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

 

US fiscal cliff a major danger to the US dollar

The most immediate danger to the US dollar is quite clearly posed by QE3. The US Federal Reserve’s monetary policy outlook should be a little clearer after Bernanke’s speech in Jackson Hole this afternoon. If it is not, then the Fed’s meeting and press conference on September 13^th should yield plenty of clues.

Whilst data over the past month or two suggests that US economic growth is recovering from its slumber in the first half of 2012, there is plenty of uncertainty ahead with the US ‘fiscal cliff’ drawing closer.

What is the fiscal cliff? The end of 2012 will see tax cuts come to an end and spending cuts dramatically, which are expected to weigh on US GDP dramatically. Tax cuts that will expire include a 2% payroll cut for workers and tax breaks for businesses, while tax hikes related to President Obama’s healthcare law will also kick in. The Congressional Budget Office estimates that the effects of all this could be a reduction in US GDP by a staggering 4.0% in 2013, while two million jobs could be lost resulting in a 1.0% rise in unemployment. So with the fiscal cliff capable of plunging the US economy back into recession, the stakes are extremely high.

                                                                                                                              

The US economy is faced with taking the pain and addressing its fiscal position in an early but huge hit, or spreading the pain over a longer period in order to safeguard a still fragile recovery (a familiar debate to followers of the UK political approach to austerity). As last year’s ‘debt ceiling’ debacle demonstrated, deadlock in the US political system can cause huge delays to major policy decisions.

In addition, this fiscal cliff issue comes in the context of an election year, so there will be no decision made on how to approach tax and spending moving forward until the leadership is determined in early November. A stop-gap measure to delay the tax rises may well come before the end of the year but you can be confident that any decision that is made will come right down to the wire.

What are the implications for the US dollar? Well, as ever there are two sides of the coin. The concerns over the US economy and the fears of recession could drive the dollar down in line with its deteriorating economic fundamentals. Contrastingly, the threat to the world’s largest economy could see the market flood back into the safe-haven US dollar. Inevitably, both strategies will be adopted but which truly prevails is uncertain.

Our bet is that the US dollar will be hurt by the fiscal cliff issue. This will likely be the case whether the US ‘goes over the cliff’ or whether delaying tactics are adopted. The can-kicking that has been evident in the eurozone has been a major weight on the euro over the last couple of years and the market response to more of the same from US policymakers will be the same.

However, the fiscal cliff is by no means the sole point of focus for the financial markets in the second half of 2012. Of course, this all comes as the eurozone debt crisis reaches new levels of seriousness. Indeed, we doubt that the fiscal cliff issue will be enough to stop the EUR/USD pair dropping significantly below $1.20 by the end of the year. The fiscal cliff will weigh on the dollar, but not to the same extent that the debt crisis will weigh on the euro.   

Richard Driver

Currency Analyst

Caxton FX

Caxton FX Weekly Round-up: Dollar poised for rally

Pressure on for revised UK Q2 GDP figure

Last week’s all-important Quarterly Inflation Report from the Bank of England provided sterling with support just when a return to the €1.25 level was looking probable. King seemed to discard the option of another interest rate cut, describing it as potentially “counterproductive” and the likely effects to be “neither here nor there.” There were no real signals that the BoE is poised to introduce further quantitative easing, which again was supportive of the pound. The MPC minutes released on Wednesday should provide further clarity in this regard; we expect a unanimous decision to hold fire on more QE.

In addition to being less dovish than expected on monetary policy, Mervyn King also stuck to his guns in arguing that UK growth is not as weak as headline data has suggested. King’s comments have increased hopes and expectations that the initial -0.7% GDP figure for Q2 will be revised up. This was supported by last week’s better than expected, although still alarmingly weak in the bigger picture, manufacturing and industrial production figures from June. If an improved GDP figure is not forthcoming on Friday 24th August, then sterling could well be hit hard.

ECB has done nothing so far but hopes remain high

Despite the ECB having failed to take any concrete action at its meeting at the start of this month, the euro remains well away from its late-July lows. This is largely thanks to ECB President Draghi’s indications that the central bank is gearing up to resume the purchasing of Spanish and Italian bonds, in an effort to bring down their unsustainably high borrowing costs.

However, while some short-term relief for the euro would likely follow some concrete action from the ECB, it will be no panacea. Bond-purchases will be tied to very strict conditions with respect to economic reforms. Mario Draghi has suggested that ECB bond-purchases would only occur once a country had requested help, but this request may not come if Germany is too strict with the conditions it attaches. At the very least, German demands may could easily delay progress. In any case, bond-purchases took place last year but we are back in panic mode once again, so we find it hard to believe that ECB action will provide anything more than a short-term lift for the single currency.

Despite the positive sentiment that has built towards the euro over the past few weeks, we continue to hold a distinctly bearish view of the single currency over the rest of 2012. While sterling has plenty of its own domestic issues, chief among which are ongoing weak growth and the threat of the UK losing its AAA credit rating, it should be able to climb higher towards €1.30 this year.

GBP/EUR is currently trading at €1.27 and another push higher may prove tricky in the short-term as GBP/USD is looking ripe for another downward correction. Despite ongoing debate within and outside the US Federal Reserve, the central bank is still resisting the urge to announce or even signal QE3. This case has been strengthened most recently by last month’s better than expected US labour market update. The dollar looks well-positioned for a return to strength this month then, which could bring the GBP/USD rate well down from the current $1.57 level.

End of week forecast

GBP / EUR 1.2750
GBP / USD 1.5550
EUR / USD 1.2250
GBP / AUD 1.5000

Richard Driver

Analyst – Caxton FX
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Sterling set for a tough month

As has been the case for many months, eurozone concerns dominated market sentiment in July, so much so that the euro hit fresh multi-month lows across the exchange rates. Immediate concerns over the situation in Spain and Greece hurt confidence significantly, with weak economic growth across the globe adding to concerns. However, market sentiment and the euro have picked up considerably in recent sessions.

After the so-called progress that was made at the June EU Summit, there have been no material developments. The peripheral bond markets are always a good indicator of market tensions with regard to the debt crisis and Spanish 10-year bonds have hit fresh euro-era highs above 7.6% in recent weeks, with equivalent Italian debt setting its own record above the 6.5% level. Whilst economic growth throughout the eurozone is contracting sharply, Spain is edging towards a full-blown bailout and Greece could yet fail to secure its next bailout tranche, which is essential if the country is to avoid collapse.

Economic conditions in the US continue to provide plenty of cause for concern. The US economy slowed from a pace of 2.8% in Q4 2011 to a pace of 1.5% in Q2 2012. Poor performance in the world’s largest economy stunted the US dollar’s progress in recent weeks by increasing speculation that the US Federal Reserve is edging towards introducing the much-debated QE3 measure. However, the Fed’s recent meeting produced yet more ‘wait-and-see’ rhetoric, which has taken some weight off the dollar for the time being.

News out of the UK has also been far from comforting. Recent data has indicated that the domestic economy contracted by 0.7%, which is a shockingly poor figure well below expectations. The Bank of England has introduced another round (£50bn worth) of quantitative easing and the government has initiated an interesting new Funding for Lending Scheme to encourage banks to step up lending, but the effects of these are some way from being felt. In the meantime, UK growth is expected to remain very weak indeed. Sterling still holds some safe-haven demand, though this may be insufficient for it to avoid losses against the euro and dollar this month.

GBP/EUR

Having hit near four-year highs up towards €1.29, this pair has since erased its gains and at the current level of €1.26, it is back where it started in July. Whilst we do maintain that the pound will remain on its longer term uptrend, we anticipate some further short-term sterling softness in the coming weeks.

Spain spooked the markets in July, with borrowing costs soaring well above the 7.0% level amid a request from the Spanish regional government of Valencia’s request for financial aid and concerns of similar emergency needs across Spain’s regions. Spain’s banks have already agreed a bailout with international creditors and it has certainly discussed a full-blown sovereign bailout with Germany, which continues to demonstrate growing bailout-fatigue. In terms of austerity and economic reforms, PM Rajoy is doing all he can but investors are still hammering Spain in the bond markets. A sovereign bailout is looking increasingly unavoidable.

