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EUR: Hit By Spanish Downgrade, More Pain Ahead

Kathy Lien, Director of Currency Research, GFT





  06/20 Meeting 07/31 Meeting
NO CHANGE 64.0% 64.0%
CUT to 0.00% 36.0% 36.0%
HIKE TO 0.50% 0.0% 0.0%



Despite today’s rally in U.S. equities, we know that investors remain nervous because the EUR/USD broke below 1.25 for the second time in 10 months.  The sell-off was sparked by independent rating agency Egan-Jones’ decision to cut Spain’s sovereign debt rating to BB- from B. This is the second time in two weeks and third time in a month that they have lowered Spain’s rating and with a negative outlook, another cut could follow. While the EUR/USD doesn’t normally have such a large reaction to announcements from Egan-Jones, when they cut Spain’s rating back in April, S&P followed 10 days later. With no action from the big 3 rating agencies in response to their last cut, the chance a follow up move after today’s decision is high. S&P currently rates Spain BBB+, Moody’s is 1 notch higher at A3 and Fitch is 2 notches higher at A.  Egan-Jones has grown increasingly concerned with the country’s deteriorating public finances and its ability to make sizable payments with interest rates on the rise. 

Aside from the downgrade, not much has changed over the 3 day weekend outside of the mood of U.S. investors who are coming back recharged and perhaps better prepared for bad news. U.S. economic data was worse than expected and completely ignored by equity investors.   The nationalization of Bankia, Spain’s fourth largest lender last week propelled the country’s funding problems and banking troubles back into the limelight. Spanish 10 year bond yields rose as high as 6.46 percent intraday before settling back down at 6.4 percent. The pullback in yields can be attributed to the improvement in risk appetite and hope that the ECB/EU/IMF will provide a backstop for the region. Yet considering that these agencies have not shown any new signs of willingness, this is nothing more than speculation.  The only explanation comes from Spanish bond yields. When Portuguese, Greek and Irish bond yields rose above 7 percent, these countries were forced to ask for a bailout and to avoid a similar disaster in Spain, European officials may be more proactive, offering support before the psychologically and financially hobbling level is reached.  Greece and their decision about the euro continue to grip the markets and will undoubtedly come back into focus later this week.

There is no question that the pair remains under pressure and the path of least resistance from a fundamental and technical basis is still lower. Further losses will hinge upon another catalyst which unfortunately could come from a variety of serious and realistic risks. This includes Spanish bond yields rising above 7 percent, an abysmal Italian bond auction tomorrow or an unfriendly outcome to the Greek election. The news needs to be bad enough to overcome the demand from bottom fishers. This morning’s Italian 6 month bill auction resulted in full uptake but at a much lower bid to cover ratio and a much higher yield.  Wednesday’s 5 and 10 year Italian bond auction will be a more important test of investor confidence. Eurozone consumer sentiment indicators are due for release tomorrow. Economic and business confidence is expected to deteriorate amid ongoing uncertainty in the region. Despite the recent decline in the EUR/USD, inflationary pressures in the Eurozone are softening according to the latest German consumer price report. CPI fell 0.2 percent in May, dropping the annualized consumer price index to 1.9 from 2.1 percent. This gives the European Central Bank plenty of flexibility to ease monetary policy and the only question is when they will act. 


The U.S. dollar extended its gains against most of the major currencies. While it can be argued that worse than expected U.S. economic data kept the dollar in demand for safe haven purposes, the rally in stocks suggests that most investors ignored the weaker reports. This is supported by the fact that the dollar did not gain momentum until Egan-Jones cut Spain’s credit rating. All of today’s economic releases were second tier which means they have very little impact on monetary policy. The Federal Reserve is focused on unemployment, consumer spending and Europe’s sovereign debt crisis. As things currently stand, there is no urgency to ease monetary policy but should Europe’s troubles trigger a deeper sell-off in the U.S. financial markets, the Fed may be forced to stimulate the economy. We strongly believe that their decision about QE3 hinges upon the outcome of the Greek elections and their decision about the euro.  Despite today’s disappointments in U.S. data, for the past month, we have mostly seen improvements. They have been gradual but made the dollar more attractive compared to other currencies. According to S&P Case-Shiller, house prices were largely unchanged in the month of March. More recent releases such as the existing home sales report have shown an uptick, undermining the significance of today’s housing market report. In contrast to the University of Michigan consumer sentiment index which showed an improvement in confidence, according to the Conference Board, consumers grew less optimistic in the month of May. The consumer confidence index dropped to a 4 month low of 64.9 from 68.7. The slowdown in job growth and the slide in equities have weighed on sentiment as the ripples from the Europe's sovereign debt crisis hit U.S. shores. Manufacturing activity in the Dallas region contracted for the second consecutive month. There has been very little consistency in the performance of the manufacturing sector this month.  Philadelphia, Dallas and Richmond reported slower manufacturing activity while Kansas and the NY region reported stronger activity. Pending home sales are scheduled for release on Wednesday – after a 4.1 percent increase in March, sales are expected to have stagnated in April. The most important event risk this week for the U.S. dollar will be non-farm payrolls and the low level of jobless claims is consistent with stronger job growth. If that fails to materialize, the dollar could give up its gains.


