Eurozone growth data comes back to haunt the euro

Data this morning has confirmed that the eurozone remains very much in recession. We knew that this was the case, but we didn’t know quite conditions were quite this bad. In the final three months of 2012, the French economy contracted by 0.3%, Germany’s by 0.6% and Italy’s by 0.9%, with all three GDP figures coming in worse than market expectations. The euro weakened on all of these data releases. Perhaps surprisingly, given that the market had the above figures already out in the open, the euro also weakened as a result of the overall eurozone GDP figure, which revealed a 0.6% contraction. Meanwhile, Portugal also posted a 1.8% contraction, while the Netherlands shrank by 0.2%. Spain we know contracted by 0.7%. Suddenly the UK’s Q4 GDP figure of -0.3% doesn't seem quite so disastrous. 

The market has been content to ignore weak eurozone data in recent months and as a result the euro has had an easy ride. Super Mario (Draghi) said he would do whatever it takes to keep the euro afloat, Greece managed to kick the can further down the road, and bond yields have been brought under control. All is well? All is not well - these eurozone figures are a reality check and really bring home what the market has seemingly been willing to sweep under the carpet. 

Perhaps the market is not ignoring it and perhaps they are looking beyond at a recovery in 2014, basking in the relief that the debt crisis no longer threatens the very existence of the euro. Either way, if data like today's continues to filter through in 2013 without significant improvement, then the ECB will be forced to act by cutting interest rates and you can be sure that the market will sit up and take notice when that happens. Germany has posted some encouraging figures so far in 2013 but it is anything but plain sailing for the euro from here.

The strong eurozone exchange rate over the past few months will surely have contributed to these awful eurozone GDP figures. The ECB remains reluctant to intervene to weaken the euro but they will have limits to what sorts of levels they are willing to tolerate. This is a key factor behind EUR/USD’s stalling ahead of $1.40. Next up, the Italian elections - expect the nerves to continue jangling over the next week or so. 

Richard Driver

Currency Analyst

Caxton FX

December Monthly Report: GBP/EUR, GBP/USD

Greece drives euro rally but US fiscal cliff looms

Sterling was broadly unchanged across the exchange rates through November, except unfortunately (depending on your exposure, of course) against the single currency, where a significant decline was seen. We have seen some progress from the eurozone in recent weeks, from Greece in particular. A deal was struck to put the country’s debt on a more sustainable path, one that could give it a realistic chance of emerging out of the current crisis, though this is clearly many years away. Most importantly, the risk of a Greek exit and euro break-up has receded – the key factor behind the euro’s latest rally.

There has been something of a dark cloud hanging over the pound in recent weeks, caused by a mixture of negative UK data and pessimistic growth forecasts from the Bank of England. This in turn filtered into speculation that the UK could lose its AAA credit rating before long.

These factors haven’t stopped the pound from sustaining some very respectable levels against the US dollar however. There has been a marked improvement in growth data from the likes of the US, China and even the eurozone in recent weeks, which in combination with progress in Greece has lifted investor sentiment from a mid-November slump. However, with little progress being made on the US fiscal cliff issue, the dollar could well bounce back before the end of the year.

GBP/EUR

Sterling weak but downside limited despite weak UK data

It has been a difficult few weeks for this pair. The Bank of England brought the market crashing back down to earth with some pessimistic growth projections in the aftermath of the surprisingly strong Q3 UK GDP number (1.0%). Sir Mervyn King & Co have been very deliberate in managing our expectations with respect to the UK economy’s performance in the final quarter of the year, highlighting in the Quarterly Inflation Report that there are significant risks of another contraction.

November’s UK figures certainly didn’t point to a very robust start to Q4, with UK manufacturing sector growth contracting and the services sector giving its worst showing in almost two years. We also saw the worst UK claimant count update in over a year (after a very good few months it must be said).

The recent public sector net borrowing figure came in worse than expected thanks to tax revenues continuing to fall short, which painted a grim picture of George Osborne’s deficit-reduction plan. With Moody’s Investor Service having recently cut France’s AAA credit rating, many in the City are speculating that UK debt will be dealt the same hand before long. There is a high risk that one of the big rating agencies will swing their axe in the UK’s direction in the coming months and this has left its mark on sterling.

It hasn’t been all bad news as far as the pound is concerned. UK inflation ticked higher to 2.7% from 2.3%, which may have discouraged one or two MPC members voting for QE in their November meeting. The minutes from that meeting revealed that in fact only one voter, David Miles, was in favour of extending the BoE’s quantitative easing programme. On balance, we do not expect any further QE from the BoE, which should be supportive of the pound in the longer-term. However, persistently weak UK growth is likely to continue fuelling QE speculation. In addition, the MPC minutes appeared to remove the option of an interest rate cut for the “foreseeable future.”

Greek disaster avoided

 From the eurozone, November was very much Greece’s month. With a deal being struck to avoid an imminent default and bring Greek debt under some recognisable control, the market may be able to put this particular eurozone worry on the backburner to some extent. Nevertheless, there remains a high degree of scepticism towards Greece’s ability to meet its targets and towards a lack of detail within the agreement. We know that Greece will be granted longer to repay its debt and that interest rates on that debt will be lowered. However, it is unclear how the intended bond buy-back (at a discount) will be funded and when it will occur.

Spain has this week made a formal request for its crumbling bailout sector, which is a relief as far as the market is concerned. This isn’t to be confused with a sovereign bailout though and Spain will surely be the subject of the market’s cross hairs once again before long. We don’ think PM Rajoy will be able to avoid requesting a full blown bailout, given the dire state of economic growth and the still elevated borrowing costs that the country is facing (despite recent declines). Any realistic analysis of Spanish growth and debt dynamics over the coming years suggests that a bailout is inevitable.

Concerns over the wider eurozone growth issue in the eurozone have eased somewhat thanks to some recent updates. Germany and France both showed unexpected growth of 0.2% in the third quarter, while Italy contracted by half as much as expected (0.2%).  Nonetheless, we see nothing within the more forward-looking figures (despite the recent upturn in the German business climate) to suggest the eurozone can avoid a recession next year.

Sterling is trading at fairly weak levels around €1.23 at present and we are sticking to our long-term and long-held view that this pair’s upside potential outweighs its downside risks. Our hopes for a move towards €1.25 by the end of the year remain intact and, more importantly, realistic. In the short-term however, there is a strong risk of a move down towards €1.2250.

