Weekly Analysis: Euro still looking vulnerable

Early year optimism disappears very quickly

There were signs of a rally in confidence and risk appetite in the session or so of 2012 but sentiment quickly deteriorated due to all the familiar eurozone-related concerns. Poor demand at eurozone bond auctions (including that of Germany, much to the market’s concern) and widening yield spreads saw the euro resume its downtrend almost across the board. Linked to this are ongoing concerns of blanket downgrades throughout the eurozone when Standard & Poor’s decides to take action. There are plenty of bond auctions this week to keep the euro under pressure; Greece will look to the market on Tuesday, while Italy and Spain will do so on Thursday.

Also in the headlines in recent sessions has been the worsening economic picture in the eurozone. EU leaders finally appear to be willing to address the issue of eurozone growth. The debt crisis is having such as impact on confidence that the region is spiralling into recession and EU leaders have earmarked the Jan 30th meeting as an opportunity to look at eurozone growth and the region’s soaring unemployment levels (10.3% for the eurozone).

Figures last week revealed a eurozone services sector contraction, as well as negative monthly growth in both German and eurozone retail sales. Forward looking data such as German factory and eurozone industrial orders also undershot expectations last week. It seems businesses on the continent are preparing for the worst and sitting on their capital. With the lack of leadership we have seen on the debt issue, it is difficult to question why.

Merkel and Sarkozy’s meeting produced little of real note; they remain committed to the progress made on introducing greater budgetary discipline in the eurozone and continue to urge Greece to reach an agreement with private bondholders on haircuts before the country is given its 2nd bailout.

The ECB will have its monthly meeting and press conference on Thursday, which will surely overshadow the BoE’s Monetary Policy Committee meeting. We think there is a greater chance of another ECB rate cut than the market is currently appreciating. Eurozone data is only going one way and with inflation also beginning to ease, Draghi could well pull the trigger for the third consecutive month. That said, we are still betting that the ECB will keep its powder dry for this month, though another cut in Q1 is almost a dead cert.

UK growth takes a more positive turn, but for how long?

Last week’s monthly set of UK growth data take a turn for the better, with each of the services, manufacturing and construction sector figures beating expectations. The services sector was particularly impressive in December.

The outlook for the UK recovery remains highly uncertain and risks are firmly fixed to the downside. Sterling should benefit nonetheless, with hopes being raised that the Bank of England may be convinced that further quantitative easing may not be necessary after all. High demand for UK debt continues to support the pound; gilts were the top performing government bond for 2011 and are starting 2012 where they spent the last.

Sterling is trading up at a sixteen month high of 1.21 against the euro and the outlook is looking very strong for GBP/EUR. Less so against the dollar, the US recovery is gathering pace at an impressive rate, which is only adding to the safe-haven appeal of the greenback. GBP/USD is trading just above a four month low of $1.54.

End of week forecast:

GBP / EUR 1.2150
GBP / USD 1.54
EUR / USD 1.27
GBP / AUD 1.51

Richard Driver
Analyst – Caxton FX
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Morning Report

Richard Driver, Analyst Major headlines from yesterday’s session surrounded Merkel and Sarkzoy’s meeting, which indicated further commitment to last month’s pact on greater budgetary responsibility rules. Elsewhere, the scandal surrounding the private currency trading by the wife of the head of the Swiss National Bank has seen the central banker step down, though policy towards swiss franc pegging will remain unaffected. Today’s session is a very quiet one in terms scheduled data releases. This week’s next main event to which the market will begin casting their eye is Thursday’s ECB meeting.
STERLING/EURO: This pair saw range-bound trading, regardless of Merkel and Sarkzoy’s show of unity. Merkel and Sarkozy demonstrated a united front yesterday; they were committed to following through with December’s agreement on tighter fiscal union and urged Greece to make quick progress on reaching an agreement with private bondholders on haircuts, so that the country can receive its second bailout. The longer these negotiations drag on, the more pressing concerns of a Greek default and euro-exit become. There was a bit more positive news from the UK economy last night, a gauge of retail sales showed the best growth in eight months and house price data was better than expected. This pair is trading just above €1.21 this morning, and we may see further sideways trading for now.	FORECAST
STERLING/US DOLLAR: Sterling benefited from a minor bounce yesterday as support levels kicked in, but a move south will surely come. Support levels at multi-month lows near $1.54 gave this pair some welcome support, and sterling proceeded to creep half a cent higher on a fairly flat trading day in general. It shouldn’t be long until the $1.54 level is re-tested however. The outlook for the USD is much-improved from this time last year. Further QE looks more unlikely to come in the context of the last few weeks data and if the recent trend of positive data strengthening the greenback continues (when in the past strong US data has increased risk appetite away from the safety of the dollar), then it could be one of the top performing currencies this year.	FORECAST
EURO/US DOLLAR: The euro enjoyed a little rebound but it will be nothing to concern those betting on downside for this pair. This pair was trading at $1.42 in late October and is currently trading fourteen cents lower, so yesterday’s half-cent short-covering will not alarm investors with bets on the euro weakening. The downtrend remains intact and clearly the market saw little to get excited about with regards to Merkel and Sarkozy’s press conference yesterday. Asian sovereign buyers will be crucial if the euro is to slow its downtrend. The intensifying crisis of confidence in the euro is likely to reduce diversification away from the USD, but EU leaders still have the power to reinstall some faith in the single currency.	FORECAST
STERLING/AUSTRALIAN DOLLAR: Commodity currencies did well yesterday and this pair stooped to more than a five month low. Sterling is trading a cent lower this morning; the aussie dollar benefited from demand for Australian government bonds but Chinese trade balance data was the key driver of this pair’s weakness. The Chinese trade surplus showed an impressive uptick, and obviously reflects positively on Australia’s exports and economy. Aussie building approvals data was also strong. Support levels at 1.50 really need to kick in today if sterling is to avoid making a move out of its current range to the downside. We still see sterling bouncing back, though the risks that it will fail are significant.	FORECAST
STERLING/NEW ZEALAND DOLLAR: The encouraging news from China also benefited the kiwi dollar, which sent this pair to almost a four month low. The kiwi dollar is making even more impressive gains than its aussie neighbour at present. This is largely due to the fact that the RBA is far more likely to cut interest rates in the coming months than the RBNZ. Building consents data from NZ was pretty poor last night, but the kiwi dollar still marched on. This pair is trading at a very low 1.95 this morning; eurozone fears need to heighten if sterling is going to return to levels above 2.00.	FORECAST
STERLING/CANADIAN DOLLAR: The Canadian dollar traded very positively yesterday and looks likely to re-test support levels down at 1.5750. The negativity surrounding Canada’s domestic economy dissipated yesterday (for how long though, remains to be seen) as US stocks saw some upside. Markets are a little calmer this week compared to last, which is a positive for the loonie. The US economic growth story looks likely to support the Canadian dollar this year, and this should outweigh and probably even reverse weakness in the Canadian economy. Negative eurozone headlines remain the biggest risk to the loonie and we still believe the pressure will return to its detriment. For now though, this pair trades just below 1.5750.	FORECAST
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