EUR Weakness Provides 3 Interesting Takeaways

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Daily FX Market Roundup 07-24-12

EUR Weakness Provides 3 Interesting Takeaways
USD: Safe Haven Trades Powers Higher
GBP: Deeper Recession in Q2?
CAD: Mixed Retail Sales Numbers
AUD: RBA Stevens Calls Australia Lucky Country
NZD: Better than Expected Chinese PMI Numbers
JPY: Growing Risk of Intervention?

EUR Weakness Provides 3 Interesting Takeaways

With Spanish and Italian bond yields on the rise and equities falling sharply in the U.S. and Europe, it is no surprise to see the euro continue to weaken against the U.S. dollar. The level of fear in the financial market is extremely high and the sell-off in the EUR/USD tells us that investors are worried about further trouble ahead. The persistent weakness in the EUR/USD along with the rise in bond yields and slide in stocks provides at least 3 interesting takeaways:

#1 – First and foremost regardless of the denials by Spanish lawmakers, investors have already begun to price in a full scale bailout. Over the past year and a half, we have seen the market turn a number of countries into panhandlers asking for help from the European Union. Borrowing costs in Spain have already reached unsustainable levels and the price action in the euro suggests that investors believe it should only be a matter of time before there is a need for a sovereign bailout. A number of developments could occur before Spain formally asks for help including a downgrade by Moody’s or Standard & Poor’s and the decision to hold an emergency EU Summit, all of which are near term negatives for the EUR/USD.

#2 – The second takeaway from the minor change in speculative positioning and the major decline in the euro is that speculators are not the only ones selling. We have heard a significant amount of interbank chatter on central banks diversifying out of euros and into other currencies, particularly the Swiss National Bank who is said to have been swapping their euros for Australian dollars. While this behavior isn’t confirmed by the SNB, we wouldn’t be surprised if they are selling euros especially if they are concerned about losing money on their massive euro holdings. The SNB’s efforts to cap the Franc’s rise against the euro led them to their accumulation of a massive amount of euros. The recent sell in EUR/USD will only require an even greater commitment to intervention and if the SNB wants to avoid losing even more money on their EUR/CHF positions, the smart thing to do would be to convert some of those euros into other currencies such as the British pound or Australian dollar.

#3 – Finally, the sell-off EUR/USD tells us that forex traders have cut their QE3 bets. Considering that the Federal Reserve won’t make a decision about Quantitative Easing until September, the pressure on the euro makes stimulus from the European Central Bank before the Fed a more likely scenario. The German IFO report is due for release on Wednesday. Given the decline in manufacturing and service sector activity in Germany, there is a good chance businesses grew more pessimistic in the month of July.

USD: Safe Haven Trades Powers Higher

Once again the U.S. dollar held steady or traded higher against all of the major currencies except for the Japan Yen. Fear and uncertainty continues to drive investors into safe haven currencies and to the dismay of Japanese officials, the Yen is still the market’s preferred safe haven trade and as a result, the currency rose against the dollar for the fifth consecutive trading day. The U.S. only released second tier economic data this morning. According to the reports, the Richmond Fed manufacturing index dropped sharply in the month of July, printing at -17.3 from -0.86 the previous month. This is the weakest reading in the more 3 years and another sign of slower growth in the U.S. economy. House prices on the other hand rose 0.8% in May, which is consistent with the gradual recovery reported in the Beige Book. New home sales are due for release tomorrow and after strong gains in May, slower growth is expected. In fact given the sharp decline in existing home sales last month, we would not rule out the possibility of a decline in the sales of new homes. Treasury Secretary Geithner is also scheduled to deliver the annual report of Financial Stability Oversight Council to a hearing of the House Financial Services Committee. There is a Q&A session, which means that Geithner could be asked tough questions about his role in halting the abuses of LIBOR.

GBP: Deeper Recession in Q2?

The British Pound traded higher against the euro, and held steady against the U.S. dollar. Today is a quiet day in the UK in terms of data. BBA mortgage approvals were released but the report had no significant impact on the currency. The number of mortgages approved for house purchases in the UK fell unexpectedly for the month of June. Numbers were forecasted to increase to 31.4K but had only rose by 26.3K. BBA statistics director David Dooks said, “Public holidays and wet weathers put a damper on mortgage approvals in June.” Bank of England Governor Mervyn King’s term is about to end and the most favorable candidate in replacing him is Financial Services Authority Chairman Adair Turner. Turner in an interview said, “Checks and balances are very important. Checks and balances have worked very well in relation to Monetary Policy Committee and I think they are increasingly working well in relation to the Financial Policy Committee. Turner is concentrating on his current role with dealing with challenges in UK banking and thinks that dealing with his current role is a good foundation before he takes on the role as the BOE governor. He notes, “As well as the very major problems in the macro economy, the need to get right the balance between bank prudential rules that make banks more resilient and the need to expand lending to the real economy.” U.K. GDP numbers are due for release tomorrow and weakness in consumer spending and trade activity means the U.K. most likely remained in recession in the second quarter.

CAD: Mixed Retail Sales Numbers

Early gains in the Canadian, Australian and New Zealand dollars were reversed by the end of the North American trading session. Canadian retail sales were the only piece of meaningful North American data on the calendar today and according to the latest report, consumer spending in Canada rose 0.3% in May. Since economists were looking for a 0.5% rise, the magnitude of the increase was less than expected but the Canadian dollar held onto its gains because excluding autos, sales rose 0.5% against expectations for a 0.1% percent. When the Bank of Canada met earlier this month they were surprisingly hawkish in the face of weaker manufacturing activity, inflation and employment numbers. Yet their decision to hold onto the view that rates need to be increased is vindicated by the stronger than expected consumer spending numbers. Better than expected Chinese manufacturing PMI numbers and optimistic comments from Reserve Bank of Australia Governor Stevens lent support to the AUD and NZD but risk aversion eventually overshadowed the positive sentiment. Stevens argued that despite slower Chinese growth, Australia is a “lucky country” because “even if the pessimists turn out to be right on one or more counts,” they would be able to cope because there is scope to use macroeconomic policy to support the economy, but only if “inflation did not become a concern.” Stevens is right in that Australia is faring much better than many other countries and for this reason, the Australian Dollar has outperformed every major currency since the beginning of the year except for the New Zealand dollar. Australian consumer prices are due for release this evening.

JPY: Growing Risk of Intervention?

The Japanese Yen continued to trade higher against all of the major currencies and every tick that the currency rises, the fear of Bank of Japan intervention increases. While USD/JPY is only at a one month low, EUR/JPY is trading at its lowest level since November 2000 while CHF/JPY dropped to its lowest level in 2 years. During a conference today Azumi said, “It is clear that the recent, one-sided climb in the yen is not reflecting the real state of Japan’s economy. We will closely watch foreign-exchange movements with a greater sense of caution from now. We will not rule out any measures against excessive moves and will take decisive action when it’s deemed necessary.” This hints of intervention in the markets but Eisuke Sakakibara who is formerly ran currency operations at the Finance Ministry notes that “intervention could only be effective when two parties agree to intervene.” Last year Japan faced international criticism for a solo intervention. Sakakibara also notes that without a second party, “it’s a waste of time and waste of money.” Japanese trade numbers are due for release this evening and they will tell us just how much damage the strong Yen has had on Japan’s export activities.

Kathy Lien
Managing Director

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