S&P Spain Downgrade is Bad News for Euro

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Daily FX Market Roundup 10-10-12

S&P Spain Downgrade is Bad News for Euro
USD: No Surprises from Beige Book
GBP: UK Government Puts Emphasis on Bank Lending
AUD: RBA Did Well, Rate Cuts Lift Confidence
CAD: Trade Deficit Expected to Shrink
NZD: Business PMI and Confidence On Tap
JPY: Verbal Intervention Falls on Deaf Ears

S&P Downgrade of Spain is Bad News for Euro

At the end of the North American trading session, Standard & Poor’s surprised the market by downgrading its rating of Spanish debt to BBB- from BBB+. Their unexpected decision drove the euro lower against the U.S. dollar and the currency would have fallen further if not for the fact that S&P brought their rating down to match Moody’s levels. Spain is now rated one notch above junk by both rating agencies who also have the country on negative watch for further downgrades. Over the past 2 months, we have been waiting for Moody’s to make a decision on Spain’s rating and now we’ll have to see which company has the courage to cut Spain’s rating to junk first. The reason why Moody’s has been so reluctant is because they don’t want to be responsible for forcing Spain to accept a bailout which would be inevitable if the country was downgraded to junk. While S&P’s announcement is not groundbreaking, it is still bad news for the euro. Spain has been holding onto its investment grade rating by a very thin thread and today’s announcement will push Moody’s to make a decision soon. It also pressures the Spanish government to ask for bailout because 10-year Spanish bond yields will most likely tick higher when they open for trading on Wednesday. Expect more weakness in the EUR/USD when European traders return to the market and see S&P’s announcement.

For the time being, there is still a high level of uncertainty in Europe but on a quiet news day, we celebrate any form of good news. Industrial production in France rose strongly in the month of August and the uptick in wholesale prices in Germany points to hotter inflationary pressures. Unfortunately none of these reports will remove the pressure caused by Spain’s reluctance to ask for a bailout. Lost in the focus on Spain has been a possibility of deal for Greece. Based on the comments made by French President Hollande this morning and German Chancellor Merkel on Tuesday, Greece is getting very close to receiving its next aid payment. They are still in negotiations with the Troika but everyone is committed to unlocking the funds before the country runs out of money next month. Merkel took a special trip to Athens yesterday to show her sign of support for the nation and her commitment to keeping the country in the euro. Hollande echoed her comments this morning and spoke for Spain when he said both nations have a shared vision for the EU in the coming weeks that include keeping Greece in the euro. They expect to make a decision on unlocking Greek aid at the EU Summit next week. With Germany and France now behind Greece, there’s a good chance a deal will happen soon, which would remove a key uncertainty for Europe that could help the EUR/USD recover. German and French consumer price reports are due for release tomorrow along with the ECB’s monthly report.

USD: No Surprises from Beige Book

The U.S. dollar ended the day unchanged against most of the major currencies. The Federal Reserve’s Beige Book report was the only piece of economic data on the calendar and unfortunately the more optimistic tone failed to lend support to the greenback. According to the survey of the 12 Fed districts, the U.S. economy expanded modestly last month thanks to improvements in the housing market and stronger demand for autos. While there have also been signs of life in the labor market, “consumer spending was generally reported to be flat to up slightly since the last report” which isn’t enough to shift the central bank’s stance on monetary policy. It is worth noting that the U.S. dollar has returned to its pre-QE3 levels against the euro. This is important as it helps to explain why currencies are beginning to consolidate after falling sharply last week – QE3 is providing a base for currencies. As we have seen in the first and second round of Quantitative Easing, flooding the markets with more dollars has not always been negative for the greenback, particularly when larger forces are at play and right now, everyone is very concerned about Spain.

