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Why EUR Shrugged Off Spanish Bailout

Kathy Lien, Director of Currency Research, GFT


  • AUd/JPY



  06/20 Meeting 08/01 Meeting
NO CHANGE 66.0% 65.4%
CUT TO 0.00% 34.0% 33.3%
HIKE TO 0.50% 0.0% 1.3%
CUT TO 75BP 0.0% 0.0%



After racing to a high of 1.2668 at the start of the Asian trading session, the euro ended the day lower against the greenback. European and North American traders clearly do not share the optimism of their Asian counterparts who drove currencies and equities sharply higher overnight. The intraday reversal in the EUR/USD and eventually in stocks reflects the market’s skepticism about the Spanish bond deal being the solution to all of Europe’s problems. With 10 year Spanish bond yields rising to a high of 6.6 percent this skepticism is certainly warranted because it does not rule out the risk of a broader sovereign bailout and the risk of a country like Greece leaving the euro. 

So far, the rescue of Spain has not turned into a rescue for the financial markets. For the past few months, everyone from investors to central bankers has been sitting at the edge of their seats fearing that more serious problems in Spain would lead to Armageddon in the markets. Spain's problems deepened after the IMF reported a EUR40 billion capital shortfall in local banks, forcing Eurozone officials to hold an emergency meeting and Spain to accept a EUR125 billion bailout. This amount would cover the capital shortfall of Spanish banks and provide some additional cushion. Yet, the EUR/USD failed to hold onto its initial gains because the Spanish bailout leaves many unanswered questions such as which bondholders will be subordinated. It also does not remove the risk of Greece or any other country leaving the Eurozone. The Greek elections are scheduled for this weekend and it will be a close one. 

Nonetheless, Spain's willingness to accept a bailout and the swift offer from Eurozone nations indicate that there is enough political will in the region to provide assistance where it is needed. Spain has now officially become the largest Eurozone economy to request for a bailout but details will not be released until the end of the month. Where the aid comes from - ESM or EFSF will determine which bond holders rank higher and who will absorb the most losses. While it may seem counterintuitive to some investors that risk could rally on the heels of a Spanish bailout, the recapitalization of Spanish bonds would reduce their need for funding from the market and require strict restructuring plans for the banks. Ultimately, this should help to restore credibility and transparency to the Spanish banking system.  The Spanish bailout is a move in the right direction but the European sovereign debt crisis is far from over. Not only will the Eurozone struggle to grow this year but we have a number of important event risks that could dramatically alter the outlook for the euro. In the meantime however as long as Spanish and Italian bond yields continue to rise and there is a risk of a country leaving the Eurozone, the EUR/USD will have a tough time rallying.


It was a mixed day for the U.S. dollar which ended the North American trading session unchanged against most major currencies. While the greenback traded slightly lower against the British pound, it edged higher against the Swiss Franc and Canadian dollars. With this in mind, all of the major currencies are well off their earlier highs against the greenback which shows that investors are unconvinced that Spain’s bank bailout will resolve Europe’s sovereign debt crisis. The near term outlook for the U.S. dollar hinges on the amount of deleveraging that we can expect this week. While consolidation is possible ahead of this weekend’s Greek elections, the possibility of a Greek euro exit and a full sovereign bailout for Spain leaves open the risk of further deleveraging. At the same time, Federal Reserve Chairman Ben Bernanke provided very little clues about his monetary plans last week which leaves the market guessing ahead of this month’s FOMC meeting. While the Fed could still increase monetary stimulus (and we expect that they will) which would be negative for the U.S. dollar, the most imminent risk is additional problems for the Eurozone. No U.S. economic data was released today but according to Fed Presidents Lockhart and Williams, both of whom are voting members of the FOMC, the outlook for the U.S. economy is grim. Fed President Williams said Europe poses a significant threat to stability and as a result, growth trends overseas are deteriorating. Fed President Lockhart also saw a slow and drawn out recovery with moderate growth and slow decline in jobless. He felt that none of the options should be off the table and is keeping an open mind at the next Fed meeting.  Bernanke may be trying to be elusive about the future of monetary policy but most other FOMC members have been transparent with their concerns. The most important piece of U.S. data scheduled for release this week will be Wednesday’s retail sales number. Consumer spending is expected to contract by 0.2 percent but according to the International Council of Shopping Centers, retail sales rose 1.7 percent last month. A recovery in spending could help the U.S. dollar by paring QE3 expectations. 