Last week’s ECB meeting was the most eagerly-awaited in a very long time but the market was left wondering what could have been. Draghi had a plethora of options available to him and after he stated that he would do “whatever it takes” to preserve the euro, he delayed any action whatsoever. The decision not to cut interest rates was unanimous after June’s 0.25% reduction, despite ECB President Draghi predicting that the eurozone economy is likely to recover only very gradually, whilst noting significant risks to further deterioration. Q2 was an awful one for the eurozone, with weakness in the periphery spreading to core states including Germany. The latest German and French manufacturing figures reveal a sharp contraction and eurozone unemployment remains a major issue, having recently reached a fresh record high of 11.2%.

Draghi disappointed the markets by suggesting that the European Stability Mechanism will not be granted a banking license, which had been previously indicated by an ECB policymaker and would have greatly increased the bailout funds’ firepower. Importantly, Draghi indicated that the ECB may move to buy up peripheral debt to ease pressure in the bond markets, but his comments fell short of a pre-commitment, never mind concrete action. German resistance to ECB bond-buying and demands for fiscal restraints represent a key obstacle to ECB emergency action.

Whilst alarm bells ring in the eurozone, the UK economy is also in a very weak state, which is best demonstrated by the recent-0.7% GDP figure from Q2, leaving the UK economy firmly in recession. Initial signs have not been positive for Q3 either; the UK manufacturing sector posted its worst figure in three years and the UK services sector gave its worst showing in eighteen months in July.

The Bank of England is clearly concerned with economic conditions in the UK, having introduced another round of quantitative easing in July to support the economy. The MPC voted 7-2 in favour of the £50bn top-up and there were suspicions that another dose would be approved at its recent August meeting in response to the latest shock GDP figure, though sterling has been spared this development. The government has also taken its own action to try to drag the UK out of recession in the form of its Funding for Lending initiative, designed to incentivise UK banks to increase lending, something that the Project Merlin initiative failed to do.

It needn’t be all pessimism towards the UK economy; there remains some fairly strong scepticism over the reliability of the awful initial Q2 UK GDP figure and in combination with the improved weather conditions, hopes for a significantly stronger second half of the year are not misplaced. The effects of the additional round of QE, the Funding for Lending programme should help the UK return to growth, though this may have to wait until Q4. Unfortunately though, initial expectations that the London Olympics will add 0.5% to UK GDP this year are receding.

The sharper than expected recession has highlighted the question marks over the UK’s treasured AAA credit rating. Rating agency Moody’s has retained its negative outlook for the UK’s credit rating, though fears have been quelled somewhat by Standard & Poor’s recent reaffirmation of the UK’s top rating with a stable outlook.

Sterling is trading at €1.26 at present, which represents a pretty aggressive decline from its multi-year high of €1.2878. With weak UK growth figures set to flow this month, we expect this rate to retrace further in the coming weeks down to €1.25. There is a risk that this pair will revisit its June lows of €1.2270 but on balance we think this is unlikely.

GBP/USD

Sterling has remained range-bound against the US dollar over the past month, fluctuating between $1.54 and $1.57. The news out of the US economy has broadly been very disappointing; June’s labour figures were alarmingly poor, manufacturing data was shaky and retail sales contracted sharply. In addition, the US economic growth rate of 1.9% (annualised) in Q1 slowed down to 1.5% in Q2 - almost half of the rate we were seeing at the end of last year.

Naturally, weak growth figures saw bets on QE3 ramped up yet again, which has been a thorn in the US dollar’s side for some time now. Ben Bernanke disappointed the market yet again in his July US Federal Reserve Press Conference. There was no QE3 announcement, nor any real signals that a move is imminent. Clearly this is good news for the US dollar, if not for global market confidence.

The recent release of July’s US non-farm payrolls figure should free up the US dollar to make some gains this month. Data revealed that 163 thousand jobs were added to the payrolls in July, which represents the best showing in five months and should ease fears of a sharp slowdown in the US for now. One thing is certain though, QE3 will remain very much on the Fed’s list of options for the foreseeable future. We see the Fed pulling the trigger on QE3 at some point in Q4.

Despite Moody’s recent reaffirmation of the UK’s AAA credit rating, market confidence in the pound appears to be waning thanks to a steady flow of weak UK growth figures. More of the same can be expected this month and to make matters worse, anecdotal evidence suggests the Olympics will fail to provide the economic boost that was initially expected. The Bank of England held off from adding another dose of QE at its July meeting but suspicions of another top-up will grow with every negative piece of UK data.

We hold a negative view of the EUR/USD pair in the coming weeks, based on continued uncertainty on all fronts; sharp contraction in eurozone growth, a possible Spanish bailout, Greek uncertainty and a continued imbalance between talk and genuine action. If EUR/USD heads down towards $1.21 as we expect, then this would almost ensure GBP/USD declines even if UK news is positive. Given that we expect news out of the UK to be negative, we feel this pair’s downturn could be quite aggressive. A move down $1.52 looks realistic in the coming weeks.

Richard Driver

Analyst – Caxton FX
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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
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The Swedish Krona has had a good run but the game could be up

Data has revealed that the Swedish economy took a surprise upturn in the first quarter of this year. This improved domestic economic performance has given the Riksbank the confidence to leave interest rates unchanged for the second consecutive meeting, though there remain calls for another cut within the central bank’s ranks.

A brighter picture in Sweden has coincided with a mild recovery in global equities and risk appetite, in the wake of May’s crisis of eurozone confidence. Greece has managed to form a coalition government and concerns surrounding a messy Greek default and exit from the eurozonehave eased, for the time being at least. Spain’s situation looked capable of spiralling out of control, with the country’s 10-year bond yields setting new euro-area records up above the dangerous 7.0% mark. Some progress has been made with regard to Spain; an agreement has been reached for the bailout of its banks and some unexpected decisions made at the recent EU Summit have eased some short-term concerns.

Whilst market confidence has turned distinctly negative in recent sessions, the positive Swedish data in recent weeks has provided plenty of support for the Swedish krona, suggestive of a strong second half of the year for the Swedish economy. However, we view the risks to market sentiment and developments in the debt crisis to be heavily skewed to the downside. As such we don’t see too much more upside for the krona from here over the next couple of months.

GBP/SEK

After this pair peaked close to 11.50 in mid-May, the krona has rebounded impressively over the past two months. Sterling has struggled against many of the riskier currencies in recent weeks. Global stocks have staged an impressive recovery from their May sell-off and the krona has tracked that bounce inrisk appetite.

Events in the UK have not helped sterling’s cause of late. Growth data has been consistently weak, suggesting there will be no swift bounce back out of the double-dip recession that the UK has found itself in. Data confirmed the UK economy contracted by 0.3% in Q1 and we expect another contraction in UK GDP in Q2. The Bank of England’s response to fading domestic activity has been to introduce yet more quantitative easing, which is of course a negative for the pound. This factor has contributed to GBP/SEK’s poor performance over the past couple of months.

The Riksbank decided to leave its interest rate at the current level of 1.50% in July. Only two votes out of six were in favour of another cut to the Riskbank’s base rate, with the majority satisfied with the upturn in Swedish activity. The Swedish economy grew by 0.8% between Q4 2011 and Q1 2012 and the Riskbank is expecting overall growth of 0.6% this year, up from previous estimates of 0.4%. We have seen some positive figures comes out of Q2 as well;Swedish industrial production rose by an impressive 3.0% in May, while industrial orders rose by 4.5%, which has sparked a good degree of optimism surrounding the Swedish growth outlook.

There remains plenty of reason for caution. Swedish unemployment is rising (up at 4.4% from 4.0%) and the Swedish economy remains very vulnerable to deteriorating eurozone conditions. This second factor will ensure that another interest rate cut later this year is always a possibility, but on balance we expect the Riksbank to hold fire. We don’t see much further downside for this pair and expect a bounce back above the 11.00 mark over the coming weeks.

EUR/SEK

This pair has come under some aggressive selling pressure in the past two months. The risks of economic disaster posed by the eurozone debt crisis are building every monthand this has seen the single currency take another sharp turn for the worse.

The short-term risks posed by Greece have eased now that a coalition government is in place but when the bailout term negotiations commence there is plenty of scope for alarm bells. Concerns over Spain have more than stepped in to fill the void; its banking sector has had to seek a bailout and despite significant progress at the recent EU Summit, Spanish bond yields remain dangerously close to 7.0%.

Investors are still sceptical towards the euro and rightly so – no long-term solution is in sight; the bailout funds are still insufficient, Germany continues to obstruct the introduction of Eurobonds, peripheral borrowing costs remain high and eurozone growth is contracting. Even the progress made at the recent EU Summit has been placed in doubt by the German constitutional court delaying ratification of the ESM changes and the fiscal pact. In addition, the euro’s yield differential has once again been reduced by a 0.25% ECB interest rate cut (to 0.75%) this month, with further monetary easing in the form of another rate cut or cheap loan offering likely this summer.

