What are the Near Term Risks for EUR?

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Daily FX Market Roundup 09-21-12

What are the Near Term Risks for EUR?
USD: Behind the Timing of Fed Announcement
GBP: Borrowing Needs Hit Record High in August
CAD: Eventually, the BoC Will Need to Shift Away from Hawkish Stance
AUD: Leading Indicators Flat
NZD: Small Increase in Credit Card Spending
JPY: WTO Warns of More Troubles Ahead of Japan

What are the Near Term Risks for EUR?

This month, aggressive monetary easing by two of the world’s most important central banks drove the euro to a 4 month high against the U.S. dollar. Since then the momentum in the EUR/USD has faded with the currency pair giving up part of its gains on a near daily basis this week. Yet the fact that the EUR/USD has still managed to hold near 1.30 is significant and suggests that investors have not given up on the short dollar trade completely. Lets be clear, the strength of the euro has to more to do with the perceived value of the U.S. dollar than optimism about Europe because the greenback is trading not far from its recent lows against other major currencies. While we believe that the U.S. currency will ultimately lose the race to debase, in the near term, there are also significant risks to holding euros.

First and foremost, the possibility of a full Spanish sovereign bailout has not disappeared with the ECB’s unlimited bond buying program. An article in today’s Financial Times renewed speculation that a bailout request could be right around the corner. The FT reports that EU officials are in talks with the Spanish government on economic reforms that could be unveiled next week. There are also some reports that the first draft of the country’s 2013 budget could be released before the end of the month but other reports say that it could delayed to mid-October. Either way, the country is trying to cut spending and benefits everywhere possible and even then, it may not be enough to avoid a bailout. Economy Minister Luis de Guindos said they plan to announce their own reform measures and timetable on September 28th. Part of the urgency stems from the risk of a downgrade by Moody’s. The rating agency has been reviewing the country’s finances for the past 3 months after downgrading it in June and their review is set to be complete by the end of this month. They wanted to evaluate the size and terms of the bank bailout and see if the German Constitutional Court would greenlight the ESM, which they did earlier this month. If Moody’s downgraded Spanish debt to junk levels (its one notch above junk right now), it would certainly be bearish for the euro particularly since they would be the first of the big 3 rating agencies to make the move. Some say that Spain could move forward with a bailout request to pre-empt a downgrade, which may not be so bad for the euro. Speculation of a bailout actually lifted the euro today and an official announcement could drive it even higher as it would eliminate a major source of uncertainty for the Eurozone. In our opinion, the impact on the euro is not so clear because the cost of a Spanish sovereign bailout would be tremendous. Furthermore, both the Spanish and German government have denied the need for a European bailout, increasing uncertainty and confusing the market even more.

We also learned this week that growth is becoming a more serious challenge in the Eurozone. The Eurozone PMI reports were abysmal and showed a growing divide between Germany and the rest of the region. Unfortunately without growth, there can be no healthy path to austerity. European leaders recognize this and agreed to a growth compact back in June but since then struggling nations have still been asked to make more painful cuts and concessions at the expense of growth. This will come back to haunt the region in the months to come and pose a major risk to the currency. More immediately, the key event risk for the EUR/USD next week will be the German IFO report, unemployment numbers, retail sales and CPI.

USD: Behind the Timing of Fed Announcement

After quite a bit of intraday volatility, the U.S. dollar ended the North American trading session lower against all of the major currencies. FOMC voters were out in force this week supporting the central bank’s decision to increase asset purchases this month. We have heard everything from their focus on the labor market to their forceful bid to support the economy. At the end of the day, the central bank recognizes that the labor market is in rough shape and with the elections looming, they were running out of time. The last non-farm payrolls report was exceptionally weak and judging from the latest jobless claims reports, next month’s numbers are expected to be equally bad. Waiting for another NFP report before easing would have put the Fed action only 2 weeks before the elections – ensuring loads of criticism about partisanship. The next opportunity after that would have been in December, which would be complicated as well because the outcome of the election is uncertain. This is why the Fed decided to ease in September and not later. However more action before the end of the year is unlikely so if the labor market worsens, there’s a good chance that investors will be left to their own devices. There are a handful of U.S. economic reports on the calendar next week – none of which are extremely important. GDP is on the calendar but these are final numbers. For the time being, we don’t expect any big moves in the greenback.