The British pound ended the North American trading session lower against the U.S. dollar and higher against the euro. Better than expected economic data failed to lend much support to sterling. According to Hometrack, house prices increased in the month of May with London house values surging 0.6 percent. The residential property market in London continues to diverge from the rest of the nation but the gains are not expected to last according to Richard Donnell, the director of research at Hometrack. He expects “increased mortgage rates and mounting concerns over the impact of the Eurozone on the U.K.’s economic growth and employment to keep demand and prices in check as we move into the summer.” The CBI Distributive Trades survey also rebounded sharply to +21 after falling to -6 last month. This survey from the Confederation of British Industry measures retail sales volume and has a strong correlation with the national retail sales index. The improvement in the labor market helped drive the CBI index to its highest level since April of last year. Consumption should remain strong in the summer with an upcoming lift expected from the Queen’s Diamond Jubilee and the Olympics. This dynamic could explain why monetary policy committee member Broadbent said the central bank’s policy stance is sufficient today. He felt that that the U.K. government has done all that they can right now and decisions affecting the U.K. are being taken or need to be taken in “other parts of the continent.” Consumer credit, net lending securities on dwellings and mortgage approvals are scheduled for release on Wednesday.


Like all of the other major currencies, the Australian, New Zealand and Canadian dollars fell victim to risk aversion but it is worth noting that all 3 currencies enjoyed a nice recovery on Monday, when U.S. markets were closed.  The prior rally was sparked by comments from rating agency Fitch who did not believe further rate cuts from RBA were guaranteed and by the hope for more stimulus from the Chinese government. The agency’s director of Asia Sovereign ratings argues that while rate cuts could be needed to stimulate growth amid tightening fiscal policy, it may not be a reasonable way to approach the markets for an inflation targeting central bank. He says that “if inflation was still rising or above their target, then I don’t think they would be cutting rates.” The Reserve Bank of Australia seeks to keep consumer prices within 2 to 3 percent and currently inflation is undershooting their target. In the first quarter, CPI growth slowed to 3.1 from 1.6 percent, so in our opinion, more rate cuts are likely. Support from China on the other hand is very realistic. The government has committed to taking additional steps to prevent a steeper slowdown in growth. We haven’t seen any measures announced yet but there were reports that they are accelerating the approval of investment projects. With Chinese industrial profits declining in April and the leading indicator index falling, the People’s Bank of China also has a stronger case. Australian retail sales are due for release this evening and given the sharp drop in the sales component of retail PMI over the past 2 months, we expect consumer spending growth to slow. Home sales rebounded sharply in April according to the latest housing market report. Canadian inflation numbers are also scheduled for release on Wednesday and inflationary pressures are expected to ease. 


The Japanese yen strengthened against all major currencies today despite the fact that the Nikkei 225 rallied on the prospect of good news from China. According to the Wall Street Journal, in the first four months of the year, the National development and reform Commission has approved more than twice as many investment projects as it did in the same period a year earlier. Japan’s two-year government bond auction also attracted the strongest demand in almost seven years. The sale drew 2.5 trillion yen ($31 billion). Job and spending data were released on Monday night. The jobless rate increased to 4.6 percent from 4.5 percent. Household spending (YoY) declined from 3.4 to 2.6 percent while retail trades (MoM) increased from -1.2 percent to -0.3 percent. The softer labor market and spending data could prompt the BoJ to ease their monetary policy further in the coming months. Manufacturing PMI numbers are set to be released tonight at 19:15 ET / 23:15 GMT. The PMI numbers have been above 50 for the past 5 months. This indicates that the sector is currently expanding, however, this trend may have a tough time continuing because the recent strength of the Yen will weigh on exports. 

EUR/GBP: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours is EUR/GBP. Starting at 4:00 ET / 8:00 GMT Eurozone will be releasing its Money Supply numbers. At 4:30 ET / 8:30 GMT the UK will release their Money Supply as well along with Mortgage Approvals, Net Consumer Credit, and Net Lending Secured on Dwellings. At 5:00 ET / 9:00 GMT the Eurozone will release its Consumer, Industrial, Economic, Services Confidence, and Business Climate Confidence Indicators.

EUR/GBP is currently trading in a range according to our Double Bollinger Bands. Our first support will be at 0.7948 which is the lowest point EUR/GBP has hit since 2008. Should this support break then the next support will be at 0.7783 which is the 61.8% Fibonacci Retracement levels drawn from January 23, 2007 low to the December 31, 2008 high. On the up side our first resistance will be at 0.8047 which is May 10th, 11th, and 25th’s high. Should this resistance break then our second resistance will be at 0.8100 which is May 21st and 22nd high and is also a psychologically significant number.