Could Spain Elections Mean More Pain for EUR?

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Daily FX Market Roundup 10-19-12

Could Spanish Elections Mean More Pain for EUR?
Dollar Rises on Risk Aversion, Looking ahead to the Fed
GBP: Supported by Drop in Borrowing Needs
CAD: BoC Could Tone Down Hawkishness after CPI
NZD: Could RBNZ Grow More Dovish?
AUD: Gold and Oil Prices Fall Sharply
JPY: Japan Warns of Impact of Rising Yields

Could Spanish Elections Mean More Pain for EUR?

Concerns about the outcome of this weekend’s regional elections in Spain and disappointment in the lack of progress at this week’s EU Leaders Summit have driven the euro lower against the U.S. dollar. The stakes are high for the Prime Minister of Spain and Europe as a whole because the outcome of election will impact the government’s decision on a bailout. It is widely believed that the Spanish government’s reluctance to ask for bailout has a lot to do with the upcoming elections. Prime Minister Rajoy’s People’s Party is worried that they could lose part of their 38 seats in the 75 member regional assembly. Considering that the Party commands a very small majority, if any seats are lost, the Socialists and Galician nationalists could push for a coalition government. The elections will be an important test of the people’s satisfaction with Rajoy’s government and his handling of the country’s fiscal and economic crisis. If the People’s Party holds onto all 38 seats, the Prime Minister would feel more confident to ask for a bailout, which would be positive for the euro. However if the party loses power, it would be a huge blow to Rajoy and could push him to delay a bailout request until after the Catalonia regional elections in November, prolonging uncertainty in the Eurozone, which is negative for the currency. Galicia is the fifth most populous region in Spain but Catalonia is much more important because they are not only the second most populous region but also Spain’s most powerful economic center. While the riots in Spain suggests that the party is at risk of losing its majority, a survey conducted by La Voz de Galicia newspaper saw the People’s Party remaining in power. Also Galicia is where the Prime Minister is from and home of the late founder of ruling party. The Basque County will be holding elections on the same day as Galicia but the nationalists have dominated this region. Once again the stakes are high for Prime Minister Rajoy and the euro.

Meanwhile EU leaders took baby steps towards further integration at their Summit in Brussels. They pledged to agree on a framework for a banking supervisor by the end of the year with gradual implementation throughout the course of 2013. German Chancellor Merkel indicated that the supervision would apply to all banks and not just small ones but this isn’t a final decision because of conflicting comments from EC President Van Rompuy. As for a fiscal union, a more concrete proposal will be presented at the December Summit. On the surface, this means that Europe would be lucky if the complete Single Supervisory Mechanism is in place by the end of next year and a fiscal union by the following year. The prospect of the European Sovereign Debt crisis hanging over everyone’s heads for another 12 months is disconcerting and explains the weakness in the euro. Eurozone PMI numbers are scheduled for release next week along with the German IFO report. PMI figures are always important and economists are anticipating a small uptick in German manufacturing and service sector activity.

Dollar Rises on Risk Aversion, Looking ahead to the Fed

Risk aversion drove the U.S. dollar higher against all of the major currencies. With U.S. stocks falling more than 1%, the tone in the financial markets is beginning to shift. Today’s sell-off in the S&P 500 shaved off more than half of this week’s gains and with the technology sector leading the losses, the Nasdaq dropped to its lowest level in 2 months. Currencies followed suit with some pairs falling more than others. We started this new trading week on a strong note thanks to better than expected U.S. economic data but as the week progressed, disappointing earnings in the technology sector was a harsh reminder of the difficult environment U.S. companies have been operating in. While there have been signs of improvement in the U.S. economy, consumers are still very cautious because of high unemployment and global uncertainty. Also, we are only beginning to see data surprise to the upside and it is too early to tell whether this will continue. Next week we will get a sense of whether the Federal Reserve feels the same way. Having just increased monetary stimulus, no additional action is expected from the Fed next week. However everyone will be combing the statement carefully to see if Fed officials grew a little less dovish following the latest economic reports. If they do USD/JPY could regain momentum and rise to a fresh 2 month high above 79.50. This morning’s existing home sales surprised to the downside but after the strongest rise in 12 months in August, a dip is not unusual. Aside from the FOMC rate announcement, the most important economic report on the U.S. calendar next week will be third quarter GDP numbers scheduled for release on Friday. GDP growth is expected to improve on the back of stronger consumer spending and narrower trade deficits between the months of July and September.

GBP: Supported by Drop in Borrowing Needs

While the British pound ended the day lower against the U.S. dollar, it held up far better than all of the other major currencies. We had a series of better than expected economic reports this week that were capped off by stronger public sector finances. According to this morning’s economic reports, the U.K. government’s public sector net borrowing needs dropped to 10.7 billion from 11.9 billion in the September. Considering that borrowing needs rose to a record high in August, an improvement is natural and unfortunately it will not save Chancellor Osborne from missing his target this year. EUR/GBP has gradually trickled higher over the past month and if data continues to surprise to the upside, further gains are possible. U.K. third quarter GDP numbers are scheduled for release next week and based on the sharp improvement in retail sales and improvement in trade activity, there is a very good chance the data will show the U.K. rising out of recession in the third quarter. Hotter GDP numbers will reinforce the division within the Bank of England and if things continue to progress the way they are, there will not be enough support within the central bank for another round of stimulus in November.

CAD: BoC Could Tone Down Hawkishness after CPI

The Canadian, Australian and New Zealand dollars fell sharply on the back of risk aversion. The Canadian dollar saw the steepest losses courtesy of their consumer price figures. CPI growth slowed to 0.2% in the month of September from 0.4% the previous month while core prices remained unchanged. Part of the decline had to do with the currency, which rose to its highest levels in nearly a year last month. A strong currency drives down inflationary pressure that was already weakened by a 14.2% in natural gas prices and 2.2% decline in mortgage interest costs. For the Bank of Canada who meets next week, lower inflation increases the chance of the central bank dropping its hawkish bias. We already know that the BoC plans to cut its growth forecasts and could also tone down the overall tone of their monetary policy statement. The Reserve Bank of New Zealand also has a monetary policy announcement next week. Despite the uptick in credit card spending, interest rates are expected to remain unchanged at 2.5%. However the RBNZ could grow more dovish, which would weigh on the NZD. Australian consumer prices are scheduled for release on Sunday evening – given a decline in consumer inflation expectations and the market’s optimistic forecast, there is scope for a downside surprise.

JPY: Japan Warns of Impact of Rising Yields

The sell-off in U.S. stocks drove the Japanese Yen higher against all of the major currencies. Last night’s Japanese economic reports were uninspiring with all industry activity rising by 0.1% in August after falling 0.6% the previous month. The coincident and leading index were both revised slightly lower. The big story in Japan last night was the Bank of Japan’s warning that the economy could contract if yields rise 2%. A 1% increase in yields would cause 3.7 trillion yen losses at banks while a 2% increase would cause 7 trillion in losses. Japanese banks hold a significant amount of government bonds and an increase in yields would mean a drop in bond prices. Currently 10 year Japanese bonds are yielding 0.78%. This week we have heard about the possibility of fiscal and monetary stimulus and based on the latest comments from central bank governor Shirakawa, increasing concerns could push the BoJ to act, but probably not as quickly as Prime Minister may hope. According to Shirakawa, deceleration of overseas economies is deepening, the European economy is gradually slowing and as a result of that, the global economy is still at risk of slowdown. He felt that Japan’s economic activity was leveling off and will eventually return to moderate recovery. Japanese trade numbers are scheduled for release Sunday.

Kathy Lien
Managing Director

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