May was broadly speaking a risk-off month, with commodity prices sliding significantly and the Greek debt crisis causing widespread market uncertainty. Central bank monetary policy took a backseat as the major currency market driver, though interest rate speculation was still in evidence under the surface. Specifically, it was the inability of the Bank of England and the US Federal Reserve to tighten policy (due to the poor performance of the US and UK economies), which has stopped their currencies from truly capitalising on the eurozone debt issues.
The single currency has suffered from the most severe debt concerns seen in months. Rumours of a Greek euro-exit and a more general euro-collapse inevitably spooked investors. Greece looks set to remain in the euro and the dominant voices out of the negotiations insist that there will be no debt restructuring. An additional aid package in return for greater austerity measures and privatization seems likely to be the substance of a resolution at this stage, and this should arrive by the end of this month. Much uncertainty still remains, not least over whether the IMF will be providing Greece with its share of the next tranche of Greek bailout aid.
Despite a broad upturn in sentiment towards the Greek situation, the risks of debt contagion have become all too apparent in recent weeks. We have seen rumours of a Greek debt restructure trigger rating agencies to downgrade the economic outlook of other struggling nations such as Belgium and Italy. We have also seen the Spanish government suffer a crushing electoral defeat which places the country’s necessary austerity measures in doubt. Portugal did receive a bailout, but borrowing costs throughout the periphery have scaled new heights.
Safe-haven currencies have benefitted from the eurozone uncertainty. The US dollar therefore had a stronger month, but it remains a fundamentally unappealing currency (due to a downbeat economic outlook and ultra-loose monetary policy). Sterling has weakened against the dollar, but has reached healthier levels against the euro as investors were forced to look for alternatives.
Sterling/Euro
This pair made some decent gains over the month, climbing two cents to trade at €1.14. However, sentiment towards the UK economy has not improved. It may even have worsened since the disappointing first quarter growth figure of 0.5%. April’s UK growth data from the manufacturing, construction and services sector was disappointing. Retail sales figures were strong but the market was unconvinced, correctly putting the growth down to temporary factors such as good weather, the Easter Holidays and Royal Wedding tourism.
Accordingly, a spike in UK inflation (up to 4.5%) and some more hawkish statements from Bank of England Governor Mervyn King failed to have any lasting sterling-positive effect. Today’s poor UK manufacturing growth data for May suggests things are getting worse, not better, and the prospects for an improved second quarter GDP figure are looking shaky.
Whilst the market is somewhat less responsive to fundamental data from the eurozone, the economic picture in France and Germany is broadly positive. The most recent quarterly GDP figures for the two core states were 1.0% and 1.5% respectively (contrast this with a 0.5% figure for the UK).
Clearly it was not a matter of sterling strength that saw this pair climb last month, but euro weakness. Asian sovereigns, previously reliable for sweeping up euros on the cheap, went missing for extended periods. News came thick and fast from various peripheral nations and various rating agencies, but the situation seems to have calmed a little, or at least the market has grown a thicker skin. This has dragged GBP/EUR two cents off its highs of €1.16 over the past week.
The euro also weakened significantly thanks to a dovish ECB press conference, after the ECB announced that the eurozone base rate was to remain at 1.25% for the time being. Trichet disappointed the market by failing to include the phrase “strong vigilance” with regard to eurozone inflation, causing speculators to pare back expectations of the next ECB rate rise from June to July.
July still seems a very good bet; eurozone inflation stayed at 2.8% y/y in May and remains well above the central banks’ target. The prospect of this rate hike should keep the euro fairly well supported over June. However, although sentiment has improved towards the peripheral debt issue, the euro still remains very vulnerable to rumours and to a slowdown in progress. Support from the Far East is crucial, but with the dollar such an unappealing currency, they will be as eager as ever to diversify their funds.
Sterling/US dollar
The $1.70 mark was looking very realistic at the start of May but a surge in risk aversion in recent weeks brought this pair back down as low as $1.60. A slide in commodity prices and intense fears of a Greek debt restructure and resultant financial crisis saw the US dollar benefit from significant safe-haven inflows. However, the decline in commodity prices has consolidated and eurozone debt concerns have faded from focus somewhat in the past week or so.
US fundamental data has been very poor indeed of late. First quarter US GDP put growth on an annualised basis at 1.8%, retail sales and consumer sentiment data was weak and manufacturing growth has slowed down alarmingly. In addition, US government debt has come under close scrutiny in recent weeks, as the Democratic government faces a deadlock with the Republicans on how to reduce its enormous deficit.
Perhaps most importantly, we have seen no real improvement in the US labour market, which is the Fed’s main obstacle to raising the US interest rate from the record low of <0.25%. The Fed’s QEII programme is likely to be discontinued this month. However, a rate rise this year seems unlikely with inflation levels subdued and the US unemployment rate at 9.0%.
A BoE rate hike seems equally unlikely this year, but the GBP/USD rate is helped by gains in the EUR/USD rate. The dollar has failed to hang on to some major gains against the single currency, which took the EUR/USD rate from $1.49 to $1.40. The euro has enjoyed a mild revival to currently trade at $1.44, which as usual has pulled GBP/USD with it.
An ascent back up towards $1.70 may be a bridge too far for this pair in coming weeks, particularly with the UK economy in such poor shape. However, sterling may be able to add a few cents to its recent rebound, with sentiment so pessimistic towards the dollar and with the euro enjoying a resurgence.
Caxton FX one month forecast:
GBP / EUR 1.12
GBP / USD 1.65
EUR / USD 1.4750
Richard Driver
Analyst – Caxton FX
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