GBP/USD

Sterling soaring against soft US dollar, but for how long?

This pair’s downtrend has been interrupted in the past fortnight by developments in Greece, which have had a very uplifting effect on market conditions. The avoidance of a messy Greek default and euro-exit saw global equities rally, weakening the US dollar significantly. The $1.60 level has been recovered as a result but as ever we view sterling to be on borrowed time above this psychological threshold.

The US economy continues to show evidence of a strong finish to the year, demonstrated not least by the recent revised GDP figure for Q3, which revealed an annualised growth pace of 2.7%. Consumer confidence continues to climb and we are seeing the US housing and labour markets make further strides.

With the Greek ‘can’ kicked down the road, focus through to the end of the year is likely to be dominated by the US fiscal cliff issue. On January 1^st 2013, a series of sharp US tax rises and spending cuts are scheduled to come into being, unless negotiations between the Democrats and the Republicans bear some fruit in the coming weeks.

The fiscal cliff could as much as half US growth next year and in doing so dent the global recovery considerably; the stakes are extremely high. It is broadly for this reason that we expect US politicians to put some sort of compromise together, in the same way we expected Greek negotiations to produce a deal. Nonetheless, nervousness over this game of ‘chicken,’ which could well go right down to the wire, is likely to lead to increased demand for the safe-haven US dollar in the coming weeks.

Sterling is trading up at $1.61 level, which we view to be an excellent level at which to buy USD. In our view, sterling is highly unlikely to set fresh highs above this pair’s fifteen-month peaks in the $1.6250-1.6270 area. Sterling’s headroom is looking increasingly limited from here and we expect a move lower in the weeks ahead.  

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Outlook: Further upside potential for euro

ECB plan triggers euro rally

Mario Draghi alluded to doing “whatever it takes” to save the euro a month or so ago and at last week’s ECB press conference, he outlined just what he meant by that. ‘Super Mario’ as he has been called, revealed a plan that involves the ECB purchasing unlimited amounts of peripheral eurozone nations’ bonds. This has already brought down Spain’s bond yields but as Moody’s has warned today, this does not solve the crisis, it merely buys EU politicians (and not the ECB) the time to address the region’s fiscal and structural shortcomings.

The ball is now effectively in Spain’s court to negotiate acceptable conditions of a bailout that would include ECB intervention in the bond markets. So we are back to the familiar balancing act of Germany extracting sufficient austerity measures without going ‘over the top.’ This could potentially weeks but there is plenty to watch out for in the interim.

Wednesday should bring the German Constitutional Court’s ruling on the legality of the European Stability Mechanism and the eurozone’s fiscal compact. The court is strongly expected to approve both initiatives but a complaint made today by a German MP regarding last week’s ECB bond-buying plan has raised the prospect of another possible delay to the decision, which has ramped up market nerves again.

Wednesday also brings the Netherlands' general election but the euro looks likely to be spared another political saga at this stage, with the latest polls indicating a close race between two pro-Europe parties.

QE3 could finally arrive this week

Going into last Friday’s non-farm payroll figure the chances of the Fed delaying QE3 for the time being were fairly well balanced but it now seems highly likely that Ben Bernanke will at last pull the trigger on Thursday. Ironically, data did reveal that the US unemployment rate did fall to a rate not bettered since January 2009. Unfortunately as the employment change figure revealed, this was not because more jobs has been taken up and will be of little comfort to the Fed. QE3 is priced into a decent extent after Friday’s dollar sell-off but there is every chance we could see another wave of risk appetite give the greenback another knock this week.

Hints of a Q3 rebound for the UK economy

 August’s PMI growth figures from the manufacturing and services sectors were much better than expected last week. In addition, data also revealed that UK manufacturing and industrial production grew at their fastest rates in 10 and 25 years respectively, bouncing back from June’s slump. This summer’s London Olympics also look likely to have made quite a sizeable contribution to the domestic growth, which has caused many to revise up their GDP forecasts for Q3. All this means that QE concerns should not apply any weight to the pound for the next few weeks at least.

Although the euro’s upward climb has stalled today, the prospect of QE3 from the Fed and a positive ruling from the German Constitutional Court could well give the single currency some further strength. This is likely to keep the GBP/EUR pinned close to or even temporarily below the €1.25 level. Against the USD, matters are rather different as the pound currently sits only marginally off a near-fourth month high. Renewed upside potential for the EUR/USD pair could well help the GBP/USD hang on to these gains in the short-term but we continue to expect a reversal in the coming weeks.  

End of week forecast

GBP / EUR	1.2450
GBP / USD	1.6050
EUR / USD	1.2890
GBP / AUD	1.5300

Richard Driver

Currency Analyst

Caxton FX

Roadmap to the Spanish debt crisis

This week is of huge significance to Spain and it might be interesting to give a brief roadmap of how Spain got into its current predicament. Up until 2008, the Spanish economy had been doing well. For instance, real estate prices rose 200% from 1996 to 2007 and the Spanish banking system (with small local banks known as ‘cajas’) had been viewed as one of the best equipped to deal with a financial crisis. Prior to 2008, some regions of Spain were very close to having full employment.

So what went wrong? In the third quarter of 2008, Spain’s economy officially entered recession, after 15 consecutive years of growth. Not a big surprise really, seeing as most countries around the world also went into recession during this period. Rating agency Standard and Poor’s then downgraded Spain’s prized AAA to AA+ in 2009. So, they adopt an economic stimulus plan worth about 5% of their GDP, which leads to the exiting recession in the first quarter of 2010. Things look optimistic.

Then investors start to take a closer look at the Spanish economy and realize that the public deficit is huge: 11.2% of their GDP. After admitting Spain was in trouble, Prime Minister Zapatero introduced austerity measures to address the problem. He raised the retirement age from 65 to 67, reformed pensions and passed a constitutional amendment forcing governments to maintain a balanced budget. Zapatero was then voted out in late 2011, and Mario Rajoy’s conservative party filled the void with an absolute majority.

However, the Spanish economy was already on a downward slide, having produced no growth in Q3 and suffering a 0.3% contraction in Q4 2011. By March, unemployment had doubled the Eurozone average by climbing to 24.4% (it now soars above 25%). In April, thousands protested across the country against the government cuts, adding political instability into the mix.

