EUR: Damage Control Begins

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Daily FX Market Roundup 07-23-12

EUR: The Damage Control Begins
USD: Driven Higher by Fear
GBP: Sterling Remains Attractive to European Investors
AUD: Shrugs Off Hotter PPI
CAD: Retail Sales Numbers Due Tomorrow
NZD: Oil Prices Drop 3 Percent
JPY: Yen Strength Testing Resolve of BoJ / MoF

EUR: The Damage Control Begins

The euro ended the North American trading session only slightly lower against the U.S. dollar following an intraday recovery that lifted the EUR/USD off its fresh 2.5 year low of 1.2068. The currency pair was sold aggressively during the first half of the European session, as investors grew more concerned about the need for a Spanish sovereign bailout. Over the weekend, El Pais, the most widely read newspaper in Spain reported that Catalonia, the second most populous region in the country could join Valencia in seeking financial help from the central government. The region of Catalonia is the largest contributor to Spanish GDP because Barcelona is one of its provinces. The paper reports that 4 other regions could also seek aid if this speculation by El Pais turns into reality, in which case Spain will not be able to avoid a sovereign bailout. With 10 year Spanish bond yields climbing to a record high well above 7% and speculation brewing, Spanish officials are focusing on damage control with Economy Minister De Guindos denying that Spain needs to be rescued by the European Union. Of course we have heard these same denials before by Greece and other European nations that have been forced to ask for a bailout.

One form of damage control however seems to have worked. Spanish and Italian stocks have been on a downtrend since the beginning of the second quarter but over the past month, Spanish stocks have fallen 13% while Italian stocks have dropped more than 11%. The sharp slide in equities coupled with the jump in Spanish and Italian bond yields forced policymakers to spring into action. We’ve seen the first damage control from market regulators. Italy banned short selling of financial stocks, effective immediately until July 27th while Spain decided to be even more aggressive by banning short selling on all stocks for the next 3 months. These announcements triggered a major turnaround in Spanish and Italian equities and the EUR/USD. Yet the IBEX (Spain’s stock market) still ended the day down 1.1% while the FTSE MIB (Italy’s stock market index) closed down 2.76%. The market’s focus is on Spain but concerns about Italy are growing. Last week, Prime Minister Mario Monti expressed serious concerns about the possibility of default by Sicily, which accounts for 5.5% of Italian GDP. Today, Italian regional authorities warned that they may not be able to open schools after the summer break if spending cuts go through. While we doubt that the Monti would sacrifice the education of Italy’s youths, this warning nonetheless highlights the gravity of the nation’s fiscal finance problems.

While the ban on short selling helped to stem the losses in currencies and European equities, if stocks resume their slide and bond yields in Europe continue to rise, an emergency summit may have to be called to deal with the market turmoil. Otherwise, it will be a problem that the European Central Bank will have to address alone when they meet on August 2nd. Eurozone PMI numbers are due for release tomorrow. Economists are looking for manufacturing and service sector activity to hold steady in July. Any downside surprises could trigger further weakness in the EUR/USD.

USD: Driven Higher by Fear

Despite the intraday recovery in the EUR/USD, the level of fear in the financial market is unusually high and as a safe haven currency, the U.S. dollar is benefitting from the concerns. The greenback traded higher against all of the major currencies with the exception of the Japanese Yen. No economic data was from released the U.S. today and nothing significant is expected over the next 24 hours outside of earnings from tech giant Apple. There are a few pieces of important U.S. data on the calendar this week but these are concentrated on Thursday and Friday. As a result, between now and then the movements of the U.S. dollar and U.S. equities will be determined by the ongoing developments in Europe. Traditionally, U.S. stocks lead the movements in the EUR/USD but in recent days we have seen the reverse where the EUR/USD is leading the movements in U.S. equities. This dynamic is being caused by the fact that most of the big developments are happening in Europe leaving U.S. equities to play catch up during the North American session. The Richmond Fed and the House Price Indices are the only pieces of U.S. data on the calendar tomorrow – given the second tier nature of these reports, the desire for safety will be predominant driver of currency flows.

GBP: Sterling Remains Attractive to European Investors

With no U.K. economic data on the calendar, risk aversion drove the British pound lower against the U.S. dollar but sterling rose to a fresh 3 year high against the euro. The pound continues to be one of Europe’s favorite safe haven currencies. Unlike other central banks in the region who have intervened to stop the rise in their currency or cut interest rates to negative levels (Denmark), the Bank of England has not resorted to any extreme measures. They recently boosted their asset purchase program but this only lowers borrowing costs and doesn’t bring it below zero (at least not quite yet). The big event for the U.K. this week will be Wednesday’s GDP number. We have BBA Loans for House Purchases tomorrow but this report should not have a significant impact on sterling. The London Olympics begins next week and will rank alongside the Beijing 2008 games as the most expensive in history. Tourism and Olympics related jobs should help to boost U.K. GDP by 0.3%. Between the Queen’s Jubilee and the Olympics, this will be a banner year for tourism, a source of revenue that is desperately needed to help pull the country out of recession.

AUD: Shrugs Off Hotter PPI

The Australian, New Zealand and Canadian dollars weakened against the greenback today despite hotter inflation numbers. Overnight, the quarterly Australia producer price report beat expectations, rising 0.5% in Q2 compared to a forecast for 0.3% growth. On an annualized PPI rose 1.1%. Unfortunately, currency traders looked past the rise in inflationary pressures and took the AUD and NZD lower on European growth concerns. If Europe continues to wreck havoc on the market and asset prices fall across the globe, commodity prices will decline, making the rise in Australian PPI a nonissue. The latest sell-off in stocks drove the price of crude down 3% today while gold prices held steady. RBA Governor Glenn Stevens will be giving a speech tonight titled “The Lucky Country.” Stevens has always been optimistic about the local economy and his encouraging words could lend support to the currency especially if tonight’s HSBC Chinese Manufacturing PMI numbers surprise to the downside. Aside from PMI, leading indicators will also be released which could cause some volatility during the Asian session. Canadian retail sales are scheduled for release on Tuesday. The Bank of Canada has surprised the market with their commitment to unwinding stimulus in the face of weakening economic data. Tomorrow’s retail sales report will go a long way in validating or questioning the BoC’s stance.

JPY: Yen Strength Testing Resolve of BoJ / MoF

The Japanese Yen strengthened against all major currencies today, rising to an 11-year high against the euro on growing concerns about the Eurozone. Europe’s turmoil and weak US data have made the yen exceptionally attractive as a safe haven currency at the expense of Japan’s export sector. Unfortunately it doesn’t appear that policymakers will provide any relief – Japanese Finance Minister Jun Azumi said today, “My stance on foreign exchange is unchanged and will never change under any circumstances. We will take decisive steps against speculative movement of excessive volatility. As far as the current situation is concerned, I’m watching it carefully.” He also said, “when we think it’s necessary, we’ll act,” which is the same line he has given for months. The appreciating yen is a headache for Prime Minister Yoshihiko Noda as stronger growth is needed to pay for and offset his consumption tax. Noda met with BOJ Governor Masaaki Shirakawa earlier today but did not hint if further monetary easing was planned. Shirakawa said, “Simply expanding the central bank’s balance sheet won’t boost the economy.” In the July edition of the Cabinet Office Monthly Report released earlier today, the government noted that the economy is moderately recovering helped by reconstruction demand, although difficulties continue to prevail.”

Kathy Lien
Managing Director

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