November was an extremely risk averse month as concerns intensified surrounding a global economic slowdown and in particular the worsening debt crisis in the eurozone. Former Greek PM Papandreou spooked the markets by calling a referendum on its latest bailout agreement (which he later cancelled and subsequently resigned from office). Berlusconi was also toppled; making way for a technocratic Italian government tasked with implementing the austerity measures and reforms necessary to bring their borrowing costs down from their current highs (a fresh euro-era record of almost 8% was set recently). Encouragingly, the new Italian PM has at least got the ball rolling with a €30bn austerity package, but the markets will reserve judgement until they see some results.
Bond yields throughout the eurozone (including German bunds, shockingly) have been on the rise and we have seen further debt downgrades as a result. These symptoms of debt contagion, taken in tandem with some ominous looking regional growth data, have seen risk appetite dry up and the euro has come under some intense pressure.
As far as sterling is concerned, an increasingly gloomy UK economic outlook and firm expectations of further quantitative easing are not weighing too badly. The strong safe haven appeal of UK gilts is triggering a steady inflow of investment into sterling, and the uncertain global outlook should see sterling well-supported against riskier currencies over coming weeks and months, though not against the safer US dollar.
Sterling/Euro
With sterling reaping the rewards of a quasi-haven status amid intensifying eurozone concerns, this pair has consolidated late October’s three cent spike up from €1.1350. Sterling reached an eight and a half month high against the euro in mid-November, and although the rate has dropped a little lower in the interim, we are still bullish on the prospects for this pair.
We saw further evidence of debt contagion in November, further downgrades, and fresh record high bond yields. Italy recently approached the 8.0% level on 10-year bond yields, a clear indicator that Germany needs to allow the ECB to be more active in the European bond market.
Growth data from the eurozone has been awful in recent weeks, and forward-looking data is pointing to what is likely to be a eurozone recession in coming months. Accordingly, we are likely to see another interest rate cut from the ECB on Thursday, which will bring the eurozone base rate down to 1.0% (probably euro-positive in the current environment). Further liquidity measures from the ECB are also likely as they seek to further ease the pressures being felt by European banks.
Progress has been made on the issue of the European Financial Stability Fund, which will be able to guarantee up to 30% of the bonds of struggling eurozone states but just how much its capacity will be expanded remains unknown. The International Monetary Fund’s involvement in addressing the region’s problems remains uncertain, recent news suggests that the IMF will lend to weaker nations through the ECB.
Eurozone finance ministers are targeting the EU summit this Friday (December 9th) to produce some sort of plan for ‘closer fiscal union.’ Merkel and Sarkozy have come up with a plan to enforce fiscal discipline in eurozone states, but whether this is accepted at the EU summit remains uncertain. The market has been repeatedly let down by these deadlines and we wouldn’t be surprised if EU leaders disappointed once again. The pressure on EU leaders to deliver has never been so great, particularly in light of Standard & Poor’s warning of a downgrade to fifteen eurozone states, including AAA rated France and Germany. This threat has seen risk appetite dry up somewhat and has put the euro on the back foot.
The UK economy is slowing down, unemployment is extremely high and growth figures are in decline. The Bank of England is likely to ramp up its quantitative easing programme in February next year as a result. However, sterling’s safe-haven status, via the appeal of the UK’s AAA-rated gilts, has come to the fore in recent weeks and we see this continuing to support sterling moving forward unless we do indeed head back into recession. For the next few weeks at least, UK government bonds should remain in demand.
It is very difficult to anticipate the ability of EU leaders to reach agreement on a long-term road to solving the debt crisis. Steps towards fiscal union does seem likely as the pressure heaps up, but eurozone finances will remain in trouble for a long time to come. On a very simplistic view, we continue to favour sterling over the euro based on the bet that progress on the debt problem will be slow and fears of economic meltdown will continue to impact on the single currency.
Sterling/US dollar
Sterling has found it tough going against the US dollar in the past month; falling stocks and rising eurozone bond yields have played into the hands of the safety of the greenback. EUR/USD fell ten cents from $1.42 in the four weeks since late October, and although we have seen a small bounce up to the current rate of $1.34, we remain bullish on the US dollar. This major downside move has therefore weighed on GBP/USD in recent weeks.
US debt came back into the headlines in November, with a Congressional ‘supercommittee’ unable to reach an agreement on how to reduce the government’s massive debt. This issue could very well come back to haunt the dollar next year, particularly if it results in further debt downgrades of US debt to follow Standard & Poor’s action in the summer. Still, for the next month this is unlikely to be a problem for the dollar and market focus is likely to remain on the eurozone.
US growth figures have picked up a little of late, and there have been one or two noises out of the Fed suggesting that the case for further quantitative easing may be weakening. Only time will tell here, Fed President Bernanke will not hesitate to add stimulus if the US economy takes another turn for the worse but again, the dollar looks safe for now and if anything, the outlook has improved a little.
Taking the shine off the dollar’s recent performance has been the positive news of coordinated liquidity measures from several global central banks. This has taken the pressure off Europe’s struggling banks. Judging by the rumours out of the eurozone and from Merkel and Sarkozy’s recent meeting, there are growing signs of progress but there will be no quick fix, regardless of what is announced at Friday’s EU Summit. As Standard & Poor’s recent threat of a blanket downgrade shows, there will be plenty more panic headlines to come. This should see the dollar remain on the front foot against sterling in the coming weeks and months.
End of month forecast:
GBP / EUR 1.1750
GBP / USD 1.5550
EUR / USD 1.32
Richard Driver
Analyst – Caxton FX
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