In the summer of last year the Spanish banking sector began to crumble. Bankia requested a €19 billion state rescue in May, which pushed Spain itself into requesting €100 billion bailout for the struggling banks. In July, one of Spain’s richest regions, Catalonia, requested aid from the central government and several more followed suit as the gravity of the crisis surfaced. With borrowing costs setting fresh record-highs, it has come to a tipping point which appears to have prompted action from the ECB.  

It goes without saying that the European Central Bank’s meeting in Frankfurt tomorrow could be crucial in the context of the Spanish and wider eurozone debt crisis. ECB President Mario Draghi has assured the market that the bank would buy enough bonds on the open market to put a stop to the “financial fragmentation” that currently exists throughout Europe. Draghi has hinted only this week that the ECB is free to buy government bond maturing in three years or less, without breaking the EU treaties and overstepping its mandate by stepping in to money-printing terrritory. This has already had a dampening effect on Spain’s soaring borrowing costs.

Whether the ECB unveils its plan to intervene in the bond markets on Thursday or not, it will do so fairly soon, that much has become pretty clear. But if a country wants to get their hands on this attractive offer from the ECB, they will first have to agree to a set of conditions. Just how strict these conditions are will determine how quickly Spanish PM Mariano Rajoy agrees to request help from the ECB.  He asserted last week, "When I know exactly what is on offer I will take a decision.” Rajoy will not be able to get the ECB’s help for free but certainly Merkel needs to be careful in not overstepping the mark when making austerity demands of Spain’s already crippled economy. There is bound to be plenty of brinkmanship involved if Spain is to request help.

Whilst the ECB meets tomorrow, Rajoy and Merkel will be also be meeting, where it is anticipated that the two leaders will be negotiating an estimated €300bn Spanish sovereign bailout. September was always ear-marked as an all-action month and it looks as if we could indeed be on the brink of some major developments. Whether or not the market will be convinced remains to be seen.

Harry Drake
Caxton FX

 

ECB President Draghi calms market fears by pledging the ECB will do “whatever it takes”

The president of the European Central Bank, Mario Draghi, has asserted this morning that, within its mandate, “the ECB is ready to do whatever it takes to preserve the euro, and believe me, it will be enough.” He added that the solution was “more Europe,” which again was music to the market's ears. Unsurprisingly, the euro has rallied on Draghi’s positive comments; EUR/USD has bounced by almost two cents.

These comments build on the relief story that was delivered yesterday by ECB policymaker Nowotny. Nowotny indicated that the European Stability Mechanism could be granted a banking license, which would in turn increase its lending capacity. The eurozone’s inadequate ‘firewall’ has long been a major gripe of investors and the fact that there are members within the ECB looking to address this was greeted with open arms. It goes without saying that Nowotny’s comments are a long, long way from becoming policy and he will certainly meet some stiff opposition within the central bank.

This week’s jawboning really ramps up the pressure on the ECB to deliver some emergency policy response of note at its monthly meeting next Thursday. If it fails to deliver a convincing plan on how to bring down Spanish and Italian bond yields which are threatening to force both countries into bailout territory, the euro is likely to come under some fresh and considerable selling pressure. Restarting the ECB’s bond-buying programme, which has been on hold for several months, would be welcomed enthusiastically, as would quantitative easing. Some action will surely come next week, as the ECB is forced to fill the policy vacuum left by the EU’s dithering politicians.

Richard Driver
Analyst – Caxton FX
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Market fears reach new heights as Spain edges closer to a sovereign bailout

The bad news for the euro just keeps on flowing. Spanish 10-year bond yields have now risen to a fresh euro-era high above 7.60%, which is a fairly accurate bellwether of market tensions that have built towards Spain and the debt crisis as a whole in recent sessions. Sustained yields above 7.0% pushed Greece, Portugal and Ireland into requesting a bailout and the chances of Spain following suit are rising all the time – another few weeks at current levels and Spain may have no choice but to ask for help.

Meanwhile, German 10-year bonds have recently fallen as low as 1.14%, and 6-month bond yields have even dipped in to negative territory; such is the appetite for safe havens, investors are actually willing to accept losses just to park their funds in the safety of German short-term debt.

The Spanish regional govenrment of Valencia has asked the central government for financial aid, and six other regions including Catalonia and Murcia are expected to do the same. Considering a €100bn bailout was only signed off for Spain’s crumbling bank sector on Friday, these signs of panic from Spain’s regions are the last thing Spanish PM Rajoy needs, particularly as he is trying to quell market fears by insisting that Spain will not require a full-blown sovereign bailout. Spain’s economy minister De Guindos is meeting his German counterpart Schaeuble today and there will be suspicions that a full sovereign bailout will be considered.

The IMF may well be hardening its stance on granting aid to failing eurozone economies, if the rumours of a possible withheld contribution towards Greece’s next aid tranche. So again, these Spanish headlines have come at unfortunate moment.

Spain is continuing to call for intervention from the ECB, De Guindos said on Saturday that "somebody has to bet on the euro and now, given the architecture of Europe isn't changed - who can make this bet but the ECB." If the ECB restarts its programme of buying up distress debt, then Spain can stop paying such high borrowing costs. The ECB has stood firm on this issue for nineteen straight weeks, claiming that the lead on solving the debt crisis should be taken by EU politicians. Stodgy progress in this regard is likely to force the ECB’s hand in the end, particularly as Italy edges closer to disaster.

Spain has major repayments to be made by October, so a full-scale Spanish bailout could well come before then. Amid all these concerns around Spain, Greece is heading towards the exit door, so it should to come as a surprise when we reiterate our bearish view of the euro.

Adam Highfield
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Euro drops on the back of central bank action

This Thursday (5, July 2012) saw the Bank of England announce that it would be increasing its quantitative easing (QE) programme by £50bn, taking the total QE to £375bn. However, the lack of movement in the markets suggest that it was fully priced in.

The market moving news from yesterday was of course the European Central Bank (ECB) announcement to cut rates, with the main refinancing rate cut to 0.75% and the deposit rate to 0%, both down 25 basis points. The rate cuts were as expected but the markets took a fairly dim view on the action taken. Trading was volatile and the GBP/EUR rose from 1.244 to 1.254 in the wake of the announcement, now pushing its three-and-a-half year high.

The cutting of the deposit rate is designed to encourage banks to lend as they would now receive no interest on money deposited with the ECB overnight. Mario Draghi said in his statement that the eurozone was likely to show little or no growth and his downbeat outlook did not help the euro or those countries that have been struggling of late.