The British pound traded higher against the euro and U.S. dollar despite dovish comments from Bank of England policymaker Adam Posen. This morning Posen said he was too optimistic when he switched his QE vote in April. He feels that the recovery in the U.K. economy has petered out and the risks in the Eurozone have increased. This creates a greater need for central banks to purchase other assets outside of government bonds to help boost the economy. He supports buying private sector assets that would better target the financial markets. These comments aren’t new – even before the most recent monetary policy meeting, Posen said he felt that it was premature for him to withdraw his support for more stimulus. As a result, we fully expect the June 20th release of the BoE minutes to show Posen voting in favor of additional Quantitative Easing. The real question then is how many additional members support his views. Given the recent deterioration in economic data and the decline in inflation, we expect more than 2 members to vote for additional easing but given the lack of action this month, we know that fewer than 5 members favored more QE because otherwise there would be a majority. The RICS house price balance and industrial production numbers will be released tomorrow. While economists are looking for stronger IP, the sharp pullback in manufacturing PMI suggests that the sector as a whole remains weak. 


The Canadian, Australian and New Zealand dollars all weakened against the greenback.  New Zealand was the only country to release data over the past 24 hours. According to the latest report, manufacturing activity declined in the first quarter.  For the RBNZ, this could increase their concerns about the outlook for New Zealand’s economy.  Weaker economic data from China added to the pain of the commodity currencies. Although the country’s trade balance increased more than expected with exports jumping 15.3 percent and imports rising 12.7 percent, retail sales growth slowed. Inflationary pressures also eased according to the CPI and PPI numbers while industrial production grew at a slower pace. These reports were the first releases since the People’s Bank of China cut interest rates last week and explains why the central bank pushed forward with growth measures as domestic demand has become a greater issue for China over the past few months. If Chinese demand slows, countries such as Australia who consider China as their number one trade partner will suffer as well. Reserve Bank of Australia Governor Stevens has already made it clear that he does not believe the outlook for the Eurozone economy is promising. The relative weakness of the Australian dollar today could reflect the market’s increased expectations for additional easing from the RBA.  No economic data is expected from Canada tomorrow but Australian business confidence and New Zealand Credit Card spending numbers are due for release this evening.


It was a mixed day for both safe haven currencies. The Japanese Yen traded higher against the euro, Swiss Franc Canadian and Australian dollars, weakened against the British pound and held steady against the U.S. dollar. Japan released its Consumer Confidence report last night and to the surprise of many, confidence increased in the month of May. Apparently the decline in stocks and the rise in the Yen did not draw away from the air optimism in Japan. Consumers grew more optimistic about their overall livelihood, income growth and employment. They also became more willing to buy big ticket items such as durable goods. While this is encouraging for the Bank of Japan who meets later this week, there is still too much weakness in the Japanese economy to change their outlook for monetary policy. Machine tool orders fell 2.9 percent last month as the country continues to struggle under the weight of a strong Yen. The Tertiary Industry Index will be released this evening followed by Domestic CGPI, which is an inflation measure and the Manpower survey of employment conditions. The Bank of Japan also nominated 2 members to the BoJ Board today. The prospective additions are Takehiro Sato, chief economist at Morgan Stanley and Takahide Kiuchi, chief economist at Nomura Securities. Sato is known for his advocacy for aggressive monetary easing while Kiuchi is known to take a more neutral stance on the monetary policy. They will be interesting additions to the BOJ with their drastically different views on the economy.

GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours will be GBP/USD. Tonight at 19:01 ET / 23:01 GMT we will be expecting RICS House Price Balance from the UK. Tomorrow at 4:30 ET / 8:30 GMT the UK will be releasing its Industrial and Manufacturing Production. Then at 10:00 ET / 14:00 GMT they will release the NIESR GDP Estimate. For the US the NFIB Small Business Optimism will be released at 7:30 ET / 11:30 GMT, followed by Import Price Index at 8:30 ET / 12:30 GMT and IBD/TIPP Economic Optimism at 10:00 ET / 14:00 GMT. Lastly at 14:00 ET / 18:00 GMT the US will release its Monthly Budget Statement.

GBP/USD is currently trading at a range. The nearest support is June 7th’s low of 1.5403, should the pair break this support a heavier support will be at 1.5267 which is May 31st, and October 5, 2011’s low. On the upside our first resistance will be at 1.5600 which is June 6th high and also a round number. Should this resistance break then the next resistance will be at 1.5800 the upper first standard deviation Bollinger Band.