FX: Europe Back in the Headlines, But Fed Still in Focus

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Risk aversion is in the air this morning with the U.S. dollar and Japanese Yen trading higher against all of the major currencies. Bernanke will be taking the stand and testifying before the House at 10am ET. The second day of the Fed Chairman’s semi-annual testimony on the economy and monetary policy is rarely as interesting as the first because everything he intended to say has been said. Nonetheless, we can hope that questions from U.S. lawmakers could still trip Bernanke up causing him to drop fresh hints on monetary policy. The Federal Reserve’s Beige Book report is also scheduled for release later this afternoon and the degree of weakness reported in the various Fed districts could trigger fresh volatility in the U.S. dollar. The latest U.S. economic reports show that the housing market remains weak. While housing starts rose 6.9% in June, permits dropped 3.7%. The trend in both starts and permits has been up one month and down the next, which isn’t particularly surprising considering that a housing market recovery always lags the broader economic recovery.

Meanwhile the focus is also on Europe this morning. In our end of day note yesterday, we warned that it is a mistake to assume that the focus on QE from the Fed means that Europe’s sovereign debt crisis has gone away. This morning’s weakness in the EUR/USD is tied to fresh concerns about stability in the region. With the memorandum of understanding for Spain’s bank bailout plan scheduled to be signed on Friday, terms of Spanish aid are being hashed out right now. A spokesman for the German Finance Minister said the Finns needs to make concessions if they want a special guarantee for their part of Spanish aid. Ten year Spanish bond yields rose 13bp this morning to 6.85%. Comments from European Central Bank Executive Board member Joerg Asmussen about Eurozone stability certainly hasn’t helped the euro as well as talk of a possible Austrian sovereign downgrade. Europe’s debt crisis is back in the headlines and with it, the weakness in the euro.

Kathy Lien
Managing Director

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