Spanish 10-year bonds have today reached levels over 7% and threaten to rise higher. 7% and above is considered by many as a dangerous, as well as an unsustainable level of borrowing costs, and was the level at which other countries, such as Ireland, had to request a bailout.

We also saw a surprise interest rate cut from the People’s Bank of China, an indication that growth in the world's second largest economy is slowing more than Beijing had previously expected. The last time the People’s Bank of China cut interest rates was shortly before poor economic data was released, maintaining its strategy of acting pre-emptively ahead of poor data. This most recent cut comes a week before a range of Chinese economic figures are due to be announced, possibly indicating a retracement in growth.

All eyes now turn to today’s announcement of US non-farm employment data due out at 1.30pm. Forecasts anticipate the data to show the number of people in employment grew to 97,000 this month, rising from 69,000 previously.

A positive announcement could lead the US dollar to be investors’ choice of currency and boost demand for the greenback, with traders lodging positions for the weekend. Should the data be worse than expected, we may also see currency flows toward the greenback, as investors become wary of the global economic condition and seek shelter with the relatively-safe US dollar.

The news will also have an impact on a number of other currencies, including the Aussie dollar and New Zealand dollar, with investors' risk appetite heavily reliant on US economic indicators.

Adam Highfield 
Analyst, Caxton FX

Spanish banks get some help but Greek elections loom

Pressures ease somewhat as Spanish banks receive €100bn bailout

The weekend headlines have revealed that Spain’s banks will be given the support they desperately need through €100bn of emergency EU funding. This is a decent signal of intent from the EU’s leaders; it buys Spain some time and eases concerns surrounding spiraling debt contagion in the eurozone, but it is far from a solution for Spain, never mind the eurozone as a whole. Indeed, the enthusiasm following the weekend’s bailout agreement already appears to have waned.

Growth-wise, eurozone data over the past fortnight has pointed evermore towards a dip back into negative territory in Q2 of 2012. Pressures are still very much being felt in the bond markets, with Spanish 10-year notes yielding almost 6.50% and Italy’s equivalent debt yielding almost 6.00%. Last week’s policy announcement from the ECB was notable in revealing that the central bank is reluctant to cut interest rates from the current 1.00% level. Perhaps more importantly ECB President Draghi is unwilling to step in and buy bonds on the secondary market. The ECB has made it clear that it will not fill the void left by the EU’s dithering leaders.

With Spain’s short-term pressures easing somewhat, the Greek saga comes back into view. This Sunday (June 17th) brings the Greek parliamentary elections, where there remains a significant risk of an anti-bailout coalition emerging. Feasibly, we could see another stalemate and another election called. The situation is incredibly uncertain and looks set to put the market on edge as the event draws closer.

Bank of England decides against QE, for now

Last week saw the Bank of England’s MPC decide against introducing another round of quantitative easing in June. The threat of more QE has been weighing on sterling of late, particularly amid a slew of weak UK growth figures. However, a surprisingly solid UK services figure may well have given some of the MPC policymakers the resolve to hold off on voting for more QE last Thursday. The minutes from the meeting, released next Wednesday, will clearly be very revealing on just how close the MPC’s call on QE was. For now though, sterling looks set to find some favour - it’s safe-haven status should be able to return to the fore as the Greek elections close in.

Elsewhere, US data has continued to point to a slowdown in recent weeks, though Ben Bernanke was unwilling to provide any clues as to the introduction of QE3 any time soon, which is dollar-supportive. He stressed the risks posed by the eurozone debt crisis to the US economy but his rhetoric smacked of a willingness to ‘wait and see.’

Sterling is trading at €1.24, with the euro having totally given back the gains it made on Sunday night as a result of the Spanish bailout progress. Nerves look likely to intensify ahead of the weekend’s Greek elections and as investors contemplate the possibility of a Greek exit from the eurozone once again, we are looking for sterling to climb back up towards €1.25 in the coming sessions.

Likewise we are looking for lower levels for EUR/USD. The euro’s relief rallies are proving more and more flimsy now as the debt crisis goes on. Another look at $1.24 is a distinct possibility, but for now it trades a cent and a half higher. A weaker EUR/USD pair will inevitably weigh on the GBP/USD pair, which currently trades at $1.5530. Whilst we believe sterling should be able to take a decent share of the safe-haven flows this month, we still view anything above $1.55 as a bit lofty.

End of week forecast
GBP / EUR 1.25
GBP / USD 1.5450
EUR / USD 1.2450
GBP / AUD 1.5800

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Sterling/Euro June Report

Sterling has continued to rally against the euro in recent weeks, as conditions in the eurozone go from bad to worse. Uncertainty, as ever, is the buzz word. The pro-bailout New Democracy Party has edged ahead in the Greek opinion polls in the past week or so, which has lifted market hopes that the country can receive the additional funding it needs and remain ‘safely’ within the eurozone.  But there is plenty more debate to be had in Greece and few will be truly confident of a positive result ahead of the fresh elections on June 17^th.

The chances of a messy ending to the Greek saga remain very high. Even if a pro-austerity, pro-bailout coalition does emerge out of this month’s elections, they will still have to find a way to deliver the major reforms and deficit reduction that the country’s €130bn bailout agreement requires. The EU Commission reminded Greece earlier this week that its bailout payments remain highly contingent but whoever wins this month’s elections, you can expect some desperate efforts to have the bailout terms relaxed to a significant degree.

Greek concerns, though likely to return to the fore as the elections draw closer, have been put on the back burner for the time-being. True to form, another struggling eurozone nation has stepped up to fill the void – Spain, or more specifically, Spain’s banking sector.  Bankia, Spain’s fourth-largest bank, requires €19bn worth of recapitalisation and it is becoming more and more apparent that Spain will need help to shore up its banking sector. The issue is having a significant impact on Spain’s government borrowing costs, with 10-year bond yields climbing dangerously towards the unsustainable 7.0% level. As ever with this debt crisis, market fears build so much they become a self-fulfilling prophecy. In short, Spain is in very serious trouble and may have to seek external help, which is no small issue given it is the eurozone’s fourth-largest economy and will inevitably turn the market’s gaze towards the third-largest – Italy.

