European bond yields in focus
Eurozone bond yields have very much come into focus in recent weeks. Italian 10-year debt climbed above the 7% mark, considered the level at which borrowing costs become unsustainable. Spanish debt is also coming under major pressure despite a strong election victory by the conservative Populist Party. There has been little good news to come out of the eurozone in recent weeks; a Greek referendum was avoided and Berlusconi’s resignation was finally tendered, but too much uncertainty surrounds the future of the eurozone for the single currency to truly benefit.
The eurozone economy is almost certainly headed for a recession, though the UK economy is also looking very vulnerable to contraction. The euro has sold off badly in recent weeks as a result, falling almost eight cents from the $1.42 level we saw in late October, and sterling has gained three cents from late October lows close to €1.13.
As well as soaring Italian and Spanish bond yields, and the alarming impact they are having on core eurozone bond yields such as France and Austria, the issue of what role the ECB is to play in a long-term plan to deal with debt crisis remains contentious. The Greek situation also remains unresolved, they still need to persuade IMF and EU chiefs to release their next instalment of aid under last year’s bailout agreement, and the second bailout agreement still needs approval. For these reasons and many more besides, the euro is struggling and we view the risks to be firmly skewed to the downside.
US debt concerns return to weigh on risk appetite further
After the panic we saw in the summer surrounding the raising of the US debt ceiling and the 11th hour agreement between the Republicans and the Democrats on cutting the America’s enormous pile of debt, the US fiscal story is back in the headlines. The ‘supercommittee’ given the task to come up with a plan on how to reduce US debt looks highly likely to announce a failure to agree later today.
At the moment, the nervousness caused by the US debt issue is benefiting the dollar significantly. However, if other credit rating agencies follow Standard & Poor’s August removal of America’s AAA credit rating, the dollar really should stand to face some pressure in the longer-term. Spending cuts will need to be agreed and implemented to appease the rating agencies and in turn the market.
Sterling remains fairly resilient to poor UK data
News from the UK economy was negative last week; domestic inflation weakened and unemployment soared in October and the Bank of England has slashed UK growth prospects for next year. It is now a case of “when” not “if” the MPC decide on further quantitative easing. Wednesday’s MPC minutes will be watched closely for this key issue, but early next year seems most likely. Nonetheless, this has been priced in to some extent.
After a very tough start to the week, sterling is trading down at 1.16 against the euro. We still hold the view that safe-haven UK gilt-buying will push the GBP/EUR pair higher towards €1.20 as we close out the year. Against the dollar we are less optimistic; a gloomy outlook for the debt situation in the US and the EU, as well as an ongoing slowdown in growth across the globe should see risk averse trades continue to benefit the US dollar.
End of week forecast:
GBP / EUR 1.17
GBP / USD 1.57
EUR / USD 1.34
GBP / AUD 1.60
Richard Driver
Senior Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.
