EUR Squeezes Higher on Illusive Support from ECB

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Daily FX Market Roundup 07-26-12

EUR Squeezes Higher on Illusive Support from ECB
USD: GDP – How Bad Will Growth Be?
GBP: London Olympics Begins!
AUD: Chinese Data on Tap
NZD: Best Performer Against the USD
CAD: Oil and Gold Prices Steady
JPY: Busy Night for Japan

EUR Squeezes Higher on Illusive Support from ECB

The euro ended the North American trading session sharply higher against the U.S. dollar. The rally in EUR/USD today came hand in hand with a sharp decline in 10-year Spanish bond yields, which is far more noteworthy than the recovery in the single currency. While short covering can explain the squeeze higher in euro, the dive in Spanish yields reflects how much faith investors have in the European Central Bank. Comments from ECB President Draghi this morning sparked a major recovery in the EUR/USD. The head of the central bank head pledged to do whatever it takes to preserve their currency. While no commitments were made, the recent sell-off in the EUR/USD is finally alarming enough that the ECB felt it necessary to reassure the market that they stand behind the currency. Politicians and policymakers have claimed that many of proposed changes fall outside of the ECB’s mandate but Draghi reminded us today that saving the euro is their mandate. This echoes recent comments made by ECB member Noyer who also said the central bank’s definitive position is to do everything in its power to keep the euro but apparently hearing it from the head of the central bank made a world of a difference.

So while the recovery in the EUR/USD was not supported by any tangible initiatives to increase the safety net for the Eurozone, the vote of confidence and commitment from the central bank head was enough to reassure investors that the ECB will not sit by idly and watch the euro disintegrate. The problems for Europe are far from over but the sharp decline in Spanish and Italian bond yields will bring immediate relief to fiscal finances. With yields below 7%, Spain will have a much easier time servicing their debt. If we are so lucky that yields stabilize below 7%, then the risk of a full sovereign bailout will dissipate. In the meantime, a number of economists are starting to put a timeline on a Spanish and Italian bailout. Nomura believes that both countries will need aid within months while RBS thinks that it could happen within days. With yields back below 7%, the urgency to act has diminished materially and therefore months is far more likely than days.

USD: GDP – How Bad Will Growth Be?

With stocks rising strongly, safe haven flows eased out of the U.S. dollar, pushing the greenback lower against all of the major currencies. The latest U.S. economic reports were mixed with pending home sales falling, jobless claims improving and durable goods orders just confusing. Yet none of today’s reports will be as important as tomorrow’s GDP number. Economists are looking for a small pullback in growth (from 1.9 to 1.4%) but we believe there could be a much a larger decline given that retail sales fell every month in the second quarter. The last time we saw 3 consecutive months of negative retail sales growth was back in Q4 of 2008, when we were knee deep in the financial crisis. At the time, the U.S. economy fell into recession with growth contracting as much as 8.9% in Q4. Of course, we don’t expect such terrible numbers, but there is good reason to believe the U.S. economy expanded by less than 1% last quarter and subpar GDP growth could renew speculation for QE3. As for today’s releases, pending home sales fell 1.4% in June after rising 5.4% the previous month. First time jobless claims dropped to 353k from 388k in the week ending on July 21st. While claims are normally more volatile in July due to auto plant shutdowns, this is a very good number that will fuel hope for a stronger recovery in non-farm payrolls. With the 4 week moving average dropping to its lowest level since April 2012, the latest jobless claims reports are consistent with payroll growth in excess of 100k this month. Durable goods orders also printed much better than expected, rising 1.6% in June, matching the prior month’s upwardly revised number. Unfortunately the details of the report was not nearly as encouraging because excluding transportation, orders fell 1.1%.

GBP: London Olympics Begins!

Like the euro and other high beta currencies, the British pound soared against the U.S. dollar today. Its gains against the euro however were far more limited considering that it was euro centric developments that drove the markets higher. The London Olympics officially begins tomorrow and the excitement in the U.K. is electrifying. Demand for British pounds will increase during this period as tourists and players from other nations descend upon the city. The London Olympics 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. Yesterday we learned that the recession in the U.K. deepened and while the data may have been distorted by holidays, growth is still very weak and the country is desperate need of momentum. No U.K. economic data is scheduled for release on Friday but all eyes will be London as the games begin.

AUD: Chinese Data on Tap

Thanks to the rally in equities, the New Zealand, Australian and Canadian dollars traded higher against the greenback with the NZD being the day’s best performing currency. The New Zealand dollar traded higher against most major counterparts after RBNZ Governor Alan Bollard left the rates unchanged. Dovish comments were expected but he stayed most neutral. Mixed U.S. economic reports limited gains in the Canadian dollar while the Australian dollar traded within a whisker of its 2 month high. Chinese industrial profits are scheduled for release this evening along with the MNI July Business Sentiment Indicator. Any pullback in profits could threaten the rally of the commodity currencies and the Australian dollar in particular.

JPY: Busy Night for Japan

The Japanese Yen traded lower against all major currencies as Japanese stocks rose for the first time in 5 days. The Nikkei 225 Index was up 0.92% to 8,443.10. A panel that will collaborate with the BOJ to combat deflation and prevent the yen from strengthening has released its final draft outlining the government’s plan for growth. The draft focuses on spending on clean energy, health and agriculture. The draft needs to be approved by the Democratic Party of Japan which will probably be dealt with by the end of next week. The draft writes, “As well as working closely with the BOJ to do all in our power to combat deflation, we will use all possible policies to prevent a vicious cycle of a rising yen and deflation.” Yesterday, BOJ Deputy Governor Hirohide Yamaguchi said that the BOJ “will not hesitate to implement additional monetary easing.” BOJ Governor Masaaki Shirakawa said in a speech today that “there may be many areas in which prices determined on futures exchanges could become benchmarks for related economic activity.” He noted that “the fact that many commodity futures in Japan are not flourishing might lead us to conclude that any market that fails to attract a sufficient amount of non-speculative activity will languish.” It is a busy night for Japan with CPI and retail trade numbers scheduled for release.

Kathy Lien
Managing Director

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