With the euro losing ground across the board, the SEK is shining out as a safer European alternative backed by stable domestic economic growth and low debt levels. There are plenty of rumours that the SEK is a popular target with the Swiss National Bank as it continues its project of recycling the euros it acquires whilst weakening the CHF.

This pair is trading at an 11 ½ half year low; whilst we do not expect any major progress in the eurozone over the next couple of months, we do expect to see this pair to benefit from a minor bounce after its sharp recent decline. The SEK remains vulnerable to major panic in the eurozone. A bounce up towards 8.80 over the coming weeks looks a good bet.

USD/SEK

As one of the safest currencies available, the US dollar has been a strong performer since early May, which has helped this pair continue the uptrend that has played out over the past year. Eurozone fears have reached new heights and the safe-haven dollar always strengthens in this environment.

The US dollar has not been without its own domestic issues though; the US economy slowed down sharplyover the first half of 2012, the Q1 GDP figure was revised down to 1.9% (y/y) from 2.2%. Consistently soft figures out of the US labour market in particular have ramped up speculation that the US Federal Reserve will announce a third round of quantitative easing (QE3). Regardless of the risks of QE3 this year though, we envisage enough safe-haven demand for the dollar to outperform.

We envisage plenty more gains for the US dollar in the second half of this year, with USD/SEK heading back up towards it recent highs around 7.30 in the coming few weeks, with fresh highs above 7.50 likely towards the end of Q3.

NOK/SEK

The Norwegian economy continues to shine, having grown by 1.1% in the first quarter of this year. The latest updates in terms of Norwegian manufacturing and industrial production were positive and retail sales growth was particularly impressive in May. There is no doubt that the Norwegian economy is proving extremely resilient to the global and eurozone economic downturn that has developed this year. Rising investment in Norway’s lucrative oil sector is providing steady support to growth and with forward-looking economic surveys looking positive;the Norges Bank has revised its GDP forecasts upward to 3.75% from 3.25% for 2012.

Clearly the Norges Bank has been eager to highlight the external threats to the Norwegian economy, most notably from the eurozone debt crisis. Indeed it stated in June that “turbulence and weak growth prospects abroad suggest the key policy rate should be kept on hold.”However, the Norges Bank is one of the few global central banks not inclined towards easier monetary policy and we currently expect an interest rate hike from the Norges bank around the turn of 2013. Of course, this will be highly sensitive to developments in the eurozone and how drastically this affects Norwegian exports.

The Norwegian krone is still a commodity currency and although Norway’s strong economic fundamentals have to a large extent offset the effects of declining oil prices on the krone, the slide has still weighed on the currency. Since the uncertainty triggered by the Greek elections in early May, the price of Brent crude has declined by almost 20% from $120 to under $100 per barrel.

This factor has contributed to a sharp downward correction in the NOK/SEK rate, dragging it down from two-year highs above 1.20 to current levels just above 1.14. We consider these levels to be much too low and are confident that we will see a strong bounce off these lows up towards 1.18 over the next few weeks.

Richard Driver
Analyst – Caxton FX

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Caxton FX Weekly Round-up: Euro takes a hammering

ECB cuts rates and the euro takes some punishment

The ECB met expectations last week by cutting the eurozone interest rate to 0.75%. In addition, the deposit rate was cut to zero. This all makes the euro the second-lowest yielding currency in the market after the swiss franc, which is likely to see investors increase their use of the euro as a funding currency for carry trades into higher-yielding currencies. This should be a major factor weighing on the euro moving forward.

For many, the ECB’s rate cut did not go far enough in offering support to the eurozone’s deteriorating situation. There is a significant chance of another interest rate cut at the ECB’s next meeting in August, as there is of alternative easing measures such as another LTRO (cheap loan offering).

The post-EU Summit optimism has well and truly run its course and the market sentiment has once again turned negative. Spanish bond yields are back up at 7.0%, while global equities have tumbled for three days straight. Eurozone investor sentiment data was very poor on Monday morning and with the market already reflecting on recent weak data from the US, Japan and China, the euro has come under some pressure.

It is not all bad news for the euro, however, as we have heard today that Spain will be granted a year’s grace until 2014 to meet its deficit target of 3%. This has been insufficient to trigger any major euro bounce, which is sitting close to 3 ½ year lows against the pound and 2 year lows against the USD.

US data spooks market and risk aversion takes hold

The key monthly figure from the US labour market disappointed last Friday. It is always interesting to see how the US dollar reacts to weak domestic data and Friday’s installment proved supportive of the greenback. Dollar-friendly risk aversion was the knee jerk response, despite the fact that the downtrend in US data is likely to push the US Federal Reserve into finally pulling the trigger with regard to QE3 later this year. There is a chance that the Fed will do so on August 1st and much depends on US data in the intervening period, but we suspect Ben Bernanke & Co will choose to keep their powder dry for another month at least.

The flight to the safety of the US dollar has seen GBP/USD lose some ground in the past few sessions. The Bank of England’s decision to inject another £50B of quantitative easing into the UK’s flat lining economy was broadly priced in, though last week’s poor growth figures from the UK’s construction and services sectors in particular were not helpful for GBP. The week ahead is fairly quiet in terms of domestic data, with only manufacturing production data and trade balance data likely to receive much attention.

EUR/USD was last week’s major mover, having tumbled from above $1.26 to below $1.23 in the space of just three sessions. We have been calling for a slide down towards and below $1.20 and this latest euro sell-off has only strengthened our resolve. GBP/USD fell as well, but not by as much (it fell from $1.57 to $1.55). This cleared the way for GBP/EUR to help itself to some easy gains up above €1.26. These are clearly strong levels at which to buy the euro in the short-term, though in the longer-term we target levels even higher in the direction of €1.30.

The market will look to the meeting of EU finance ministers over the next two days for a decision to activate the buying of peripheral EU debt but as ever there remains plenty of scope for disappointment here.

End of week forecast
GBP / EUR 1.2625
GBP / USD 1.5475
EUR / USD 1.2250
GBP / AUD 1.53

Richard Driver

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

Caxton FX July Currency Report: EUR, USD, GBP

Euro enjoys some respite but looks poised for another decline

It’s been a volatile few weeks with market sentiment chopping and changing, amid several important eurozone and US developments. Despite increasingly poor US growth data, the market was deprived the decision from the US Federal Reserve to introduce quantitative easing. Global economic growth in general is on a clear downtrend trend and investor confidence remains extremely fragile as a result.

From the eurozone though, we have at least seen some rare progress. The second attempt at the Greek general election produced the ‘least worst’ result and a coalition government has finally been formed. This development has eased short-term concerns of a messy default and a ‘Grexit’ but the real progress is yet to be made. Greece still needs to find a way of renegotiating the crippling terms of its bailout agreement, though Merkel’s tough stance provides plenty of scope for deadlock.

Euphoria relating to the avoidance of a Greek disaster (for now) was short-lived, with concerns towards Spain quickly taking hold. Spain’s bailout request for its troubled banks comes amid a host of downgrades to both the sovereign and its banks’ credit ratings, while soaring government bond yields threaten to force Spain itself into a bailout request.

Crucially, the results of the recent EU Summit exceeded expectations by some distance. Commitments were made on a more flexible use of the EU’s rescue funds in the sovereign bond markets (though details were conspicuous in their absence). Importantly, the EU rescue funds will be able to shore up Spain’s banks directly rather than being channeled via the government’s already debt –laden books. It was also confirmed that those loans would not have senior creditor status, easing concerns from private bondholders that they would be last in the queue for debt repayments.

June was an eventful month in terms of the UK economy as well, with speculation rife over Bank of England monetary policy. The Monetary Policy Committee made no changes in June, though the minutes from its meeting and subsequent comments were very revealing as to its next move. David Miles, the lone dove in favour of quantitative easing in May was joined by three other MPC members in June. We are expecting the pro-QE camp to secure a majority at its meeting this week, though the impact on sterling should be minimal.

GBP/EUR

Sterling poised for higher climbs against the euro

Sterling has edged higher against the single currency, which continues to suffer from the pressures of the debt crisis. Whilst EU leaders have made some steps in the right direction of late, we still see stalling eurozone progress pushing sterling higher against the single currency.