The UK economy is looking particularly downbeat at present, having been hit with the confirmation that it is firmly in double-dip recession territory. Unsurprisingly, consumer confidence has taken a sharp downturn. April’s growth data from the services and manufacturing sectors was poor and a gauge of UK retail sales showed the worst figure in almost four years. The last update from the UK labour market was a little more encouraging but we will need to see more than one good month before hoping for sustained improvements.

Amid all of this bad domestic economic news, as well as the grave threats posed by the eurozone debt crisis, it might be assumed that more quantitative easing is bound to be introduced by the Bank of England in order to drag the UK out of recession. Certainly the IMF has made its views known on the issue, encouraging the BoE to act soon to safeguard the UK economy.

However, the noises out of the MPC have not suggested that such a move is imminent, despite the recent sharp decline UK inflation from 3.5% to 3.0%. A key reason for this is that the BoE sees UK inflation in the medium term as equally likely to exceed its 2.0% target as undershoot it.  In addition, Spencer Dale has recently stressed the argument that the recent quantitative easing doses are still feeding through to provide stimulus and that a further round is not appropriate at present. This position is supported by the recent improvement in UK money growth.

With only one MPC policymaker voting in favour of QE at the MPC’s May meeting, in the form of David Miles, there is plenty of dovish recruitment to be done in the coming months if the BoE is to pull the trigger again on further monetary easing. Sterling seems safe in this regard for June at least, though eurozone risks could feasibly escalate sufficiently to prompt BoE action in July or August.  

So, despite the UK economy sitting uncomfortably in a double-dip recession and facing a prolonged period of period of stagnant growth and ultra-low interest rates, sterling looks free to continue taking advantage of an increasingly euro-negative environment. Sterling/Euro climbed a further two cents in May, leaving this pair with gains over 4.0% in the past two months. We envisage further gains for the relative safe-haven pound in June, with the Greek elections and rising Spanish bond yields providing plenty of motivation to exit the euro.

Richard Driver
Analyst – Caxton FX

For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Greek opinion polls provide some hope but confidence still fragile

Greek opinion polls give the market some hope

The euro was given some relief in early Monday trading by the positive news that in Greece, the conservative and pro-austerity party - New Democracy – has edged ahead of the anti-bailout party Syriza in the opinion polls. If New Democracy can hang on to their lead and re-establish a pro-bailout, pro-austerity and pro-euro coalition, then fears of a Greek exit should subside. Judging by the euro’s brief and fairly minor bounce since the weekend though, the market remains understandably cautious.

Concerns over Spain are also growing, as the country’s ten year bond yields climb towards 6.50%, bringing into view the dangerous 7.0% benchmark which forced other peripheral nations, like Portugal and Greece, into requesting bailouts. Spain’s fourth-largest lender Bankia requires a bailout and the Spanish region of Catalonia is also in need of help to refinance its debt. Consequently, the risks of a Spanish sovereign bailout are increasing, which would create a huge amount of stress on the EU’s aid resources, as well as raising major question marks over Italy.

In addition to these mounting Spanish concerns, growth data from the eurozone was all pointing the wrong way last week. Figures from the German, French and eurozone-wide services and manufacturing sectors almost all disappointed, suggesting that the eurozone’s avoidance of economic contraction in Q1 will prove temporary.

With respect to the issue of Eurobonds, Germany doesn’t look like it will budge. What’s more, Austria, the Netherlands and Sweden have joined Germany in expressing their opposition to the idea of common eurozone bonds, so market hopes for a silver bullet have once again been quashed.

US GDP figure should confirm slowdown

This week brings two important growth figures from the US, in the form of the revised GDP estimate for the first quarter of 2012 (due on Thursday). The figure is expected to be revised down from 2.2% to 1.9%, well off Q4 2011’s impressive quarterly reading of 3.0%. Friday brings the monthly update from the US labour market and improvements in this area are expected to be moderate at best.

The US dollar’s safe haven status has very much come to the fore in the past month. Clearly ongoing softness in US figures keeps QE3 on the table as far as the Fed is concerned but we see safe-haven demand helping it appreciate further across the board. In particular, we foresee heavy losses for EUR/USD in the second half of this year, which will inevitably drive GBP/USD lower too.

Sterling is trading up above €1.25 this afternoon, with the positivity surrounding the Greek opinion polls already having dissipated. Sterling weathered some awful data last week, including a downward revision to the UK’s Q1 GDP figure to -0.3% and a steep drop in the domestic inflation rate. However, sterling’s safe-haven status still looks likely to push it even higher against the euro.

In contrast, sterling is always going to be under pressure against the US dollar. It should benefit from a minor short-covering bounce soon, though a return anywhere close to $1.60 looks a stretch now. Risk appetite away from the US dollar is likely to be hard-pushed to return in force ahead of the June 17th Greek elections.

End of week forecast
GBP / EUR 1.26
GBP / USD 1.5750
EUR / USD 1.25
GBP / AUD 1.6050

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Monthly Report: Euro verging on a sharp decline

The euro and other risky currencies continued on their uptrend in February, spurred on by the ongoing impact of the European Central Bank’s (ECB) mid-December LTRO (cheap loan offering), further improvements to the US economic recovery and the emergence of a Greek bailout agreement.

The ECB’s cheap loans have ensured that credit conditions in Europe have eased this year and have fuelled a rally in eurozone bonds. A long-awaited Greek bailout agreement finally arrived in February, quelling fears of a messy Greek default in mid-March.

However, huge uncertainties surround both the Greek and wider eurozone debt situation. In addition, data this year clearly points to the onset of a recession in the euro-area. Asian and Middle-East sovereigns are nonetheless sticking by the euro and persisting with their project of diversifying their FX reserves away from the US dollar.

UK growth data continued on its uptrend in February, with the UK services, manufacturing and in particular, the retail sector, finding some much-needed traction. The Bank of England’s (BoE) Quarterly Inflation Report gave sterling a lift by increasing its long-term forecasts for UK inflation.

A UK interest rate rise remains a long way off- probably at least two years - but a higher inflation projection reduces the Monetary Policy Committee’s (MPC) incentive to introduce further UK quantitative easing (QE). However, this was not enough to stop two MPC policymakers from voting for £75bn, rather than the £50bn that was decided, of additional QE in February, a factor which hurt the GBP/EUR rate in particular last month.

GBP/EUR

Sterling has found it hard going against the euro in recent weeks, stalling at the €1.21 level and subsequently falling three cents (though it has since recovered to trade at €1.1950). The relief that Greece finally managed to break the deadlock and reach a bailout agreement helped the euro.