On the docket tomorrow are jobless claims and the monthly trade balance report. Claims fell significantly over the past 2 weeks and this improvement has been consistent with last week’s better than expected jobs report. The question now is whether these improvements in the labor market have been sustained. If jobless claims remain below 370k, there is not much to be worried about but if they rise back above 385k, then the level of job growth will come into question once again. The U.S. trade balance on the other hand is expected to widen but the sharp improvement in manufacturing activity according to the ISM report suggests that room for improvement. Fed Presidents Yellen, Raskin, Plosser and Bullard are all scheduled to speak tomorrow. Yellen who is a big proponent of Quantitative Easing said last night that low interest rates are needed to spur growth and policy will normalize when the economy recovers. QE3 earnings are still in focus with the next important ones being JPMorgan’s earnings on Friday.

GBP: UK Government Puts Emphasis on Bank Lending

The British pound ended the day unchanged against the U.S. dollar and euro as the lack of U.K. economic data has led to quiet trading in the pound. In fact, there are no additional economic reports from the U.K. this week leaving sterling at the whim of risk appetite. In a continued attempt to stimulate the economy, the U.K. government is putting greater emphasis on bank lending. The country’s Financial Services Authority relaxed capital requirement and liquidity rules on banks to encourage them to lend. More specifically, banks will not be required to hold additional capital on loans made under the Funding for Lending Scheme, which is another program aimed at boosting lending to households and businesses at lower rates. According to the Financial Times, who broke the story, banks no longer need to maintain a 10% core ratio on their assets and will instead be subject to individual capital targets that will give them the flexibility to fall below that target as needed. Looser capital requirements suggest that the U.K. government is not yet satisfied with the uptake on FLS. Lower capital buffers could be dangerous but the FSA believes that the “reduction in risk arising from this new lending caused by an improvement in credit conditions should offset the risk from lowering capital buffers.”

AUD: RBA Did Well, Rate Cuts Lift Confidence

The Canadian and New Zealand dollars held steady against the greenback while the Australian dollar edged higher for the third day in a row. What makes the AUD different from the CAD and NZD is that the former experienced a steep slide over the past month so a mild recovery is not out of the ordinary. The CAD and NZD on the other hand have been consolidating quietly amidst the lack of fresh economic data. The recent rate cut from the Reserve Bank of Australia has gone a long way in boosting business and consumer confidence. According to the Westpac Banking Corp, consumer confidence rebounded in October thanks to the 25bp rate cut from the RBA and the prospect of additional easing in the months to come. While a reading below 100 means that the number of pessimists outweighs optimists, the “time to buy a dwelling” component rose to its highest level in 4 years. Australian employment numbers are due for release this evening and a small rebound in job growth is expected after employers unexpectedly cut payrolls by 8.8k last month. The labor market numbers will be critical in shaping expectations for the next RBA meeting. New Zealand Business PMI and consumer confidence numbers are also scheduled for release along with Canadian trade numbers. A smaller trade deficit is expected for Canada with manufacturing activity continuing a solid clip.

JPY: Verbal Intervention Falls on Deaf Ears

Due to the sell-off in U.S. equities, the Japanese Yen traded higher against all major currencies. No major economic reports were released out of Japan last night but Japanese officials continue to express their concern about Yen strength. Prime Minister Noda was the latest government official to warn that decisive action will be taken when necessary because the “yen’s strength is a serious problem and out of step with Japan’s economy.” Unfortunately verbal intervention has fallen on deaf ears as investors become all too accustomed with empty threats. In this case, there is even less merit because Japanese officials have been saying that they will take action “when necessary” which suggests that above 78, they may not be keen to intervene. The only piece of data released last night was Machine tool Order,s which fell 3% year over year last month. A different report on machine orders and consumer confidence are due for release this evening. We expect confidence to slip in the same manner as the Eco Watchers Survey, which dropped to its lowest level in 4 years last month. As long as the Yen remains strong, it will be difficult for the Japanese economy to recover but intervention by the government won’t change the trend of the Yen. Japan just needs to wait it out because a stronger global recovery is needed for the Yen to finally bottom.

Kathy Lien
Managing Director

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