Sterling’s gains may be a little surprising given that news from the UK economy has been consistently negative; the UK manufacturing and construction sectors remain in the doldrums, while UK services sector continues to grow but is unable to pick up the slack. Data out of the labour market has been typically poor and the Q1 GDP contraction has been confirmed as -0.3%. Disappointingly, the Q4 GDP figure for 2011 was revised down from -0.3% to -0.4%, though such backward-looking data was not damaging to sterling.

There have been some small pockets of optimism, with UK retail sales bouncing back impressively from April’s collapse but as emphasised by Bank of England policymakers in recent weeks, the risks posed by the eurozone debt crisis are great and the UK’s prospects are highly uncertain. Overall, UK growth data over past three months (Q2) points is indicative of another contraction in UK GDP, so the double-dip recession rolls on.

Accordingly, we now fully expect the MPC to introduce another round of quantitative easing at its next meeting on July 5th. The UK inflation rate dropped from 3.0% to 2.8% in May, which along with ever-increasing concerns over UK growth as expressed in last month’s MPC minutes, seems almost certain to push the MPC into additional monetary stimulus this week. With regard to a cut to the BoE’s record-low interest rate of 0.50%, the issue has certainly been discussed by the MPC but QE is looking the preferred route to supporting the domestic economy at present.

EU leaders take some steps in the right direction

Unsurprisingly, conditions in the eurozone were extremely volatile in June and this will doubtless remain the case in July. While New Democracy may have secured a narrow victory in the re-run of the Greek general election and formed a coalition government, the renegotiation of Greece’s bailout agreement is bound to place Greece uncomfortably under the spotlight once again in the coming weeks. Greece’s negotiations with the Troika over its bailout terms are expected to take place on July 24th, so expect some major uncertainty around this date.

Importantly, the EU Summit has eased concerns surrounding Spain by producing an agreement to allow the EU’s rescue fund to directly recapitalise its banks, rather than adding to the sovereign’s debt to GDP ratio and driving up its borrowing costs. Market players were also extremely relieved to learn that bailout loans to Spanish banks will not be granted senior creditor status and that the eurozone rescue funds will be used more flexibly to allow peripheral bond-buying.

Nonetheless, the euro has been sold after its recent rally, which goes to show the scepticism and doubts that remain with regard to the future of the eurozone. Growth-wise in Q2, the euro-area could be looking at the worst quarterly growth figure in three years. There are also still huge implementation risks to the decisions that were made at the EU Summit, as shown by Finland and the Netherland’s recent pledge to block any bond-buying by the eurozone’s bailout funds.

The eurozone’s €500bn bailout resources are still inadequate and Merkel continues to stand firm against the introduction of Eurobonds. Progress was certainly made at the EU Summit but they were crisis management decisions, rather than decisions which can fundamentally change the direction of the debt crisis. No long-term solution is in sight and in addition, the ECB is set to reduce the euro’s yield differential this week by cutting its interest rate from 1.00% by at least 0.25%.

In short, we remain bearish on the euro and continue to favour the safety of sterling. There should be several opportunities to buy euros with the interbank above €1.25, while there is a significant chance of seeing this pair test its 3 ½ year highs of €1.2575.

GBP/USD

Sterling looking vulnerable against the greenback after strong run

The US dollar traded rather softly for much of June, which was not wholly surprising given the huge rally it enjoyed in May. The dollar has been held back by profit-taking in the wake of the USD’s May rally. It has also been hemmed in by fears (or hopes, depending on your exposure) that the US Federal Reserve will decide to usher in further quantitative easing (QE3). QE3, if it comes, will boost risk appetite away from the US dollar as investors target higher-yielding assets.

In its June 20th meeting and subsequent announcement, the Fed decided not to pull the trigger on QE3 and the dollar responded positively as you would expect. US data has without doubt increased the chances of QE3; figures from the retail and manufacturing sectors have been particularly disappointing, while consumer sentiment has also taken a turn for the worse. Most importantly as far as the Fed is concerned, key growth data from the US labour market weakened for the fifth consecutive month in June. Nonetheless for now, the Fed is keeping its powder dry with regard to QE3, holding it back to deal with a potentially even greater deterioration in US growth.

US dollar to bounce back

As shown by the knee-jerk response to the recent EU Summit, progress on the eurozone debt crisis can always lift market confidence to weaken the dollar. However, as shown by the market’s fading post-Summit enthusiasm, investors are proving increasingly hard to convince.

We think that the tough resistance that EUR/USD is meeting at levels above $1.27 will hold, which should usher in a move lower and possibly a retest of May’s lows below $1.24. GBP/USD is meeting resistance at $1.57 and we also think this resistance level will hold, making a move lower for this pair equally likely. We consider current levels to be a strong level (in the current circumstances) at which to buy dollars, with the rate heading back down to $1.55 in July.

Monthly Forecasts

GBP/EUR: €1.2550
GBP/USD: $1.55
EUR/USD: $1.24

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

Interest rate cut seems inevitable as the ECB looks to ease the debt crisis

The Governing council meeting of the ECB is set to meet in Frankfurt on Thursday and it is widely expected that it will produce the decision to lower its interest rate. It is a measure of the eurozone’s poor debt and growth dynamics that the ECB interest rate has already been cut to its current record low 1.00% level from its August 2008 level of 4.25%.

Clear indications have been made that the ECB is looking to cut the base rate. ECB Chief Economist Peter Praet has stated in the past week that “there is no doctrine that interest rates cannot fall below 1 percent…they (rate cuts) are justified if they contribute to guaranteeing price stability in the medium term." These comments followed others from another ECB policymaker who stated that a rate cut was an option that would be discussed in its July meeting. In light of this rhetoric, the market is rightly confident that another emergency cut will come from the ECB on Thursday.

A rate cut should come as no surprise given the prevailing conditions in the eurozone. Data this week has revealed that eurozone unemployment has hit its highest ever level of 11.1%. Growth data from the eurozone, including Germany worryingly, has been consistently poor and it is quite clear that the region had re-entered negative growth. Q2 could actually prove to be the worst quarterly growth performance in three years.

Eurozone inflation has also eased significantly this year, falling to 2.4% from the 3.0% level at which it ended 2011. Germany has always been obsessed with controlling inflation but even it must have softened its stance on loose monetary policy in light of the news that its domestic inflation rate eased more than expected to 1.7% last week.

There are plenty of doubts surrounding the impact of another interest rate cut. The Bank of England has decided not to cut interest rates despite entering a double-dip recession, precisely because of the limited impact that such a move would yield. However, a rate cut would translate into significant savings on the huge amount of loans that European banks have taken from the ECB over the last year.

There is the argument that a rate cut will actually undermine confidence as the ECB is seen to be desperately exhausting its options, but we reject this. Our view is that a rate cut will actually be welcomed as a piece of assertive action amid growing eurozone turmoil, though the reduction of the euro’s interest rate differential will stop this boost in confidence resulting in any material support for the euro.

It goes without saying that a rate cut will not solve the problem in the long term. The financial crisis in the Eurozone has come about due to structural problems, and as such, the solution must involve structural change. Lowering interest rates is not capable of fixing this crisis. In fact as ECB President Draghi has noted, long-term solutions to the debt crisis are in the hands of the EU’s political leaders, not its central bankers. The ECB can only really ease conditions in the short-term, as shown by the two rounds of cheap loan offerings in the past year or so (LTROs).

There are differing views on just how much Draghi & Co will cut the base rate by and the size of the cut is likely to impact on the market response. A 0.25% rate cut may not be enough to satisfy the market’s appetite for emergency measures. A 0.50% cut is possible but a quarter percent cut seems more likely, with the ECB declining the options of another cheap loan offering or bond-buying.

Adam Highfield
Analyst – Caxton FX
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Cyprus joins the queue for aid and the euro is looking vulnerable

Cyprus has become the fifth Eurozone country to apply to Brussels for an emergency bailout, after similar calls for help from Portugal, Ireland, Greece and Spain. Heavy dependence on the Greek economy has pushed Cyprus into this corner. The Cypriot banking sector is oversized for a country with only one million residents and it suffered badly from significant write-downs on Greek sovereign bonds. Cyprus hasn’t been able to access the debt markets since 2011 since being downgraded to ‘junk’ status by Moody’s and S&P, Fitch’s move to follow suit yesterday provided the final push to force the country into a bailout request.

In the very short-term, €1.8bn (around 10% of its domestic output) is required to recapitalise its second largest bank, Cyprus Popular Bank, while its largest bank, Bank of Cyprus has reportedly called for aid of around €500 million. Plenty more will be required for state financing and the country really requires a buffer from any further spillover effects from Greece.

