Euro still rallying but for how long?

Euro recovers from S&P with a major bounce

The euro has responded impressively to Standard & Poor’s blanket downgrade of nine eurozone credit ratings (which wouldn’t have been the case had Germany been axed). The market is extremely short of euros and what we are seeing is those short positions being covered, particularly as hopes are raised for a Greek deal on private sector creditors. Whether or not a deal emerges remains to be seen, 60-70% haircuts have been rumoured but until there is an official announcement, the market remains completely in the dark. Unsurprisingly, a deal was not reached on Monday as was hoped and it looks like we may have to wait another few weeks for progress.

The euro has benefited from some remarkably positive eurozone bond auctions of late; the impact of the ECB’s cheap loan offering in evidence once again. Spain in particular saw terrific demand and yields also eased. On the data front, there was a staggeringly strong German economic sentiment survey which contributed to the euro’s best week in months. The IMF joined the party on Wednesday, with reports suggesting that it would be making a further $1 trillion available to the eurozone. This, predictably, was later revised down to “several billion dollars.”
So, there have been some genuine developments for the euro in the past week or so - S&P’s downgrade aside - but beyond the short-term, not enough to sustain further gains or even maintain current levels from our point of view.
Sterling struggling ahead of UK GDP and MPC minutes

Wednesday’s session is an important one as far as sterling is concerned. We will see the preliminary UK GDP figure for the final quarter of 2011, which is expected to show a marginal (0.1%) contraction. The minutes from the MPC’s last meeting a fortnight ago will also be watched closely for clues as to whether the Bank of England’s quantitative easing programme will be stepped up again in early February. Our bet is that it will but downside risks for sterling should be fairly limited on this front, with the market having priced it in to a large extent. The UK GDP figure could well have a material impact on the sterling exchange rates if it undershoots already pessimistic expectations.

UK unemployment numbers reached fresh highs last week and UK inflation declined aggressively, neither of which are positives for the pound. On a brighter note, UK retail sales picked up a little in December, which was to be expected in light of November’s appalling showing.

The euro is trading strongly this morning on the back of some positive manufacturing and services PMI data. There have also been some positive political developments this week; Germany has stated it is open to increasing the firepower of the eurozone bailout fund and there has been progress on details relating to the permanent bailout fund – the European Stability Mechanism (to be introduced later this year). The euro should be able to hang onto most of its recent gains, though further climbs look a push. With GBP/USD at $1.56 and EUR/USD at $1.3050, the dollar looks ripe for a recovery soon. At the end of the week, we are likely to learn the US economy grew impressively in the last quarter of 2011, which should improve the prospects for the US dollar regardless of any boost to risk appetite that it may trigger.
 
End of week forecast

GBP / EUR 1.20
GBP / USD 1.55
EUR / USD 1.2950
GBP / AUD 1.49

Richard Driver
Analyst – Caxton FX

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Richard Driver, Analyst Eurozone finance ministers rejected the private bondholders’ offer yesterday and asked them to consider a sub-4% yield on new bonds. There was no euro sell-off though, as there was reason for hope thanks to a statement from Germany indicating that it is now open to boosting the firepower of the eurozone’s rescue funds.   We have seen a raft of eurozone PMI data this morning, which has actually been broadly positive.  Today’s session has brought some positive public sector net borrowing data from the UK but pairings are no doubt going to be driven by headlines from Europe.
STERLING/EURO: A deal regarding the deployment of the permanent bailout fund was reached yesterday, which offered the euro a little support. There was positive news for the euro that the European Stability Mechanism will be able to provide emergency loans, provided they have the backing of 85% of eurozone government under qualified majority voting. There was a slightly more concerning headline that investors fear Portugal will require a second bailout at some point. Sterling is trading at a weak looking €1.1920 this morning, with the euro having been helped by some positive German and eurozone-wide manufacturing and services data.	FORECAST
STERLING/US DOLLAR: This pair traded within a very tight range yesterday, having been rejected at the $1.56 level. Sterling has climbed by almost three cents in the past week or so but is meeting some fairly stiff resistance at these levels. These are strong levels at which to sell sterling and buy USD, particularly given the uncertain outlook in the eurozone and UK economies, as opposed to the upturn we are seeing in the US. Sterling is trading at $1.5550 and it would be no surprise to see some further sideways trading as investors hold off ahead of tomorrow night’s Fed statement.	FORECAST
EURO/US DOLLAR: Strong data and optimism surrounding future emergency funds in the eurozone outweighed the absence of Greek PSI deal.   The German services sector ticked up impressively last month and its construction sector bounced out of negative territory as well. The services sector of the eurozone as a whole followed suit and also moved back into positive growth, though its manufacturing sector contracted marginally. The figures have understandably been taken as a positive, particularly amid all the talk of a eurozone recession. There is a sense that eurozone finance ministers are getting somewhere in dealing with the debt crisis moving forward (via the ESM), and the possibility that Germany will allow the fund to be expanded is a real positive. This pair is thus trading up at $1.3050.	FORECAST
STERLING/AUSTRALIAN DOLLAR: The aussie dollar is weakening ahead of what is likely to be some weak Australian inflation data. Australian inflation data is likely to reveal slowing price pressures for the fourth consecutive month. If the data this evening is weak, the arguments for another Reserve Bank of Australia rate cut will be strengthened once again. Asian stocks also spent their fourth day in the green out of five, which boosted demand for the aussie. Sterling is trading at 1.4850 this morning and it looks as if we may see a bit of a bounce in this pair today.	FORECAST
STERLING/NEW ZEALAND DOLLAR: Sterling is trading a little higher today, with European markets responding cautiously to the overnight Greek news. We have not seen data from New Zealand yet this week, but we have some credit card spending, manufacturing and trade balance data to look forward to in the coming week. Also important for the kiwi dollar this week will be news from the US economy; the Fed is meeting over the next two days and will be giving a statement tomorrow night, and the US GDP figure comes on Friday. There is plenty of potential positivity as far as risk is concerned here. Nonetheless, sterling is finding some favour this morning amid a decline in European stocks, as investors search for safety.	FORECAST
STERLING/CANADIAN DOLLAR: Canadian data and US stocks were positive yesterday afternoon, though Canadian retail sales figures may be weaker today. This pair traded sideways yesterday, as the markets lay in wait for news regarding Greece’s PSI negotiations. It is certainly a disappointment that nothing concrete emerged last night and it has been indicated that a deal can be expected before Feb 13th, though we don’t have to remind you how many times we have been left wanting before. US stocks have benefited from an impressive recovery in recent sessions, which is really fuelling the loonie. This pair is trading at the low level of 1.57 this morning.	FORECAST
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