FX: Reasons for Optimism from U.S. and Europe

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EUR/USD has now comfortably cleared the 1.30 level and hit a high of 1.3060 in early North American trade. Better than expected U.S. data and the prospect of a Spanish bailout lifted the mood in the currency and equity markets. The biggest story this morning is the management upheaval at Citigroup. CEO Vikram Pandit resigned along with President/Coo John Havens. Pandit will be replaced with Michael Corbat, the bank’s CEO of Asia, Middle East and Africa. Investors responded to the news positively with stocks soaring as change is good for Citigroup because shares of the company have fallen close to 90% since Pandit became CEO. For the currency market, the risk on mood in equities should help to sustain the rallies in EUR/USD, GBP/USD and other major currencies.

U.S. economic data continues to surprise to the upside, helping to keep a bid underneath USD/JPY. Consumer prices rose 0.6% in the month of September, bringing the annualized pace of CPI growth up to 2.0% from 1.7%. Core pries grew at a slightly slower pace of 0.1%, against expectations for a 0.1% rise. Despite a downward revision to the past month’s report, industrial production rose 0.4% last month and capacity utilization increased from 78% to 78.3%. This means that not only has manufacturing activity improved but production is becoming more efficient as well. According to the Treasury International Capital flow report, foreign demand for U.S. dollars rose to $91.5 billion from $74.0 billion in the month of August. Nearly all of the purchases were for long term assets with particularly strong demand coming from banking centers such as the U.K., Switzerland and the Caribbean. The increase in demand for dollars is consistent with concerns about Europe and the strong rally in the greenback this summer.

Germany Softens Stance on Spain Bailout

The rally in the euro this morning has been driven by increasing speculation of a possible bailout for Spain. We have long believed that despite the denials by Spanish officials, a bailout is inevitable and will most likely occur after the October 21st regional elections. The excitement kicked off with an article in the Financial Times that outlined how a Spanish bailout would look like and the ways it would differ from the bailouts for Greek, Portugal and Ireland. The most important distinction is that Spain would not be removed from the financial markets. With 2 more days to go before the EU Leaders Summit in Brussels, there’s a small possibility that Spain could be given more leeway vis a vis a precautionary credit line. According to Dow Jones, a Spanish official said last night they would prefer to “apply for a credit line, a request that the ESM make more money available if needed.” The reason why the Spanish government likes the idea of a credit line is because it would provide a backstop to Spain without having the same stigma as a full scale bailout. Two senior Coalition lawmakers in Germany said they are open to the idea of a precautionary credit line for Spain. Over the past 2 weeks, we have seen more cooperation from the German government, which is good news for the euro. Not only has EUR/USD soared as high as 1.3060 today but Spanish stocks are up 2.5%, confirming that investors are pleased with knowing that more help from Spain could be on its way.

Kathy Lien
Managing Director

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