The bailout is expected to amount to approximately €10 billion, which is equal to over half of the Cypriot GDP, currently standing at €17.3 billion. Along with the Spanish application for bailout funds for its banks, Cyprus’ bailout application has today been formally accepted by the Eurogroup. The funds will come from either the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM) when it becomes active. This comes after controversial but ultimately unsuccessful bailout negotiations with Russia and China. Dimitris Christofias, the Cypriot president, had expressed his wariness of the strict conditions that would come with an EU bailout. In particular, Cyprus’ rock bottom (10%) corporate tax threshold may be a cost of the bailout request. The terms of the bailout will surface in the coming weeks.

In terms of the impact on overall sentiment towards the eurozone, the Cypriot request for a bailout will not in itself weigh too heavily. Whilst it is another worrying example of debt contagion and does build on increasingly negative eurozone sentiment, Cyprus is the eurozone’s third smallest economy and this bailout request been a long time coming. Market nerves at the moment are more firmly fixed on the eurozone’s fourth-largest economy- Spain. The euro is posting significant losses across the board; the key EUR/USD pair looks likely to retest its multi-month lows of $1.2285 in the near future.


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

Spain requests bailout and adds to the euro’s woes

Spain formally requested assistance from its Eurozone partners on Monday, in light of the continued deterioration of its domestic banks. Luis de Guindos, the Spanish Economy Minister, sent the letter to Jean-Claude Juncker, who heads the group of Eurozone finance ministers, in the hope of obtaining a bailout loan thought to be in the region of €100bn. However, a lack of detail over the size of the bailout is a source of considerable market uncertainty. The news was fully expected following weeks of speculation over the condition of Spanish banks, and following the first call for help on 9th June.


What is also a source of nerves is where the bailout funds will come from. The recent bank restructuring in Ireland could be used as a precedent, in which case the loans would be channeled from the existing bailout fund, the European Financial Stability Mechanism, into Spain’s Fund for Orderly Bank Restructuring (Frob), which in turn will direct the money to those banks that need it. In this model, the loans would rank equally with private bondholders. If the loans come from the European Stability Mechanism, the new bailout fund, they will rank as senior debt and with the Greek haircuts fresh in the memory, the result would be investors hitting Spain will higher borrowing costs. The former option looks to be the likely choice. Another key concern is that as the bailout loans are likely to be channeled through Spain’s government, this means adding billions to Spain’s sovereign debt and increasing the country’s debt-to-GDP ratio considerably (from 70% to 80%). Again, this will have implications in Spain’s credit rating and borrowing costs.

These two factors are already an issue; Moody’s has downgraded Spanish debt to Baa3 (one higher than ‘speculative’), as well as issuing 28 fresh downgrades to Spain’s banks yesterday. This has resulted in a rise in the yield on Spanish 10-year debt to 7%, the government appears to be edging towards a sovereign bailout. Whilst in the short-term a bailout of the eurozone’s fourth largest economy would be a huge source of huge panic, a Spanish bailout may be the kick that EU leaders need to finally break ground on a long-term path to solving the debt crisis. Only time will tell.

So how has the euro responded? The Greek election result provided only a temporary respite and with the ongoing issue of the Greek bailout renegotiation ahead Spain edging closer to disaster, market tensions are rising. The euro has suffered a downwards correction in the past few sessions, dipping from $1.27 to $1.25, and allowing GBP/EUR to climb from €1.24 to €1.25. We maintain a negative outlook for the euro.

The EU Summit at the end of this week provides ample opportunity to calm market nerves, though the track record of these crisis meetings producing major progress is not a good one. Merkel has been typically stubborn on issues such as mutualised debt (Eurobonds) and with the Greek PM ill, no progress is likely to be made on the Greek bailout issue. Decisions with regard to Spain will be crucial if stocks are to avoid a further sell-off and if building pressures in the bond markets are to ease. The euro could be poised for a move lower.

Adam Highfield

Caxton FX

Spain confirms bailout request and the euro heads lower

The euro’s recovery shows signs of topping out in absence of QE3

The first three weeks of June were excellent ones for the euro but the past three sessions have punishing ones for the single currency. The Fed’s decision last Wednesday night not to pull the trigger on QE3, much to the disappointment of many market players, has seen the dollar strengthen significantly.

We also saw some awful economic data out of the eurozone at the end of last week. Monthly German manufacturing growth hit almost a three year-low, a German business climate survey hit a two-year low and growth data from the eurozone as a whole was distinctly poor as you might expect.

The Spanish Economy Minister has today formally requested a bailout to recapitalize its ailing banking sector, though the details as to the size of this bailout have not yet emerged. Unless funds well in excess of the €100bn bailout (which has been assumed) are offered, then market fears of an insufficient bailout are likely to persist. What we also do not know is whether the bailout will be granted via the Spanish government or whether the sovereign will be bypassed. The likelihood is that Spain will shoulder the loans, which will add to the country’s mounting debt. It is hard for the market to respond positively to this bailout, as it is just a liquidity solution; the fundamental issue of rising debt remains unaddressed. To add to the negative sentiment towards Spain, Moody’s is expected to downgrade Spain’s credit rating once again this week.

EU leaders meet at a summit at the end of this week to tackle issues relating to Greece, Spain, a banking union, Eurobonds and much more. The market has today demonstrated its lack of faith that any groundbreaking progress will emerge from the EU Summit, with the euro declining sharply, Spanish and Italian bond yields rising and global stocks tumbling. Market confidence is very much on the wane, which is all good news for the US dollar.

MPC minutes point to QE call in July

Last week’s MPC minutes provided a surprise in revealing a 5-4 split (against QE) in the vote on whether to introduce more QE in June, after a voting pattern of 8-1 against in May. Posen had made it clear that he had jumped ship from the dovish camp prematurely, so his QE vote was expected. However, the additional voting shifts from BoE Governor Mervyn King and Paul Fisher were a genuine surprise. In light of the surprise decline in UK inflation from 3.0% to 2.8% in May, as well as the overtly dovish language expressed in last week’s minutes, we fully expect the doves to gain a majority in the quest for more QE in July. This should not weigh on the pound though, as a July move is fully priced in.

The week ahead brings familiarly high levels of risk, with Spain and Italy both having to auction off some debt. The EU Summit is the main event and the potential for disappointment is all too clear. Because of this, sterling is trading at €1.2450 – a strong rate, which could well get even better by the end of the week. With BoE monetary easing now fully expected next month, the downside risks posed by UK data releases look rather limited. As ever, EU leaders have the capacity to trigger a major relief rally for the euro, though we remain sceptical.

Sterling has lost ground to the US dollar in recent sessions, hurt by a significant shift down in the EUR/USD pair. GBP/USD is now trading below $1.56 and we expect to see the dollar strengthen further this week.

End of week forecast
GBP / EUR 1.2475
GBP / USD 1.55
EUR / USD 1.2425
GBP / AUD 1.57

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 election out the way but euro remains vulnerable

Greece votes in favour of the euro but market relief short-lived

The long-awaited Greek elections last Sunday produced the result the market wanted, but only to an extent. New Democracy - the main pro-bailout, pro-euro party – won the election, but by only the smallest of margins, so the uncertainty of coalition-forming remained. What also remains are the inevitable attempts to renegotiate Greece’s bailout terms by any coalition that does form. With Merkel sounding as tough as ever on Greece this week, negotiations are likely to be tense and drawn out.

The market has been to the brink several times before in the case of Greece and the euphoria in response to the Greek election result was understandably short-lived. Certainly the worst-case scenario – a victory for the leftist Syriza and a potential euro-exit- was avoided but investors know full well that Greece’s second bailout will not buy sufficient time for Greece to get its house in order in a permanent sense, so the country’s painful saga continues.

Spain is very much in the headlines at present, as the country’s 10-year bond yields have broken through the dreaded 7.0% level which has forced other eurozone nations into bailout requests. Spain has already reached an agreement for a €100bn bailout of its banking sector, but these borrowing costs could ensure the sovereign itself will be requesting a bailout before long. The delay to the second part of the audit of Spain’s banks until September has not helped sentiment one bit, with suggestions being made that Spain’s bank could need more than €100bn.

Germany is likely to be the next country to dominate the headlines, though unsurprisingly not due to economic weakness or high debt levels. June 29th will see the German parliament vote on the EU fiscal treaty and the creation of the permanent eurozone rescue fund. Any indications that Angela Merkel is losing her grip on power domestically are likely to weigh on the euro significantly. Nonetheless, Merkel is widely expected to prevail in the vote.

