EUR in the Crosshairs

Sovereign debt contagion fears have resurfaced, with bank stocks suffering the brunt of investor selling this morning, after Moody’s downgraded Portugal’s credit rating and rumors that Ireland is now in the crosshairs, has virtually eliminated all of last weeks capital markets risk recovery.

To think that the market thought it was going to be quiet ahead of the ECB, BoE and NFP announcements? Softer Euro-zone data and concerns over the health of the Chinese economy have again pushed investors away from riskier currencies back towards those perceived to offer safety as traders scuttle towards the exit’s ahead of Trichet’s ‘now’ highly anticipated press conference after the ECB’s supposedly +25bp tightening tomorrow. What can he say to stop the Euro-zone bleeding?

The EUR is trying to get a small lift from ‘paunchy’ German manufacturing orders (+1.8%, m/m), however, fear continues to dominate.

The US$ is a stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘volatile’ session.

Forex heatmap

There are some tentative signs that US manufacturing is growing. Yesterday, US factory orders ‘modestly’ advanced in May, with the increase less than expected (+0.8% to $445.3b). Digging deeper, the increase was broad based, but less than the +1% that the market had hoped for. A barometer of business spending within the data, non-defense capital goods orders ex-aircraft, increased +1.6%. This report is ‘mildly’ positive for US GDP, which is due for release at the end of this month. The US economy has suffered through the first three-months of 2011, weighed down by higher gas prices and unemployment.

Moody’s downgraded Portugal’s sovereign ratings by 4 notches to Ba2, citing the risk that Portugal will need a second bailout. In addition, the second Greek aid package by the EU/IMF will mean that any future aid to Portugal will require costly private market participation. Moody’s is the first of the big three agencies to rate Portuguese bond as sub-investment grade. It’s worth noting that the Portuguese government so far has strong political support for the austerity measures and has IMF/EU funding committed through 2013.

The dollar is higher against the EUR -0.53%, GBP -0.33%, CHF -0.37% and lower against JPY +0.05%. The commodity currencies are weaker this morning, CAD -0.13% and AUD -0.03%.

The CAD continues to ‘chop’ around, as investors move out of higher yielding currencies and into the buck. Not having any significant economic releases in North America, the loonie is taking its cues from broader market sentiment. Over the past week, the CAD had appreciated +3%, breaking through some key support levels. Investors have been booking some modest profit, trimming holdings of riskier assets after S&P’s said a debt-rollover plan for Greece may prompt a ‘selective default’ rating for the country.

Higher than expected inflation data last week (not seasonally adjusted, +0.7% vs. +0.3%), has investors pricing in a BoC hike for October and the reason they pushed the currency to a monthly high, aided by rising oil prices. Expect the loonie to be subjected to the pull of either risk or risk aversion trading strategies ahead of North American employment data this Friday. The currency is vulnerable with US data likely to print weak into mid-July (0.9648).

The AUD, for a higher yielding risk sensitive currency, stayed close to home outright ahead of a government report that the market expects this evening to show that the country added the most jobs in three months. The currency has advanced for a second consecutive day as traders pared bets on a cut in interest rate by the RBA. Earlier this week, investors had been buying stocks and risk currencies, based on a belief that the passing of the proposed Greek austerity measures would see a large degree of fear and anxiety dissipate. That’s not to be the case, capital markets now have both Portugal and Ireland in their crosshairs.

Any of the aggressive gains have been capped, on fear that Greek austerities plan will not resolve Europe’s sovereign-debt crisis. Technically, the market is waiting for funding schedule clarity. Concerns that global growth is slowing has prompted some investors to bet that the RBA will cut interest rates some time later this year.

Currently, the market is pricing a no hike in August unless inflation and employment surprised on the upside and the situation in Greece and the Euro-zone peripheries clears up sufficiently for a powerful rebound in risk appetite. Global data needs to improve before we can embrace any rate hike policy thinking. Investors remain better sellers on rallies (1.0687).

Crude is lower in the O/N session ($96.87 -0.02c). Crude prices climbed to their highest price in more than two weeks yesterday after the Greek bailout signaled that global economies may stabilize, boosting fuel demand and on the back that recent technical selling was overdone at the end of the second quarter.

WTI crude slumped-11% last quarter, as Greece’s debt crisis fueled concerns that Europe’s economic recovery might be stalled. EU officials agreed last weekend to make the expected payout to Greece, after their parliament passed new austerity measures. Euro-zone finance chiefs gather next week to tackle the country’s long-term lifeline.

Providing crude support, the IEA said members would release +60m barrels from strategic reserves over 30 days to make up for a supply shortfall in Libya, was Goldman Sacs cutting its estimate for the potential price affect of the release, because the actual amount sold may only be about +39m barrels, as some member countries plan to only reduce inventory requirements for refiners.

The market is concerned that the ‘tightness’ in the oil market will continue to undermine the fragile global economic recovery. This is why the IEA and its members agreed to release crude from their SPR’s to ease some of this market tension. According to analysts, this supply move is significant, as it ‘represents a reach by member countries for the remedy of last resort to high oil prices’.

This year’s energy spike is being cited ‘as the reason for the global economic slowdown. Analyst’s note, that from its peak, crude is off-20% and from the IEA announcement down -4.3%. The technicals see strong support first appearing at around $87.

Gold prices have recouped all the previous two session losses, as concerns about global debt problems persisted despite last week’s Greek bailout. The strength of the yellow metal comes on the back of increased safe-haven demand for the commodity after S&P’s warned Greece that it would treat rollover of privately held Greek debt as ‘selective default’ and on Portugal’s credit cut. According to FT, Trichet would continue to accept Greek government bonds as collateral for loans to banks as long as at least one ratings firm does not deem Greece to be in default.

Longer term, weaker fundamentals are expected to support this crowded trade during the second half of the year. It’s hard to find another catalyst for gold prices to push higher just now. The yellow metal is likely to be range-bound between its long term strong support level of $1,485 and $1,530 ahead of this Friday’s NFP.

The commodities dependency on the buck and the outlook for US rates is likely to remain a supporting factor. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on these deep pullbacks until proven wrong ($1,516 +$4.20c).

The Nikkei closed at 10,082 up+110. The DAX index in Europe was at 7,428 down-12; the FTSE (UK) currently is 6,000 down-24. The early call for the open of key US indices is lower. The US 10-year eased 3bp yesterday (3.15%) and another 3bp in the O/N session (3.12%).

After five day’s of declines, treasuries managed to stop the bleeding as a deteriorating credit outlook for China’s banks encouraged demand for the safety of US Fixed Income. Moody’s issued a report claiming that China’s local government debt is $540b larger than officially reported. Not to be left in the cold, S&P’s said on Monday that a debt-rollover plan for Greece may prompt a ‘selective default’ rating for the country.

Last week yields aggressively backed up after the Greek parliament reduced the risk of default by implementing austerity measures and after EU officials approved an aid payment to the country, to prevent ‘this’ default. Analysts believe we are now approaching ‘yield levels’ that are more justifiable.

According to a new poll from ICAP, money managers are more bearish on Treasuries than they have been all year, believing yields to remain elevated after this Friday’s employment report. NFP is expected to show employers added more jobs last month.

With rumors that the PBoC would raise interest rates as early as this weekend should temporarily cap yields in the short-term, as does Portugal’s rating cut with rumors of Ireland to follow.

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This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell