Euro Drops Below 1.30- Are Rate Cuts Next?

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Market Drivers for April 23, 2013
Euro drops through the 1.3000 level on weak PMIs and talk of rate cut
Chinese PMI misses sending Aussie lower
Europe 0.59% Nikkei -0.29%
Oil $88/bbl
Gold $1422/oz

Europe and Asia:
AUD Conference Board Leading Index 0.3% vs. 0.2%
EUR German PMI Manufacturing 47.9 vs. 49.0
EUR German PMI Services 49.2 vs. 51.1
EUR Euro-Zone PMI Manufacturing 46.5 vs. 46.8
EUR Euro-Zone PMI Services 46.6 vs. 46.6
GBP Public Sector Net Borrowing 16.7B vs. 14.3B

North America:
USD Markit US PMI Prelim 9:00
USD House Price Index 9:00
USD New Home Sales 10:00

The EUR/USD broke below the psychologically key 1,3000 level in the wake of much weaker German PMI data and renewed speculation of a possible ECB rate cut at the upcoming meeting in May. Overall it was a clear risk-off night in FX as the weaker than forecast Chinese PMI data knocked Aussie and USD/JPY lower while cable was pushed through the 1.5200 figure on larger than expected UK Public Sector Net Borrowing.

The German PMI figures were horrid with services sector slipping into contractionary territory while the manufacturing sector sunk deeper below the 50 boom/bust line. German PMI services declined to 49.2 from 51.1 eyed and 50.9 the period prior. This was the first time that the services sector dipped below 50 since October of 2012 indicating that the weakness in the EZ in general is finally seeping into the region’s largest economy. Manufacturing dropped to 47.9 from 49.0 eyed.

The weakening German PMI data casts doubt on any possible recovery in Q2 of this year and suggests that growth may be negative for 2 quarters in row. The news also revived talk of a possible ECB rate hike and given the deteriorating fundamentals in the region the prospect of such a move has certainly increased. EZ policy makers clearly need some stimulus to revive the moribund economies of Europe and a rate cut would be the quickest and least expensive policy course.

Credit conditions in the EZ remain constrained while price pressures are non-existent. Although a rate cut is unlikely to offer and quick stimulus as the transmission mechanism in Europe remains broken, it will drive the EUR/USD lower helping the troubled export sector. One thing is clear. Europe has reached the limits of its austerity policies with even Germany now suffering the consequences of its actions and therefore a more accommodative posture will be necessary if growth is to revive in H2 of this year.

Meanwhile, the disappointing HSBC Chinese PMI data which printed at 50.5 versus 51.4 forecast is signaling that Asia is slowing as well. The Aussie dropped to 1.0220 in the aftermath of the release, but the pair continues to hover above the 1.0200 support level. Whether it can hold that figure will depend on North American flows. If US equities sell off in response to the overnight news and if the US flash PMI readings confirm further slowdown in activity the AUD/USD could test the 1.0200 level as the day progresses.

All of this risk-off price action has certainly taken a toll on USD/JPY which broke below 99.00 and remains near the 98.50 level in mid-morning European trade. The pair has failed to breach the 100.00 mark yet again and may have set a near term top for the time being. Despite the continued efforts by the Japanese authorities to weaken the yen, the growing concerns over global economic slowdown are capping the move in the pair for now.

Boris Schlossberg
Managing Director

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