EUR Getting Killed, 1.20 in Sight

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Daily FX Market Roundup 07-20-12

EUR Getting Killed, 1.20 in Sight
USD: The Safe Haven Trade is Back
GBP: IMF Suggests UK Shift to Growth Focus
CAD: Softer Inflationary Pressure
AUD: Hotter Inflationary Pressure
NZD: Credit Card Spending Rises
JPY: Japanese Investors Still Buying Foreign Bonds

EUR Getting Killed, 1.20 in Sight

It has been another rough week for the euro, which dropped to a fresh 2 year low against the U.S. dollar, 3 year low against the British pound, 12 year low against the Japanese Yen and record against the Australian, New Zealand and Canadian dollars. What is particularly disconcerting about these milestones is that they have been set on a regular basis this month. The euro is being killed by ongoing debt troubles and unfortunately even the approval of a bank bailout for Spain has not calmed the markets. With 10 year Spanish bond yields climbing to a record high of 7.18%, Spain is officially the hotspot for uncertainty and if yields do not decline, the problems will only worsen.

This morning, the plan for a bailout of Spain’s banking sector was officially approved by the EU. The announcement was widely expected because to deny the bailout would have meant catastrophe for the euro and the financial markets. Yet, to the dismay of policymakers, the bailout of Spain has not reduced borrowing cost for and now the country’s third largest city, Valencia has asked for financial assistance from the government. For the euro and Spain this is terrible news because it means that the country is one step closer to a full-scale sovereign bailout. The weakness of euro today has to do with investors finally realizing that a bank bailout will not be enough. Too little too late is the problem because the market is now pricing in the possibility of a full sovereign bailout for Spain, especially now that GDP growth for 2013 has been revised down to -0.5 percent from +0.2 percent. Independent rating agency Egan Jones also downgraded the country’s debt rating to CC+ from CCC- and said the chance of a default over the next year is 35%. Aside from the rise in yields, the killer today was also the decline in the Spanish and Italian stock markets, which both fell 5.8% and 4.3%, respectively.

Eurozone PMI numbers, the German IFO report and consumer prices are the primary euro area economic releases on the calendar next week. In all likelihood, these numbers will show that growth is just as large of a problem as fiscal finances and weak economic data could drive the EUR/USD to 1.20.

USD: The Safe Haven Trade is Back

Safe haven flows into the U.S. dollar drove the greenback higher against all of the major currencies except for the Japanese Yen and the strength of the Yen only confirms risk aversion is behind today’s moves. As we wrote in our note on Thursday, the lack of U.S. economic today means that the dollar will trade on Europe. Unfortunately Europe is still a big headache for investors with uncertainties growing by the day. As we have learned this past week, sluggish U.S. growth creates its own problems but what matters now is that they do not pose nearly as much near term risk to the global financial markets as Europe’s troubles. The most important piece of economic data due from the U.S. next will be Q2 GDP. With retail sales falling every month in the second quarter, we expect significantly weaker Q2 GDP numbers. While this should be negative for the dollar and harden the case for QE3, the report won’t be released until Friday, which means that Europe could remain in focus in the front of the week. The only other economic reports expected from the U.S. are durable goods, new and pending home sales along with the final University of Michigan Consumer Confidence report. The most important thing that US dollar traders need to keep in mind is that the Fed is still on the fence about QE3 and clarity in monetary policy by any other central bank will help the outlook for their currencies.

GBP: IMF Suggests UK Shift to Growth Focus

While the British pound weakened against the U.S. dollar, it rose to a fresh 3 year high against the euro. The divergence in the performance of sterling shows how different investors are looking at the currency. Europeans see it as a safe haven while Americans and possibly Asian traders still look at sterling as a risk currency. Either way from this week’s economic reports, we know that the U.K. economy is weakening and policymakers are open to the idea of more stimulus. Next Wednesday, second quarter GDP numbers are scheduled for release and based on the sharp pullback in spending between April and June along with the deterioration in trade, we anticipate a material slowdown in growth. The U.K. is already in a technical recession after 2 quarters of negative GDP growth – a third consecutive quarter would mean that the recession isn’t just technical. The IMF called on the U.K. government to shift their focus from austerity to growth if the economy continues to weaken next year. They suggested targeted tax cuts and higher infrastructure spending as ways to jumpstart the economy. Unfortunately today’s data shows that the U.K.’s fiscal position is still very weak. While the government collected more tax revenue, they reported a larger deficit.

CAD: Softer Inflationary Pressure

The sell-off in global equities put pressure on all commodity currencies. However even though the Canadian, Australian and New Zealand dollars weakened against the greenback, they soared to fresh record highs against the euro. While the commodity producing countries have their own challenges when it comes to growth, in comparison, their economic outlook is much brighter than Europe. The sell-off in oil prices also didn’t help the Canadian dollar, which was a dealt a triple blow from risk aversion, weaker economic data and lower oil. According to the Canadian consumer price report, inflationary pressures in Canada eased in the month of June. CPI dropped for the second straight month by 0.4 percent and core prices fell the same amount. While annualized CPI growth ticked up to 1.5 from 1.2 percent, it is hard to believe that the Bank of Canada is talking about raising interest rates when manufacturing activity is contracting and inflationary pressures are easing. Based on the price action of the Canadian dollar, which fell sharply after the CPI report, many investors are also skeptical about how long the BoC can remain hawkish. In contrast, inflationary pressures accelerated in Australia during the second quarter with export and import prices rising strongly. In New Zealand, credit card spending also rebounded in June thanks to stronger net migration. The main events for the commodity producing countries next week include inflation reports for Australia, retail sales numbers from Canada and a central bank monetary policy announcement for New Zealand.

JPY: Japanese Investors Still Buying Foreign Bonds

Risk aversion drove the Japanese Yen higher against all of the major currencies. The Yen has performed particularly well against the euro and Swiss Franc with EUR/JPY falling to a 12 year low and CHF/JPY to a 2 year low. While the strength of the Yen continues to frustrate Japanese policymakers, it appears that they aren’t any more inclined to intervene in the currency and the reason is because they care more about the level of USD/JPY than EUR/JPY. Last night Bank of Japan Governor Shirakawa said Europe’s crisis is the biggest risk to Japan’s economy in part because it may lead to Yen strength. He added that external demand is weak but domestic demand is strong, which should help Japan return to a moderate growth path. According to the weekly reports on Japanese purchases of foreign bonds. Low yields abroad have not stopped domestic investors from buying foreign bonds. The weekly data can be volatile which is why we looked at the 4 week moving average and it showed Japanese purchases of foreign bonds at JPY930 billion, the highest since September 2010. The Cabinet’s Monthly Economic Report is scheduled for release next week along with the all important trade, CPI and retail sales numbers.

Kathy Lien
Managing Director

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