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EUR Fails To Benefit From Equity Reversal

Kathy Lien, Director of Currency Research, GFT





  06/20 Meeting 07/31 Meeting
NO CHANGE 64.0% 64.0%
CUT TO 0 BP 36.0% 36.0%
HIKE TO 50BP 0.0% 0.0%



It has been an extremely volatile day in the financial markets. Currencies weakened across the board with the euro easily taking out its year to date low against the U.S. dollar. Stocks also sold off but the EUR/USD failed to benefit much from the end of day recovery that took equities well off its lows. There have been no new developments with regards to Greece and perhaps this is the very reason why investors continued to sell euros. Throughout the European and North American trading sessions, there was a volley of speculation about whether the ECB, the Greeks and Europe in general are assessing and preparing for the consequences of a Greek euro exit. In our opinion, it would be irresponsible for Europe, central bankers around the world and CEOs of major financial institution to not be actively evaluating the potential impact of a Greek exit and how to handle it. As a result, we believe that none of the denials are credible. Instead, we believe that every major G10 nation and financial institutions are drafting up contingency plans in case Greece decides to drop the euro. There is fear that Greece could make an announcement over the long weekend in the U.S., using the prolonged market closure to their advantage but we don’t believe they have the political will to make such a major decision before the election. Meanwhile, very little has come out of the informal EU dinner. As of the NY close, a statement has not been released but so far, we know that the Italians and French support Eurozone bonds while the Germans and Dutch oppose them. The big decisions will probably be made in late June when EU leaders formally convene. One possible solution that has been partially credited for today’s intraday recovery in risk is FDIC like Eurowide guarantees for bank deposits. There is talk that Merkel supports this scheme but nothing has been confirmed and convincing healthier nations to bear the cost of Eurowide deposits when there already exist deposit guarantees by national banking systems could be difficult.

In the meantime, EUR/USD traders should keep their eyes on Spanish and Italian bond yields. Although tensions have escalated the ECB and EU’s urgency to act will be limited as long as the problems do not spill over to larger nations such as Italy and Spain. Ten year bond yields are our gauge of contagion and the closer Spanish yields get to 7 percent, the greater the likelihood of a response from the ECB. The dramatic recovery in stocks should help to limit the downside in the EUR/USD for the time being but only up until Thursday’s European economic reports are released. Manufacturing and service sector PMI numbers are on the calendar along with the German IFO report. Currently, economists are looking for steady readings for most of the releases. In fact, Eurozone manufacturing and service sector activity is expected to accelerate slightly thanks to stronger performance in France and Germany. The IFO report on the other hand is expected to show a small pullback in confidence. With EUR/USD short positions at such elevated levels, better than expected numbers could trigger a short squeeze in the currency. Weaker numbers on the other hand could drive the EUR/USD to fresh 22 month lows.


Although the S&P 500 staged a dramatic recovery to end the day in positive territory, currency traders kept most of their money in dollars and yen. The greenback barely forfeited any gains against the euro, British pound and Japanese Yen and only gave up part of its gains against the commodity currencies. Better than expected U.S. economic data is a breath of fresh air in an otherwise depressing global economic environment. New home sales rose 3.3 percent in the month of April with house prices rising 0.7 percent. Both existing and new home sales reports tell us that the housing market is recovering. House prices also rose 1.8 percent in March according to the Federal Housing Finance Association. The labor market has been the central bank’s number one concern but the housing market has also long been a source of frustration for the Fed. While the real estate market is still a long ways from full recovery, we have three pieces of confirming data that show it moving in the right direction. The U.S. labor market will return to focus on Thursday with the release of jobless claims. Over the past few weeks, claims have been low which is consistent with a stronger non-farm payrolls report. If claim falls again, we could be looking at job growth around 150k in the month of May. Durable goods orders are also on the calendar and like new home sales, a very weak March has set the stage for a rebound in April. The latest U.S. economic reports reduces the need for QE3 but if Europe’s problems boil over and the stock market falls another 10 percent, then expect the Fed to spring into action. We continue to expect the market’s appetite for risk to drive the flows in the dollar.