Sterling firm ahead of MPC minutes release

Tomorrow’s MPC minutes will reveal the voting pattern with respect to the introduction of further UK quantitative easing at the MPC’s June meeting. Today’s weak inflation data has already made the domestic environment a more QE-friendly one, though we look back to last week’s Mansion House for indicators that the majority of the MPC will have different ideas. King announced an £80bn ‘funding for lending’ speech, which suggests the BoE are looking at alternative ways of boosting UK growth.

This week also brings US Federal Reserve monetary policy into sharp focus, with the central bank meeting and giving its statement and economic projections on Wednesday. Increasingly weak US growth data has pressurised the dollar of late but we continue to bet that the Fed will hold fire for now.

Having dipped as low as €1.2270 last week, GBP/EUR is now trading at €1.24, which is a reflection of the market’s muted response to the Greek election. We remain confident that we will see May’s highs just below €1.26 before long, though developments in Greece and Spain could have the final say about just how soon this will be.

Sterling is trading at $1.57, thanks to fears that the Fed is edging towards QE3. The current retracement in the EUR/USD pair is not something we see being sustained much past $1.28, which leaves upside potential from the current $1.2660 level as pretty limited.

End of week forecast
GBP / EUR 1.25
GBP / USD 1.5650
EUR / USD 1.25
GBP / AUD 1.53

Richard Driver

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

Doom and gloom on the domestic front but GBP remains popular

The perpetual threat to the global financial system that is Greece has dominated the headlines in recent weeks. The country’s May 6th elections saw the ruling pro-bailout coalition fail to secure sufficient support from Greece’s angry electorate. This ushered in a month of huge uncertainty as the market looked ahead to another Greek election on June 17th; with speculation growing that Greece’s anti-bailout parties would curry enough favour to form a coalition. The logical result of a rejection of Greece’s second bailout agreement would be default and an exit from the euro, so it should come as no surprise that the euro suffered further declines.

The pound was a key beneficiary of these euro declines, despite the negative implications that the eurozone debt crisis has on the already dire state of the UK economy. Recent data not only confirmed that the UK entered a double-dip recession in Q1, but it contracted by 0.3% rather than the 0.2% initially estimated. Taken with April and May’s growth figures, which are pointing to a soft start to Q2, this has unsurprisingly triggered fresh speculation that the MPC will edge back towards introducing more quantitative easing in the second half of the year. We are doubtful in this regard, for now.

Sterling is trading at impressive levels against the euro and despite a period of profit-taking in the past week or so, it remains at strong levels against the majority of global currencies thanks to its safe-haven, euro-alternative tag. However, as usual there is one currency sterling can’t outperform in the strongly risk averse trading conditions that characterised most of May – the US dollar. The dollar has helped itself to some easy and significant gains across the board as the eurozone debt crisis forces market players to unwind their riskier positions in favour of the safest of assets.

GBP/EUR

Sterling remains firm and continues to threaten higher climbs against the euro, 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, 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 17th. Yet another Greek election is a distinct possibility.

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 – no mean feat. The EU Commission has recently reminded Greece 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.

Spain rings alarm bells

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 as a whole. 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 that they tend to become a self-fulfilling prophecy. In short, Spain is in very serious trouble and its government has admitted as much – requesting EU help with bank capitalisation. This is no minor development given that Spain is the eurozone’s fourth-largest economy and emergency help for Spain will inevitably turn the market’s gaze towards the third-largest – Italy.

UK economy still looks frail

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 and weakness in UK growth figures has become alarmingly consistent. 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.

Euro to weaken further

So, despite the UK economy sitting uncomfortably in a double-dip recession and facing a prolonged period of stagnant growth and ultra-low interest rates, sterling looks free to continue taking advantage of an increasingly euro-negative environment. Some major steps towards EU fiscal union will be required to ease market sentiment, and the obstacles to this are all too clear.

Sterling/euro hit heights of €1.2575 in mid-May but has come off those highs to the current level of €1.24. 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. €1.26 is a realistic target in the coming few weeks.

GBP/USD

Whilst sterling has enjoyed something of an easy ride against the troubled euro, against the US dollar it has been an altogether different story. Again, market uncertainty best explains the US dollar’s stellar performance in May. It’s fair to say that the market is in a state of panic at the moment, concerned with a ‘Grexit’ and most recently a ‘Spexit.’ Amid such monster question marks, there has been widespread flight to the safest assets such as the US dollar. Sterling may be markedly a safer alternative to the single currency, but its safe-haven status cannot compare with that of the greenback.

The rug has finally been pulled from underneath the EUR/USD pair. The scale of the eurozone’s current problems is now being reflected in the price of the euro; EUR/USD has declined by over 5.0% from $1.3150 to $1.25 in the space of just one month. We do see the EUR/USD pair considerably lower in the coming months, which will inevitably weigh on the GBP/USD pair.

The US dollar is not without its own domestic economic concerns, with recent data confirming that the US economy grew at an annualised pace of 1.9% in Q1, down from the initial estimate of 2.2% and well down from Q4 2011’s 3.0% pace of growth. Progress in the US labour market has also slowed right down, which has once again seen speculation that the US Federal Reserve will introduce QE3 step up a gear. Whilst the US economy is stalling as we enter the summer, it is still firmly in recovery mode. We continue to hold the view that the Fed will want to gather more evidence about the US recovery’s direction before pulling the trigger on more quantitative easing, so we view the current QE3 concerns as over-hyped.

Safe-haven dollar to outperform

Sterling has recently revisited January’s lows below $1.53, having suffered a 6.5% drop against the US dollar in the space of just four and a half weeks. Sterling has finally bounced against the US dollar and is currently trading at $1.55, but we think this will prove temporary. A consolidation period was always likely after such a steep drop, but we should see lower levels tested once this current bout of profit-taking on the dollar’s recent rally has run its course. Lower levels in the $1.51-1.52 area could well be seen in June as the negative eurozone headlines once again take their toll.

Caxton FX one month forecast:

GBP / EUR : 1.26

GBP / USD : 1.5150

EUR / USD : 1.2050

Richard Driver

Analyst – Caxton FX
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Greek coalition talks collapse and prospect of new elections hurts euro

Sterling remains flavor of the month
Sterling has climbed by a further three cents against the euro in the past fortnight. Sterling’s progress against commodity currencies such as the AUD, NZD, CAD and ZAR has been ever more impressive in the past few months. Sterling has climbed by over 10% against the ZAR and NZD since mid-Feb, while it has advanced against the ZAR by the same margin since mid-March.

Sterling’s safe-haven status is behind its demand and this is not something we see disappearing any time soon. Also helping the pound was last week’s MPC vote against further quantitative easing. Whilst there will be some nerves surrounding the voting pattern (to be revealed by the MPC minutes next week), stubbornly high inflation seems to be of greater concern to the policymakers (thus making more QE harder to justify). Tomorrow’s Quarterly Inflation Report from the Bank of England will be highly relevant in this regard. A firmer inflation outlook is likely to be provided, which again should be broadly supportive of the pound.

Euro suffers from lack of Greek coalition agreement

Global investor confidence and risk appetite has taken a turn for the worse in the past fortnight, driven by concerns over Greece. Since the failure of the ruling Greek coalition to maintain sufficient votes at its recent election, major doubts have arisen as to whether Greece will remain within the euro. Coalition talks have collapsed and another election will be held in mid-June, which means the current uncertainty will be extended. As a result, Spanish and Italian bond yields are on the rise, with the former’s 10-year debt yields looking particularly alarming at fresh 2012 highs over 6.25%.

Should an anti-austerity coalition government surface from the current mess, then Greek bailout funds would be withheld, leading to default and a probable Greek breakaway. The knock-on effects in the eurozone and the global financial system as a whole are expected to be more drastic than those of Lehman’s collapse. It is no surprise then, that the euro has suffered a significant decline, with perceived safer-currencies such as sterling and the US dollar filling the void.

GDP data out of the eurozone was very mixed indeed this morning. Italy broadly stuck to the script by contracting by 0.8% in Q1 of this year, while French growth remained stagnant. However, the German economy grew by 0.5% in Q1, which helped the eurozone economy as a whole avoid a technical recession by posting a 0.0% GDP figure. This development has given the euro a mild boost today but with so much austerity still to be delivered in the eurozone and today’s forward-looking economic sentiment surveys showing a fairly sharp decline, eurozone growth is highly likely to return to negative territory this year.