Consequently, leading stock indices such as the S&P 500 and the FTSE 100 are not far off four-year highs. 10-year bond yields in key eurozone states like Italy and Spain have come back down to a far more comfortable level of 5.0%, thanks largely to the ECB’s LTRO action, and confidence and risk appetite has largely been on the up, which rarely benefits the pound against the riskier euro.

Still, we are confident that the euro will continue to be dogged by negative eurozone headlines throughout this year. The fact that Ireland recently announced it will hold a referendum on the EU fiscal compact agreed in January highlights the scope for delay, market nerves and potential U-turns with regard to long-term political progress on the eurozone debt issue.

Another eurozone frustration is the ongoing wrangling over the expansion of the eurozone’s bailout resources. The current firewall is inadequate to deal with crises in Spain and Italy and it has been made clear that eurozone members must stump up more cash before the IMF makes more funds available. A lack of leadership in the EU will inevitably filter into diminished appetite for the euro.

Furthermore, the Greek situation is far from resolved, despite its recent bailout agreement. In the short-term, Greece still hasn’t reached a firm deal with its private sector creditors on a debt-swap. If the Greek collective-action clause is activated, which will occur if 90% of Greece’s creditors fail to participate in the proposed debt-swap, then the deal would cease to be classed as voluntary and credit default swaps would be triggered, which would likely result in another wave of financial turmoil.

Debt issues aside, the eurozone’s growth outlook also points to weaker sentiment towards the single currency. Whilst the ECB seems satisfied with leaving the eurozone interest rate at 1.00%, instead focusing on monetary easing via the €1trn of cheap loans it has granted in the past three months, the likelihood is that the eurozone as a whole is set to enter a prolonged recession. Data has revealed that the eurozone economy contracted by 0.3% last quarter and PMI data from February suggests Q1 will be little better. That said, one bright spot for the euro has been some improved forward-looking German business and consumer confidence surveys but risks remain to the downside.

As far as the UK economy is concerned, growth data has continued to pick up in the past month, best demonstrated by the strongest monthly retail figure since last April’s Royal Wedding. Despite the familiar and ongoing risks coming from the eurozone, the UK is looking increasingly likely to avoid another quarter of negative growth, which would take it into a technical recession. The BoE added another £50bn to its QE programme last month but the move was fully priced in and sterling weathered the announcement pretty well.
Judging by less dovish comments from Mervyn King of late and the BoE’s recent Quarterly Inflation Report, February’s QE move should be the last of its kind this year, even though MPC policymakers, Posen and Miles, put the market on edge with votes for £75bn.

The most significant risk to sterling continues to be posed by the credit rating agencies. Moody’s put the UK on a negative outlook in February; a loss of the UK’s prized AAA rating is a major pillar of support for the pound and its loss would be very damaging indeed.

Growth will not continue on its current trajectory this year, but the most important thing is that the UK doesn’t slip back into recession. Government borrowing figures improved last month, which should keep debt downgrade fears at bay for now. On balance, we are still betting a double-dip will be avoided in the UK.

€1.18 provided ample support in late February and sterling has since rallied to €1.1950. Largely due to the plethora of risk events that lie ahead in the eurozone, as well as the euro’s rally running out of steam of late, we are looking for a stronger GBP/EUR pairing in the coming weeks and months, which should see it revisit January’s multi month highs above €1.21 in March.

GBP/USD

After a couple of dips below $1.57, sterling has gone from strength to strength in the past week or so. In contrast, the US dollar has seen weak demand this year, amid pretty positive trading conditions; the dollar is always likely to struggle amid rising equity prices. Data from the US economy has played a key role in the improved sentiment within the financial markets.

February’s key monthly US unemployment figure improved for the fourth consecutive month to post a nine-month high. The US manufacturing and services sectors also provided further scope for optimism, as has the recent upward revision of US GDP for Q4 of 2011, which revealed an annualised growth rate of 3.0%.

The steady flow of improved US figures seems to have taken the US Federal Reserve by surprise. Fed Chairman, Ben Bernanke, caused a major stir in the currency markets this week by omitting any references to QE3 in his speech. Instead, he cited improvements to the US economic performance, particularly within the US labour sector. Whilst the Fed has made it clear that it doesn’t anticipate raising interest rates until late 2014, a US outlook with no more quantitative easing is a distinct positive for the US dollar.

It has certainly been a relief to see UK growth pick up in the past few weeks. Whilst it is outperforming its eurozone counterparts, the US economy is the frontrunner and its 2012 outlook is significantly brighter. The UK’s vulnerability to a sharp eurozone downturn outweighs that of the US, which should again favour the dollar as investors assess their options.

In the event that UK growth does run out of steam, QE and debt downgrade speculation will certainly resurface to the detriment of sterling. QE will not be a concern with regard to the US dollar any more, while it has already demonstrated it can withstand a debt downgrade as it did last summer (when S&P cut United States’ AAA rating). These are perhaps longer-term considerations but will doubtless come to the fore in coming months.

We see downside risks to the eurozone situation resulting in a downward correction in global stocks and increased safe-haven flows into the US dollar soon. Asian and Middle Eastern sovereigns are continuing to diversify out of the US dollar into the euro but even this should not be enough to prop the euro up at these levels this year.

We are looking for a major reversal in the EUR/USD pairing, which points to a firmer USD moving forward. This will inevitably weigh on the GBP/USD pairing. In the short-term, we may see sterling make one last charge at $1.60 (which it currently trades marginally below) and beyond, an attempt at $1.61. However, we are looking for GBP/USD to reverse most of its recent gains in the medium term, correcting back down towards $1.57.

Caxton FX one month forecast:
GBP / EUR 1.2150
GBP / USD 1.57
EUR / USD 1.2950

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Greek set to receive bailout but euro's upside potential looks limited

The euro has enjoyed a remarkably strong start to 2012, rebounding considerably from what was a very steep decline at the end of last year. Greece has been the primary focus of recent weeks - talks stalled between Greece and its private creditors over a debt swap deal and the Greek coalition has struggled to agree on the necessary austerity measures. At last, a Greek deal has been announced, which should pave the way for a €130bn second bailout that will avoid a messy and potential disastrous Greek default.

