Behind the Solitary Strength in the Euro

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Daily FX Market Roundup 08-13-12

Behind the Solitary Strength in the Euro
EUR: Germany and France Report Weaker Spending
GBP: Mourning the End of a Much Needed Period in Spending
AUD: Hit By Profit Taking
CAD: Oil and Gold Prices Unchanged
NZD: Extends Losses in New Trading Week
JPY: Slower GDP Growth

Behind the Solitary Strength in the Euro

With no major U.S. data on the calendar today, the dollar held steady or traded higher against all of the major currencies with the exception of the euro. Considering that U.S. stocks also moved lower, the strength of the greenback is consistent with a tinge of caution or risk aversion ahead of Tuesday’s key U.S. economic reports. The unusual strength of the euro can be attributed to short covering or a reduction in euro funded high beta FX trades. In Plain English, this means some investors who have shifted their euro holdings into other currencies like the AUD and NZD are taking profits, which also explains why EUR/AUD is the day’s best performing currency pair.

While the recent decline in European bond yields helped to reduce volatility in the foreign exchange market, the stability of the euro stems from nothing more than a promise from European policymakers to do everything in their power to protect the currency. No concrete steps have been taken to follow through on that pledge but investors are spending so much time in the sun that they are forgetting about the growing pressures on the European economy. According to this morning’s German data, wholesale prices are on the rise due in part to the increase in food prices. The high level of unemployment in the Eurozone makes any increase in prices an even greater burden on the pocketbooks of European consumers. German and French second quarter GDP numbers are scheduled for release tomorrow and growth is expected to slow in both countries. As a result, it is hard attribute the recovery in the EUR/USD to fundamentals. However the ZEW survey of investor confidence will tell us whether the recent decline in yields helped to stabilize confidence.

Furthermore, profit taking on euro funded high beta FX trades could also be temporary. Over the weekend, the Nikkei, Japan’s largest financial newspaper, reported that Germany may start to allocate some of its forex reserves to currencies in the Asia Pacific region. As long as Europe’s sovereign debt crisis remains unresolved, there is still a risk in holding euros. With this in mind however, most of Europe is still on vacation and we don’t expect any major developments until the Jackson Hole Summit at the earliest. Apparently ECB President Draghi is scheduled to speak at this meeting between central bankers, economists and policy experts at the end of the month.

Dollar Trades Higher Ahead of US Data

Currencies are treading quietly ahead of Tuesday’s heavy U.S. economic calendar. This is a busy week for U.S. data and the most important release on the calendar will be tomorrow’s retail sales report. Economists are finally looking for a rebound in consumer spending after 3 consecutive months of weakness. We haven’t seen this long of a stretch in negative retail sales growth since the recession in 2008. While there is very little momentum in the U.S. recovery, the economy is still growing with the labor market rebounding last month. As a result, we would surprised if retail sales did not turn positive in the month of July. Along these same lines, food and gasoline prices also increased last month, which should contribute positively to retail sales values. More companies in the sector also beat than missed their sales forecasts. However since economists are looking for a rebound in spending, a softer release would have a much larger impact on the U.S. dollar. Producer prices on the other hand should rise as the increase in food prices begins to push inflationary pressures higher. Yet any impact on the dollar should be limited because this week’s economic reports are not expected to be a game changer for the Federal Reserve. The U.S. central bank is worried about jobs and the question of more stimulus hinges on only two things –the pace of job growth and Europe. The increase in retail sales is only expected to be nominal.

GBP: Mourning the End of a Much Needed Period in Spending

The Olympics is over and tourists are beginning to leave the hustle bustle of London. For the U.K., the end of the summer games means the end of a much needed period of increased spending, tourism and economic activity. Britain now remains quiet, just like the price of the British pound, which held steady against the U.S. dollar. While sterling sold off against the euro and Swiss Franc, its weakness is largely attributed to strength in other currencies. Bank of England Governor Mervyn King said the UK must focus on reforming its banking industry and reiterated his dovish outlook for the Eurozone which is one of the main factors holding back UK’s economy. He noted, “If the rest of the world were growing normally, the rebalancing and recovery of our economy would be much easier. But it isn’t. Even the rapidly expanding emerging-market economies are slowing, and the problems of the euro area continue with no obvious end in sight.” King said that while the Olympics may boost confidence, they “cannot alter the underlying economic situation we face. But it is slowly healing.” King also noted that, “conditions are in place for a recovery” and that the BOE is “doing all we can to help bring it about.” Policy maker Adam Posen who will step down at the end of the month urged its bond purchasing program to buy private sector assets. He said, “As long as the central bank isn’t monetizing government debt in the primary market then I don’t think it matters that much what assets the central bank acts on.” Consumer prices are due for release tomorrow and inflationary pressures are expected to drop by 0.1%, compared to a decline of 0.4% the previous month.

AUD: Hit By Profit Taking

The Australian, New Zealand and Canadian dollars all weakened against the greenback. It has been a quiet day for the commodity currencies as no new data will be released until tonight. Despite the latest decline, the AUD and NZD have been one of this year’s best performing currencies. These commodity producing countries who were once reliant on exports to perform have strengthened despite signs of slower global growth. Its relatively sound fiscal finances and high interest rate have made them extremely attractive safe haven currencies. The RBNZ and RBA have kept their bank rates at 3.5% and 2.5% respectively which are the highest rates among the most developed countries. The RBA left its rates unchanged left week even though RBA Governor Glenn Stevens said rates “remained high.” Australia has kept its core inflation within its target of 2-3% as higher retail sales, housing prices and home loan approvals show the nation is pressing ahead. Data expected for tonight includes retail sales for New Zealand and NAB business confidence for Australia.

JPY: Slower GDP Growth

The sterling, euro, Swiss Franc and greenback traded higher against the Japanese yen, while the kiwi and Aussie traded lower and the loonie remained flat. Japan’s second quarter GDP growth slowed from 1.3% to 0.3% against expectations for a rise of 0.6%. Despite the poor data, Economics Minister Motohisa Furukawa said in a statement that Japan’s economy is growing and is expected to continue its expansion in the third quarter. He also said, “Japan’s economy continues in an uptrend led by domestic demand.” He admits the slowdown is due to the impact of the Eurozone crisis on Japanese exports. However, the Eurozone crisis is not the only thing responsible for the less than expected GDP; the strong yen has also curbed exports. The BOJ refrained from easing last week. BOJ Governor Misaaki Shirakawa said the central bank is not considering following the ECB in cutting rates as the bank rate is already at a low 0.10%. Although few expect Japan to be in a recession, the dismal GDP data is adding pressure on the government and BOJ to do more to bolster the economy. Yoshihiko Noda has gotten his controversial bill to increase consumption tax passed last week which may help to combat a rising deficit. Data expected for tonight includes the tertiary industry index which is expected to decline by 0.3%.

Kathy Lien
Managing Director

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