GBP: Borrowing Needs Hit Record High in August

The British pound traded higher against the U.S. dollar and held steady against the euro. According to our colleague Boris Schlossberg, “Public Sector Net Borrowing excluding financial sector interventions stood a 14.41 billion GBP in August, compared with 14.365 billion GBP in the same month a year earlier. This was the highest August borrowing on record, albeit slightly less than analysts’ expectation 15.5 billion GBP figure.” Based upon this data, Chancellor George Osborne is likely to miss his forecast for a deficit of 120 billion pounds but Bank of England Governor Mervyn King said missing his pledge on debt reduction is acceptable in light of the global economic slowdown. King said yesterday that the UK, which is currently in recession, will most likely experience slight growth in the coming months. He said, “I think the next quarter will probably be up. I think we’re beginning to see a few signs now of a slow recovery, but it will be a slow recovery. After a banking crisis one can’t expect to get back to normal and I fear it will take a long time.” Of course, the recovery will be heavily dependent on the situation in the Eurozone since it has cast a “black cloud of uncertainty” over the global economy. No major U.K. economic reports are scheduled for release next week. Q2 GDP is on the calendar but like the U.S. data, it is a final release and will therefore have a nominal impact on the currency.

CAD: Eventually, the BoC Will Need to Shift Away from Hawkish Stance

The Australian and New Zealand dollars edged higher against the greenback as the Canadian dollar weakened. The only piece of North American data on the calendar today was Canadian consumer prices and according to the report, inflationary pressures in Canada increased last month by 0.2%, which was slightly less than expectations but up from a decline of 0.1% in July. Core prices rose 0.3%, which was in line. Wholesale sales in Canada on the other hand dropped 0.6%, a steeper decline compared to the prior month. Overall, these latest economic reports continue to question of how much longer the Bank of Canada can hold onto their hawkish monetary policy stance. In addition, we have seen deterioration in the country’s trade deficit, housing market (building permits), labor productivity and factory output. With an abundance of poor data, Carney may have to rethink his plan about increasing rates and at bare minimum they may need to move to neutral when they next meet. Earlier this month, the Bank of Canada reminded the markets that they are looking to raise rates, making them the only G7 central bank thinking about tightening monetary policy. Australian data wasn’t that hot either as leading indicator growth stagnated in the month of July. New Zealand on the other hand saw a small increase in credit card spending, which validates our belief that the RBNZ will remain on hold for the remainder of the year. For the comm dollars, the most important pieces of data next week will be Canadian retail sales and GDP along with New Zealand trade figures.

JPY: WTO Warns of More Troubles Ahead of Japan

It was a mixed day for the Japanese Yen, which appreciated against some currencies and weakened against others. The lack of consistency has everything to do with the lack of data from the U.S. and Japan. The Bank of Japan’s monthly report released yesterday stated exports and industrial production were relatively weak and the BoJ reiterated that the economy’s recovery from the earthquake has come to a pause. Due to the slowdown in China and rising uncertainty in the Eurozone, the World Trade Organization cut its growth forecast for global merchandise trade. As an export dependent country, this is bad new for Japan – we have already seen Japanese exports fall 5.8% in August year over year. WTO Director-General Pascal Lamy said, “The main reason for growth slowing down is, of course, Europe. We also know the US is lower than expected, Japan is not in great shape.” Despite the BoJ’s asset purchase expansion, Lamy called for more to be done to boost global growth. Next week will be a busy one for Japan with consumer prices, retail sales, industrial production, overall household spending and employment numbers scheduled for release.

Kathy Lien
Managing Director

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