Risk aversion and weaker economic data drove the British pound lower against the U.S. dollar. Retail sales fell 2.3 percent in the month of April with sales excluding autos dropping 1.0 percent. While record rainfall kept consumers out of the stores, concerns about the global economy and continued austerity by the U.K. government also made consumers reluctant to spend. Sluggish demand, high unemployment and softer inflationary pressures will make the decision for more stimulus by U.K. policymakers less difficult, especially if Europe’s problems continue to grow. In other words, if Greece decides to leave the euro, triggering a global financial market sell-off that necessitates responses from central banks, the BoE would probably be one of the first to sign up for more easing. With this in mind however, the minutes from the most recent monetary policy meeting revealed an 8 to 1 decision to leave asset purchases unchanged.  We have to appreciate where the market was when the BoE met earlier this month. On May 10th, oil prices were $97 a barrel and the FTSE 100 was at 5545. Today, oil prices are at $90.40 and the FTSE is at 5266. If the meeting was held today, monetary policy committee members would be far more dovish. In fact, BoE member Posen recently said his decision to withdraw his support for more stimulus is premature and this morning, BoE member Bean admitted that QE may need to be restarted if economic conditions weaken.  Although the voting record remains unchanged, the tone of the MPC minutes was still dovish because the decision to halt bond purchases this month was "finely balanced."  Looking ahead we have revisions to GDP and unfortunately the numbers will show that the U.K. economy fell into recession in the first quarter.


Australian, Canadian and New Zealand dollar all lost ground to the greenback today. As S&P GSCI commodity index fell to the lowest level in five month in a risk-off trading session, traders sold off high-beta commodity dollars and bought safer assets. While the weakness in the currencies persisted, the Australian economy showed signs of firmer growth as leading indicators increased 0.2 percent in March. According to Conference Board, rural goods exports and money supply made the largest contributions to the gain. Australia has depended on its resource boom to power much of its growth. The mining sectors produce close to one fifth of the country’s GDP. Thus, any contraction in global commodity demand could pose significant threat to the country’s recovery. In Canada, consumer spending printed in line with expectation at 0.4 percent. “Warmer than usual weather in March advanced the purchase of spring merchandise such as clothing, footwear, bicycles and lawn and garden products,” Statistics Canada said in its report. “General merchandise stores registered higher sales for a third month in a row, rising 1.1% in March. Department store sales increased 1.3%, more than offsetting a decline in February.” However, core retail sales posted a measly 0.1 percent increase versus a forecast of 0.5 percent. While Canadians have gained more confidence in its economy, consumer spending is not quite on the pace of resuming their 2011 role as the main driver of growth. Looking ahead, New Zealand will release its trade balance which is expected at 445 million. Moreover, if there were additional signs of slowdown in Chinese manufacturing, we could see more weakness the comm. dollars. HSBC’s Flash Chinese Manufacturing PMI report is due for release this evening.


The Japanese yen traded higher against all of the major currencies today. Despite Fitch’s downgrade and a negative trade balance, investors still bought into yen’s haven status amid headline risks in Europe. While the trade deficit has narrowed to 0.48 trillion in April from 0.62 trillion the month prior, the export-reliant country has not posted a positive trade balance since April 2011. The prolonged appreciation in yen not only caused slimming margins for Japanese exporters but also put more pressure on the Bank of Japan. Although many market participants including Finance Minister Jun Azumi have called for more action from the central bank, BoJ has maintained its overnight interest rate close to 0.1 percent. Bank Governor Masaaki Shirakawa added that the drawbacks outweighed benefits in cutting rates. Nonetheless, Shirakawa remained firm on bank’s commitment to fight deflation. “The BOJ has not leaned towards neutral stance at all. The BOJ's policy stance is to pursue strong monetary easing as stipulated in the April statement following our outlook report. That has not changed at all,” said Shirakawa. Meanwhile, Prime Minister Yoshihiko Noda has hit another stumbling block with a downgrade in debt rating. Fitch has cited the unsustainability of Japan’s fiscal plan and political impasse as two of main reasons for the cut. “The country’s fiscal consolidation plan looks leisurely relative even to other fiscally-challenged high-income countries, and implementation is subject to political risk,” said Andrew Colquhoun, head of Asia-Pacific Sovereigns at Fitch. This move has added more urgency for Noda’s government to push through the proposed tax bill to rein Japan’s staggering debt. Without more fiscal stability, the country could face more headwinds going forward. Looking ahead, the trading in yen could hinge of risk appetite with the lack of any major economic releases.

EUR/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is EUR/USD. From eurozone, we expect German PMI at 3:30AM ET/ 7:30 GMT, followed by German Ifo business climate survey and EU PMI at 4:00AM ET/ 8:00 GMT. The economic data from the US are durable goods and jobless claims at 8:30AM ET/ 12:30 GMT.

After today’s decline, EUR/USD has fallen deeper into a downtrend which we determined using our double Bollinger Bands. The nearest support is at today’s low of 1.2545. If EUR/USD declined further, we could see the pair bounce off of the psychologically significant 1.25 handle. On the upside, the pair could find some resistance at today’s high of 1.2687. Should EUR/USD rally higher, a previous level of contention could contain the pair’s strength at 1.2824.