Sterling is trading at €1.25 today, which represents near enough a three and a half year high. We are not calling a top to this pair’s ascent just yet either, with nerves surrounding Greece likely to deteriorate over the coming weeks. In risk averse conditions, the pound has understandably traded a little softer against the US dollar, coming off its highs of $1.63 to trade two and a half cents lower today. This pair could well test the $1.60 level fairly soon, though we are not anticipating any major collapse.

End of week forecast

GBP / EUR 1.26

GBP / USD 1.5950

EUR / USD 1.27

GBP / AUD 1.61

Monthly Report: GBP/EUR and GBP/USD

Sterling has performed excellently in the past month, hitting fresh multi-month highs almost across the board. Some notably less dovish Monetary Policy Committee (MPC) minutes provided the trigger for a sterling rally in April, with the market subsequently betting against the likelihood of further Bank of England (BoE) quantitative easing (QE) - a key factor which has weighed on the pound over the past seven months.

The Office of National Statistics (ONS) last week announced the disappointing news that the UK economy contracted by 0.2% in the first three months of 2012. Taken with Q4 2011’s 0.1% contraction, this latest GDP figure signalled the UK having entered a technical recession. Nonetheless, sterling continues to enjoy strong demand as circumstances worsen on the continent.

The US dollar is still struggling to capitalise on its economy’s comparative strength. US growth data has fallen off its impressive uptrend somewhat, as shown by April’s softer unemployment figures and the recent undershoot in the first quarter US GDP figure.

This has played into the hands of the more cautious members of the US Federal Reserve, including Chairman Ben Bernanke, who refuse to rule out the possibility of another round of US quantitative easing. The market is becoming increasingly obsessed with the Fed’s monetary policy outlook and ongoing QE3 speculation continues to hurt the dollar’s performance.

The eurozone’s debt and growth situation is looking no better and worryingly, perhaps as a result of this lack of progress, the eurozone has become embroiled in fresh political uncertainty. French President Nicholas Sarkozy, could well suffer electoral defeat on the 6 May, whilst Greece will be holding parliamentary elections on the same date. Both elections could have significant ramifications on the direction of eurozone debt crisis in the short and long-term.

GBP/EUR

April saw sterling finally break away from the €1.21 level that had proven so sticky in the year to date. News out of the eurozone has been distinctly negative of late but unusually, the latest direction in this pair wasn’t predominantly euro-driven, but the result of much-improved sentiment towards the pound.

Economically, the situation in the UK remains extremely shaky. While April’s growth figures from the manufacturing, construction and services sectors were all encouraging and retail sales growth was staggeringly strong, the UK GDP figure for Q1 revealed a disappointing 0.2% contraction.

The market appears to be more than a little sceptical with regard to the ONS’s findings and will be looking for an upward revision to the GDP figure on 24 May. Regardless, the headlines surrounding a ‘double-dip recession’ are likely to weigh on consumer and business confidence alike.

UK suffers the double-dip

Whether or not the UK is indeed in a technical recession, UK growth will remain extremely weak in 2012. Disappointingly, Moody’s has recently placed doubt over the likelihood of any economic boost to the UK as a result of the London Olympics in the summer. The eurozone crisis continues to pose the greatest risk to the UK economy. As shown by the latest UK manufacturing figures, export orders are slowing and the eurozone’s economic contraction will undoubtedly drag on domestic activity.

The good news for sterling, however, is that its appeal is not based on economic growth potential. Sterling still represents a convenient alternative to investors looking to exit the euro but stay within Europe. Sterling is also a currency over which there is no threat of intervention looming (unlike the Japanese yen and the Swiss franc).

Despite the recent double-dip headlines, the UK government has reiterated its commitment to the austerity path, in order to maintain the faith of both the credit rating agencies and investors, thus keeping borrowing costs low. As a result, sterling’s ‘second tier’ safe-haven status has really come to the fore in the past few weeks and will provide plenty of support as the debt crisis rolls on.

MPC steps away from QE

Most importantly, sterling is now a currency over which there is perceived to be a reduced threat of quantitative easing, which contrasts particularly with the US dollar. The minutes from the MPC’s April meeting revealed that Adam Posen did not vote for additional QE, which took the market very much by surprise and left only David Miles as the solitary voter for additional monetary easing.

After a slight increase in UK inflation up to 3.5% in March, the MPC increased its medium-term inflation projections. The MPC’s apparent preoccupation with UK price pressures, over and above the state of UK growth, has seen bets on the likelihood of further QE from the BoE scaled back. With the MPC likely to remain in wait and see mode’ at its May meeting on 10 May, the pound has gone from strength to strength. Beyond this month though, there remain significant risks that the more pro-QE arguments will resurface to haunt the pound.

Downside risks to the euro

With regard to the single currency, events in the eurozone over recent weeks have certainly weighed on confidence, though not as much as one might expect. Growth data from Germany, France and the eurozone as a whole disappointed in April and another quarterly contraction is likely to be announced on 15 May. This will put the eurozone in the same boat as the UK - in technical recession. However, there’s no doubt the eurozone faces greater downside risks to growth than the UK moving forward and its recession is almost certain to continue through Q2.

Last month’s Spring IMF meeting failed to convince the markets that EU leaders have a proper handle on the EU’s ongoing crisis. The region’s ‘financial firewall’ has been bolstered by a further $430bn, which is a significant development. However, rating agency S&P has recently seen fit to downgrade eleven Spanish banks, which has seen Spanish and Italian 10-year bond yields make their way back up towards the dangerous 6.00% mark -a good bellwether of rising market tensions.

These rising tensions can largely be put down to fresh political concerns. 6 May brings the second and final round of the French presidential election. Nicholas Sarkozy is facing a likely defeat by Socialist candidate Francois Hollande, which places huge uncertainty over the EU’s Franco-German leadership, the EU’s fiscal compact and its ‘austerity first’ position.

Meanwhile in Greece, parliamentary elections threaten to prevent the country’s two leading pro-bailout parties from securing a majority, which again casts uncertainty over Greece’s bailout situation. In addition, the Dutch government’s collapse as a result of disagreements over austerity measures is telling of a growing political discontent across the region. There is a significant risk that the austerity backlash could spread to the UK local elections this week but the government is nonetheless unlikely to be derailed on its commitment to deficit-reduction.

GBP/EUR has climbed by over 2.50% in the past month, hitting fresh multi-month highs up to this week’s peak above €1.23 (the highest since July 2010). We are looking for further gains in the rate as conditions in the eurozone continue to deteriorate, with the €1.25 (80p) level representing the first key target.

GBP/USD

The US dollar remained soft in April, hemmed in by weaker US economic data and ongoing dovish rhetoric from US Federal Reserve Chairman Ben Bernanke. The monthly US jobs figure for March revealed that half as many jobs were added to the payrolls compared to February and US GDP data for the first quarter of 2012 came in at a disappointing 2.2% (annualised), against expectations of a 2.6% reading. Clearly the US economy is recovering at a far stronger pace than what we are seeing in the UK but it is the implications that this slower pace of growth (the US economy grew at a pace of 3.0% in Q4 2011) has with regard to the US Federal Reserve monetary policy.

The Fed was slightly brighter in its analysis of the US economy last month but is highly likely to remain in ‘wait and see mode’ for the foreseeable future. Bernanke has repeatedly put the brakes on any over-optimistic projections of US growth and has reminded the market that if the pace of US growth softens further from its current moderate pace and progress on the labour market issue stagnates, then QE3 is still very much on the table. Every time Bernanke emphasises the possibilities of QE3, the dollar sells off as risk appetite is boosted and investors chase higher yielding assets, such as the Australian dollar or stocks and shares.

The US dollar has found some favour in the past couple of sessions, helped by a stronger US manufacturing figure. However, a slide in the EUR/USD pair as a result of poor growth figures from the eurozone (Italy in particular) has proven more influential.

It has been difficult calling a top to the GBP/USD’s recent rally in the year to date. It must be said that with the recent poor UK growth figures in mind, doubts are likely to creep in with regard to the likelihood that the MPC will resist further QE this year. This may make this pair’s 8-month high of $1.63 a tough level to breach. We continue to anticipate that EUR/USD will fall through the $1.30 threshold this quarter and whilst sterling should hold up better against the dollar by comparison, a significant decline remains likely. Therefore, we are anticipating GBP/USD to ease back towards the $1.60 level, from the current rate below $1.62.