Growth in the UK economy picked up a little in January, which has fuelled some hope that the British outlook may not be as gloomy as once feared. Growth will remain sluggish even in a best case scenario, so it was always a question of by how much, not if, the Bank of England would increase its quantitative easing programme at its recent meeting. £50bn of additional asset-purchases has been announced but sterling was unaffected as the move was fully priced in.

Despite building eurozone concerns, risk appetite is in fairly good shape at present and this has seen the US dollar weaken off in recent weeks. Nonetheless, we maintain a bearish outlook for risk assets this year and a bullish view of safer currencies such as sterling and the US dollar.

GBP/EUR

Sterling’s progress against the euro has stalled in recent weeks. The imminence of further quantitative easing has pegged sterling back somewhat. However, the key resistance factors for GBP/EUR have been some intense short-covering by a market that had bet heavily against the single currency and some relieving (albeit frustratingly slow) progress towards a second Greek bailout that will avert a default in March.

The current Greek situation remains highly uncertain however. The deal may broadly have been agreed but the Greek parliament still needs to approve it; it contains further crippling austerity measures, which will likely be a tough sell to Greek MPs.

Fears of another eurozone credit crunch have eased in recent weeks, largely due to the ECB’s cheap loan programme to ease credit lines. The cheap loans scheme (which will be replicated at the end of this month) is in effect quantitative easing through the back door and has filtered into the eurozone bond markets, resulting in lower yields across most of the periphery, most importantly in Spain and Italy.

However, Portuguese bond yields have not responded as the ECB would have liked, which indicates that another crisis scenario is just around the corner. Speculation is building that we will need to see another second bailout scenario in Portugal, whose bond yields are on a very similar trajectory to Greece’s last year.

The UK’s AAA credit rating and the demand of UK gilts remain the key drivers of any sterling strength. The market has made its peace with increased quantitative easing from the Bank of England and the issue shouldn’t weigh on the pound too much this year.

A plunge back into recession, of which there is a significant risk, is the main risk factor hanging over sterling. Negative growth combined with ongoing elevated debt levels will surely attract the attention of the rating agencies and the rug could well be pulled from under the pound. Still, some strong January growth figures, typically led by the UK services sector, suggest there is some room for optimism. Add to this the growth-friendly effects of further QE and a double-dip may just be averted.

GBP/EUR has consolidated around the €1.20 mark since the turn of the year and we don’t envisage any major or sustained forays below this level. 84p (or €1.1905) should provide some decent support and the balance of risks look skewed to another move north of €1.20 in coming weeks.

GBP/USD

Sterling has had a superb run against the US dollar, bouncing well off its lows of $1.5250 to trade six cents higher. As evidenced by stronger stocks in January (an historically strong month for equities), risk appetite has been fairly prominent in recent weeks, which has weakened the US dollar considerably. As usual, GBP/USD has tracked a considerable rebound in the EUR/USD pairing, which we don’t see lasting too much longer.

The US Federal Reserve’s announcement that it expects to keep interest rates at record lows close to zero until late 2014 has done the US dollar few favours by fuelling risk appetite. Likewise the greenback’s strange relationship with US economic data has swung out of its favour. The encouraging signs out of the US economy, as evidenced by the lowest unemployment levels in three years, have added to the prevailing risk-friendly environment.

However, once market sentiment sours as a result of the eurozone crisis (as it inevitably will do) and investors flood back into safe-havens as we anticipate, then the robust figures coming out of the US economy should work in the dollar’s favour again.

GBP/USD’s rally looks to have some more legs in the short-term, which could see the $1.60 level tested. Beyond this though, we see the rate coming back down (perhaps quite aggressively) towards $1.55, in line with our bearish view for the EUR/USD pair.

Caxton FX one month forecast:
GBP / EUR 1.21
GBP / USD 1.5750
EUR / USD 1.3050

Richard Driver
Analyst – Caxton FX


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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

For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

ECB rate cut could be positive for the euro

There have been plenty of positive developments for the eurozone of late. The IMF looks increasingly likely to be a third line of defence and it has been agreed that the European Financial Stability Fund will be able to guarantee up to 30% of troubled eurozone state’s bonds.

Most importantly, six major central banks last week announced coordinated liquidity measures to take the pressure out of the global, and particularly the European banking system. The unified emergency response has given appetite for riskier assets such as the euro a real shot in the arm.

We have also seen some progress in Italy, with new PM Mario Monti announcing a fresh 30bn austerity package, which should serve to appease the markets for the time being.

All eyes now turn to the Thursday’s monthly interest rate decision from the European Central Bank. A higher interest rate is typically positive for a currency and a rate cut a distinct negative. However, circumstances in the eurozone are anything but normal and a second consecutive monthly rate cut to the ECB’s base rate (currently 1.25%) could well be taken as sign that EU officials understand the gravity of the region’s problems and are acting proactively and assertively. Other liquidity measures are also likely to be announced by ECB President Draghi.

Friday brings a key EU Summit which has been hyped as ‘make or break.’ This is a bit overdone but there are plenty of signs that we will see some decisions made on fiscal union amongst eurozone states. Headlines today reveal that Merkel and Sarkozy have reached an accord on eurozone budgets and potential sanctions. The markets have been disappointed before and whilst investors are likely to hope for the best while the positive headlines flow, but many will be preparing for the worst.

Conditions in the US improve but not so for the UK

US economic figures have broadly taken a turn for the better in the past fortnight, suggesting the US economy can have a stronger 2012 than has recently been indicated. This has added to the improved sentiment in the market in recent sessions.

UK data has been less impressive; November’s UK construction and manufacturing figures revealed a further slowdown and have done little for the prospects of final quarter growth. Services sector growth enjoyed a minor uptick but levels are well off what we were seeing earlier in the year.

George Osborne was very negative indeed about the prospects for the UK economy in his Autumn Statement. The Bank of England will be sitting on the sidelines until February as far as more quantitative easing is concerned, so we will just have to hope that activity picks up in the next few months.

Sterling is trading at €1.1650, off its recent highs above €1.17 in light of an upturn in global risk appetite. Against the US dollar, sterling is trading more robustly up at $1.57, having bounced of lows of $1.54 in late November. We don’t see any major moves in the GBP/EUR pair this week but we may see EUR/USD continue to head higher as equities recover. This should keep GBP/USD well-supported, regardless of the growing concerns surrounding the UK economy.

