Daily FX Market Roundup 10-08-12

Euro Receives No Help from Activation of ESM
How will Q3 Earnings Affect the Dollar
GBP: Hit by Cautionary Comments from Osborne
AUD: Stronger Chinese Data Provides Much Needed Support
NZD: Smaller Increase in House Prices
CAD: Oil Prices Remain Below $90 / Barrel
JPY: Strong Yen Expected to Drive Trade Deficit Higher

Euro Receives No Help from Activation of ESM

The euro received no help from the launch of region’s permanent rescue fund, the European Stability Mechanism or ESM for short. At this point, a lending capacity of 200 billion euros is just not enough to restore confidence in the Eurozone and it doesn’t appear that European nations have grown any more willing to provide support to countries in need. Aside from kicking off the fund, European Finance Ministers are discussing Spanish and Greek finances in Luxembourg today and tomorrow. Unfortunately, no decisions are expected. Everyone from the Spanish Finance Minister to the EU President claims that Spain does not need a bailout and regardless of whether these are denials or reality, skepticism by investors prevented the EUR/USD from rallying further. The economic challenges in Spain and Greece will continue to cast a dark cloud over the euro which ended lower against the U.S. dollar for the first time in 5 trading days.

Spain has a major bond redemption at the end of the month and they are trying to sell bonds to raise money for the payment. If demand falls short or the country ends up paying a significantly higher yield, they may find their backs to wall with choice but to ask for help. So far, EU President Juncker says he is satisfied with the steps taken by Spain, which echoes last week’s comments from ECB President Draghi. This leads us to wonder if European officials are trying to sweet talk Spain into accepting a bailout. The country’s greatest fear is the demand for more austerity and if European officials hint that additional belt tightening may not be needed, Spain may be more willing to ask the ECB to activate its bond buying program. This fear was evident in the comments from Spanish Finance Minister de Gundos who continues to claim that there isn’t any need for more austerity.

A decision about releasing the next aid payment to Greece was also put off as the Troika continues negotiations with Greek officials. The Prime Minister warned last week that the country’s coffers will be empty if international aid isn’t received by the end of November. German Chancellor Merkel is headed to Athens tomorrow to assess the situation and show her support for keeping Greece in the euro. This morning, Finance Minister Schaeuble tried to downplay the significance of her visit by saying that her first trip in 5 years isn’t exceptional and she doesn’t represent the Troika, which is true but the purse is in her hands. These conflicting comments show how politics continue to hamper progress in the Eurozone. The status of Europe’s sovereign debt crisis is best summed up by Juncker’s comment that the start of the ESM is good news but not enough. Additional reforms are desperately needed and on the top of the list are a fiscal and banking union that will put everyone under a big European umbrella. This won’t be easy but its one of the few ways to end Europe’s sovereign debt crisis.

How will Q3 Earnings Affect the Dollar

It was a mixed day for the U.S. dollar, which weakened against the commodity currencies but strengthened against the euro, British pound and Swiss Franc. The lack of U.S. economic data left FX traders focused on Europe’s finance ministers meeting and third quarter earnings. Corporate earnings reports are receiving more attention than usual this quarter because they are expected to fall for the first time in 11 quarters as Q3 is expected to be the worst earnings season in 3 years. The Dow Jones Industrial Average climbed to it is highest in nearly 5 years last week which is at odds with the level of U.S. growth and expectations for corporate earnings. Outside of the open-ended liquidity provided by central banks, there’s very little justification for the strong rally that we have seen in equities. The unemployment rate dropped below 8% for the first time since 2009, but the pace of the U.S. recovery is far from desirable. Millions of Americans are still out of work and few companies are hiring because consumers are not spending. Add slower growth in China and Europe to that equation and we understand why more than 75% of the S&P 500 companies providing guidance see earnings falling short of analyst estimates. Why are earnings important to forex traders? Because weak earnings could set off a reversal in U.S. stocks and cause a general sense of risk aversion that could push the U.S. dollar and Japanese Yen higher. In this market environment, risk on / risk off is still the biggest driver of demand for dollars. Currency traders have been treading cautiously in anticipation of fresh direction from economic data or news flow and disappointing earnings could trigger a turn in the euro and a deeper sell-off in the British pound and Australian dollar. Yet there is also scope for an upside surprise because corporate management have mastered the art of under-promising and over-delivering. Over the past 4 years, 72% of S&P 500 companies beat earnings estimates. The bar has been set so low that better results could drive a further rise in equities and currencies. Stronger earnings should drive safe haven flows out of the dollar don’t expect an improvement in risk appetite to be significantly negative for the greenback as there is still greater uncertainty in the Eurozone and Asia.

GBP: Hit by Cautionary Comments from Osborne

Sterling weakened against every major currency today on the back of pessimistic comments from U.K. Chancellor Osborne. Speaking at the Tory Conference this morning, Osborne said the recovery is taking longer than they had hoped and while the government is committed to “finishing the job we started,” the U.K. faces more hard choices in the fall. He said it is unrealistic to expect the government to cut the budget at a faster pace, which may explain why the Financial Times reported that the Office of Budget Responsibility could tell the government this fall that they won’t be able to meet deadline to reduce public debt by 2015-2016. If the current weakness in the economy continues, they may even have a tough time meeting their targets in 2016-2017. If true, austerity will be a way of life in the U.K. for the next 4 years. Given Osborne’s warning that serious decisions need to be made beyond the next 2 years, Britons could face more belt tightening, creating the need for easier monetary policy. The BRC retail sales report and RICS house price balance are scheduled for release this evening along with trade and industrial production numbers Tuesday morning. Given the sharp decline in manufacturing PMI and drop in new orders, economists are looking for a larger trade deficit and weaker industrial production. Softer U.K. economic data would harden the case for more Quantitative Easing from the Bank of England and add pressure on the British pound.

AUD: Stronger Chinese Data Provides Much Needed Support

The Australian, New Zealand and Canadian dollars traded slightly higher against the greenback following better than expected Chinese PMI numbers. According to HSBC, service sector activity in China expanded at a faster pace in the month of September. This independent report conflicts with the government’s own survey that found service sector activity slowing last month. Regardless of which reading is more accurate, the fact of the matter is that the world’s second largest economy is slowing and causing pain across the region. The Australian dollar has fallen sharply over the past month and last night’s economic reports gave AUD/USD traders even more cause for concern. Falling job advertisements are indicative of weaker labor market conditions. No economic data was released out of Canada but house prices rose at a slower pace in New Zealand. Tonight, Australian business confidence is scheduled for release and given recent domestic data we would be surprised if businesses grew more confident last month. Canadian housing starts are also on the calendar and a smaller rise is anticipated.

JPY: Strong Yen Expected to Drive Trade Deficit Higher

Risk aversion drove the Japanese Yen higher against all of the major currencies. With no major U.S. or Japanese economic reports released over the past 24 hours, speculation of central bank intervention returned. Midday, the Nikkei, one of Japan’s leading newspapers quoted an unnamed Japanese source saying that Japan is ready for decisive action on the Yen. These familiar words from Japan do not tell us anything new about the government’s willingness to intervene in the Yen. There’s no question that the strong currency is taking a big toll on the Japanese economy but over the past year, intervention occurred only when USD/JPY dropped below 77. Japanese officials know that intervention rarely works but desperate times could call for desperate measures as the Prime Minister looks forward to a tough battle with Shinzo Abe at the general elections. Japanese trade numbers are due for release this evening and unfortunately the numbers are expected to be ugly. The country’s current account deficit is expected to balloon while the current account surplus is expected to shrink.