Richard Driver
Currency Analyst
Caxton FX

Caxton FX Weekly Round-up: Sterling Rallies

IMF boost emergency fund by $430bn but EUR remains pressurized

The weekend’s IMF and G20 meetings produced some real progress in the form of a combined $430bn of additional loans, to be used in the event of a deterioration of the eurozone debt crisis. Good news then, but Spanish 10-year bond yields are trading around the dangerous 6.00% level, and Italy’s equivalent debt is yielding 5.75% today, so it clear that the market remains characteristically skeptical.

The French presidential elections have increased the pressure being felt by the euro in recent sessions. Socialist candidate Francois Hollande received the most votes in the weekend’s initial round of voting and the euro, as well as European equities, has declined as a result. The final election will be held on May 6th and this political uncertainty is likely to weigh on the single currency in the meantime. The markets would probably prefer Sarkozy to remain in power, thus reducing the risk of a breakdown in cooperation between France and Germany on dealing with the debt crisis. Fresh concerns have also sprung up with respect to the Netherlands, which is likely to hold elections in light of the government’s collapse after failing to agree measures to slash its budget deficit.

As well as the weekend’s political concerns, the markets have had to digest some further disappointing eurozone economic data. A German manufacturing growth figure hit almost a three year low and figures out of the eurozone as a whole were equally alarming.

MPC's Posen gives sterling a boost

Sterling enjoyed a staggeringly strong week last week and has started the current one where it left off. MPC policymaker Adam Posen provided the main catalyst for the rally, with the minutes from the MPC’s April meeting revealing that he did not vote for further quantitative easing. The market may have got ahead of itself in pricing out the likelihood of further BoE quantitative easing. Posen may well have voted for no change due to the recent uptick in inflation and may have just preferred to see the current round of QE run its course (which it will have done by time of the MPC’s next meeting in early May). More monetary easing from the BoE is still a distinct possibility if UK inflation eases in the second half of the year and economic growth remains stagnant.

UK Q1 GDP figure to show some growth, albeit scant

Wednesday brings the release of the first quarter UK GDP figure. After last week’s excellent UK retail sales figure, we are fairly confident that we will not see another quarterly contraction. Estimates are falling around the 0.1% growth level, which is indicative of the uncertain footing from which the UK economy is building. Nonetheless, news that the UK has avoided a technical recession will be welcome (though the risks of disappointment are not insignificant).

Sterling is trading at almost a six-month high of $1.6150 at present and we continue to view these to be excellent levels at which to sell the pound. The Fed is likely to be more hawkish in its communiqué this week, whilst the US GDP figure is also likely to be impressive, which could well help the US dollar bounce back. Sterling is trading at almost a two-year high against the euro above €1.2250 and further gains are looking likely, though we may see upward progress stall as nerves kick in ahead of Wednesday’s GDP figure.

End of week forecast
GBP / EUR 1.23

GBP / USD 1.6050
EUR / USD 1.3050
GBP / AUD 1.5750

Richard Driver

Currency Analyst

Caxton FX

Less Dovish MPC Minutes Give Sterling a Major Boost

The recent release of the MPC minutes has given the pound an excellent boost. Adam Posen, the policymaker who has so often stood alone as the Bank of England’s arch dove, has seemingly abandoned his quest for further quantitative easing. Two votes became one in the MPC’s April meeting then, with only David Miles seeing fit to vote for a further £25bn in asset-purchases, though he stressed the decision was “finely balanced.”

The last quarterly inflation report assumed a fairly steady downtrend in UK inflation but the MPC is now noting higher medium-term inflation risks, which reduces the attractiveness of further QE. Higher inflation requires tighter monetary policy. For David Miles, the threat of a third consecutive decline in UK growth and another technical recession looms too large and he voted for extra £25bn of QE accordingly. Clearly, next week’s Q1 UK GDP figure will be crucial and the risks of another negative reading are not insignificant. However, April’s PMI surveys from the UK’s manufacturing, construction and services sectors were very encouraging and the recent UK labour statistics also provide room for optimism. The recent UK retail sales figure, which revealed stunning 1.8% growth in March, should ensure a positive GDP number on April 25th.

The BoE does appear to be moving away further monetary easing at present but the UK economy remains distinctly fragile. Many market players will be assuming further QE is now off the table but if inflation eases towards the end of the year and growth remains weak, dovish arguments will once again come to the fore. What’s more, the eurozone debt crisis could force the BoE’s hand if the situation in Spain and Italy deteriorates rapidly.

There is also the issue of Adam Posen’s thinking – whether he has really given up on more asset-purchases. Posen has indicated that he merely saw fit to let the current round of QE run its course. Posen will be able to reassess the need for a top-up in May, by which time the BoE’s inflation projections will have been formally updated and we will know whether the British economy has suffered the dreaded ‘double-dip.’ Only time will tell on this issue, but it’s fair to say the market may have jumped the gun in respect to Posen’s ‘change of stance.’ Our bet is that we will see Posen vote for more QE before the end of 2012.

Regardless, the majority of the MPC appear far too concerned with upside risks to inflation, and perhaps with preserving the BoE’s credibility on the issue of maintaining price stability, to step up QE at its next meeting in May or any time soon.

Whilst sterling’s safe-haven status has enabled it to weather the constant threat of QE hanging over it, it has undoubtedly weighed on demand in recent months. Sterling has now been freed up to rally in the aftermath of the minutes, climbing to a 20-month high against the euro and a six month high against the US dollar. Even higher levels will be seen against an increasingly weak single currency, though we maintain a negative outlook for the pound against the US dollar.

Richard Driver

Currency Anlayst

Caxton FX

Rising Spanish bond yields highlight market nerves

UK services sector growth suggests no UK double-dip recession

In addition to last week’s strong March growth figures from the UK manufacturing and construction sectors, the services sector joined the party by coming in well above forecasts as well. This probably means that the UK has avoided a entering a technical recession (two consecutive quarters of negative growth), albeit by what is likely to be just the narrowest of margins. Indeed contrary to the OECD’s forecasts, this is what the NIESR have argued in the past week (0.1% growth in Q1).

A second gauge of the UK manufacturing sector was more disappointing last week and has taken the edge off some of the positive sentiment surrounding the UK economy. It certainly is true that this sector has underperformed badly in the past six months and needs to pick up if the UK’s fledging recovery is to pick up any pace. The services sector cannot be the sole source of growth. In terms of important growth figures coming up this month, the 24th April preliminary Q1 GDP figure is the real focus, though next week brings the release of the MPC meeting minutes, as well as the monthly updates from the UK labor market and the retail sector.

US Non-farm payrolls disappoint but no need to panic

Last Friday’s key monthly update from the US labour market revealed that half as many jobs (120k) were added in March, compared to February’s showing. This gives credence to Ben Bernanke’s refusal celebrate the US recovery from the financial crisis. The coming week is noticeably quieter on the data front, with Friday afternoon’s US consumer sentiment figure (forecast to improve) likely to be a highlight.

The dollar struggled a little on the back of Friday’s US jobs figure but it has since recovered. This data will encourage greater caution in the market but it alone won’t trigger large scale revisions of US dollar bets. Global stocks and commodity prices are in decline at present, which is keeping the safe-haven dollar in pretty robust demand, though it is having to wait for significant gains against the pound.

Spanish bond yields on the rise

Nerves surrounding the Spanish and overall eurozone debt situation are clearly on the rise, as shown by the general risk-off tone to present trading conditions. Spain’s Economy Minister today refused to rule out the need for a Spanish financial rescue. PM Rajoy has announced a further €10bn of budget cuts but as Spanish 10-year bond yields climb towards 6.0%, it is evident that market nerves are on the up.

If concerns continue to heat up, the ECB may be persuaded to cut interest rates again to restore sentiment, which is unlikely to be euro-positive. At the very least, an exit from the ECB’s current liquidity measures (monetary easing) is unlikely to come soon; Draghi indicated as much last week. The euro looks poised for a move lower.

Sterling was the third best performing currency against the US dollar in the first quarter of 2012 and it continues to hold up pretty well. GBP/USD’s current levels of $1.5850 remain a good level at which to buy US dollars. Against the euro, sterling is also performing very well. GBP/EUR is trading not too far away from a 19-month high, though it could suffer a short-term downward correction if it fails to push higher from here.

End of week forecast

GBP / EUR 1.2050
GBP / USD 1.5750
EUR / USD 1.3025
GBP / AUD 1.5550

Richard Driver
Currency Analyst

Caxton FX