End of week forecast
GBP / EUR 1.16
GBP / USD 1.5750
EUR / USD 1.36
GBP / AUD 1.50

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Greek debt returns to the spotlight

German minister Wolfgang Schauble today expressed concerns that Greece may be unable to meet its debt repayments by June. This triggered a wave of uncertainty within the debt and currency markets, as fears remerge that Greece may be forced into restructuring its debt.

ECB policymaker Bini Smaghi has also joined the discussion. Smaghi stated that a restructuring of Greek debt would be disastrous for its economy - he, pointed to the risks to its banking sector, social cohesion and even democracy within the troubled state. Greek government bonds have come under real pressure today as a result. Smaghi warned that public speculation over eurozone debt issues can turn out to be self-fulfilling prophecies (almost certainly true of both the Irish and Portuguese bailouts), and so might be the case here. Smaghi went on to assert that if Greek banks were to lose access to ECB financing, then “The Greek economy would be on its knees”, which seems somewhat hypocritical to me...

Last week saw Portugal request a bailout - the market remained broadly unconcerned, perhaps relieved that the issue had finally been addressed. The real concerns were that Spanish and Italian debt would come under pressure as investors focused elsewhere, but these struggling states have impressively been able to maintain investor confidence thus far.

Greek officials have denied the need to restructure their debt; but then again Portugal strongly rebuffed accusations that they would require a bailout (and we all know how that ended). The current picture of Greece’s economy is one of GDP contraction, low tax revenues, soaring unemployment and vicious public sector cuts. Prevailing arguments suggest that this is creating a downward spiral from which the state cannot pull out - unless its debts are written off.

The euro has come under real pressure as a result of the various comments that have surfaced today, dropping by over a cent against the dollar. Could this finally be the turnaround in the euro we’ve been waiting for? It seems unlikely. We’ll have to wait and see how the Greek situation develops, but today’s euro-weakening should only be a temporary. We have seen time and again the resolve of Asian sovereigns to buy the euro, particularly when it has dipped in the European session.

In addition, we’re already seeing the euro recover as we speak, suggesting that market concerns may have been overdone. Nonetheless, this has been a welcome break for a struggling UK currency, which is now trading at a more palatable level above €1.13.

Richard Driver
Currency Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Crunch Time: EU Summit

Next Friday’s EU Summit marks a self-imposed deadline for eurozone leaders to reach an agreement on a “comprehensive package” to deal with the region’s fiscal problems. Progress was made earlier than expected at the preliminary Summit last weekend, and the markets responded positively – perhaps too positively if Trichet’s recent pessimistic comments are anything to go by.

Most significantly, EU leaders reached an agreement to expand the European Financial Stability Fund (EFSF). However, the more realistic tones coming out of the Summit are stressing that “the devil is in the detail” and whilst broad principles were agreed, the financial technicalities involved in actually implementing those principles pose a huge obstacle to concrete commitments.

Certainly, the enlarged bailout fund is a step in the right direction but it is more difficult for the EU member states to agree in what proportions they should contribute. One would assume larger states such as France and Germany would shoulder the burden but their national publics are growing tired of this ‘duty.’ Another issue surrounds the continuation of the ECB’s bond-buying role instead of allowing the EFSF to buy bonds on the secondary market, which Trichet feels particularly aggrieved about. Superseding all of this is the fact that the EFSF is set to expire in 2013, with the European Stability Mechanism to replace it, so agreement on the shape of this longer-term fund is paramount next week.

Coming into this month, the markets were cynical as to progress on EU debt issues. However, with Trichet turning up the heat on EU leaders (indicating borrowing costs would be increased in April with an ECB interest rate hike) we saw greater political commitment last weekend and increased market confidence followed. The euro has strengthened against the US dollar and sterling accordingly, despite several recent peripheral credit downgrades and very high bond yields.

It is possible that agreement on a “comprehensive package” next week will trigger a strong euro rally next week, persuading the markets that the eurozone debt problem can finally be put to rest. More likely though, in this risk adverse environment, is that the markets will greet an agreement positively but remain broadly cautious on the euro. Any gains will be incremental as markets await further proof that the situations in Portugal, Spain and Greece will improve. Sterling is likely to suffer against the single currency if the Summit is successful, at least in the short term, given that the ECB is almost certain to raise interest rates before the BoE. However, the pound should continue to outperform the US dollar, tracking euro strength.

Richard Driver
Analyst – Caxton FX


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Will the eurozone debt crisis flare up once more via Portugal? And what will it mean for the euro?

Eurozone leaders are meeting this weekend in a prelude to the main EU summit in a fortnight’s time, where they will attempt to work towards an expanded bailout fund to deal with the region’s debt problems. As ever, the market expects little progress.

Addressing the key issue, it’s less a question of whether Portugal will need to accept a bailout and more of a question of when. The likelihood is that this will be sooner rather than later as the longer Portugal delays the inevitable, the more expensive it will become. The ailing country’s 10-year bond yields reached euro-era highs yesterday at 7.55%, which is simply not sustainable. Portugal opposes turning to the EU and IMF for help, but similar bond yield trends triggered bailouts for Greece and Ireland last year, and if Portugal sticks to its stubborn line then monetary assistance may be forced upon it by April.

As if things weren’t bad enough for poor old Portugal, Trichet has recently indicated that the ECB will raise interest rates to fight inflation (as discussed in the last blog), which will only increase borrowing costs for a country that remains in recession. So, what choice does Portugal have?

Interestingly, the market has moved the spotlight back onto Greece this week, in light of Greece’s recent credit downgrade. However, the markets are fickle and the Portuguese problem will be back in the headlines before long.

The impact that a Portuguese bailout or a Greek default will have on the euro is not as clear as might be imagined. A trend appears to have emerged of fading market sensitivity to eurozone debt crises over the past year; Greece shocked investors, Ireland less so, and more recently the euro has strengthened across the board despite these imminent periphery issues. On the other hand, investors may lose patience with the eurozone’s inability to find a long-term solution. Clearly a firm agreement on the bailout fund at the end of this month would do much to set investors minds at ease.

For the time being, the single currency seems set to continue to benefit from its new “front-of-the-queue” status with regard to raising interest rates. However, once this arrives (consensus is that this will be in April), focus will then shift to the effect that this rate rise could have on countries like Portugal, and their impending funding issues. Accordingly, a long-term euro uptrend is far less secure than its monthly outlook and sterling could yet revisit the winning ways it enjoyed early this year, especially following its own rate hike (potentially May/June), which is bound to entice investors.

 
Richard Driver
 
Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.