currency pair in play for Monday will be NZD/JPY. The economic data that we expect from New Zealand will be credit card spending at 11:00PM ET/ 3:00 GMT. From Japan, we have industry activity index at 00:30AM ET/ 4:30 GMT, followed by leading index at 1:00AM ET/ 5:00 GMT.

NZD/JPY has been on decline for this week and currently trades in a downtrend, which we determined using our double Bollinger Bands. The closest support is at 58.23, the low in December 2011. A break below, the pair could target the swing low of 57.01. On the upside, today’s high could contain the pair’s rally at 60.7. Should NZD/JPY climb higher, the lower first std. dev. Bollinger Band could provide major resistance.