Caxton FX January Outlook: GBP/EUR/USD

December was an awful month for the single currency; the crucial EU Summit failed to satisfy market expectations and the euro was punished accordingly. Preceding the Summit, hopes for a holistic, assertive and credible plan to deal with the region’s debt profile were elevated higher than ever. Unfortunately the fiscal compact on budgetary discipline and various other commitments that were made did little to convince the market that EU leaders are on the right track. The region’s debt dynamics are finally taking their toll on the euro in a very material way.

Sentiment towards the UK economy has been at a particularly low ebb in recent weeks; growth figures have been disappointing and sights have been set very low for 2012 growth. Nonetheless, with the UK government remaining committed to its deficit reduction plan, there continues to be strong (and sterling-supportive) demand for UK gilts and there remains minimal scope for Bank of England intervention.

The focal points for this month are inevitably eurozone-related. Investors will be looking to the EU Summit on 30th of January with hopes for major decisions to deal with the debt situation. Growth will also be discussed and this has up until now remained a largely unaddressed problem. The eurozone looks likely to head back into a technical recession this year, and it goes without saying that the region cannot solve this crisis without economic growth.

Sterling/Euro

Slow progress and poor leadership are hurting the euro almost across the board at present. Sterling has climbed to a sixteen-month high of €1.2150 against the euro, which says far more about waning confidence levels towards the single currency than it does about the UK’s economic growth prospects.
Out of last month’s EU Summit came an agreement to top up the eurozone’s bailout resources by €200bn in IMF loans. Typically, and almost symbolic of EU leaders’ inability to take action, this figure was later revised down to €150bn. Agreements to bring forward the introduction of the European Stability Mechanism (the permanent bailout fund) by a year to the middle of 2012 and to enforce stricter budget discipline are valuable long-term developments, but they do little to deal with the region’s very pressing short-term issues. The market is short-termist by nature; investors are far less concerned with avoiding future crises, they are preoccupied with the threat that the current crisis poses to the very existence of the euro.

Rating agency action (or the threat of it) is worrying the market at present. The bodies responded to the latest EU Summit inaction by downgrading the ratings of eurozone states such as Belgium and put several key nations such as Spain and Italy on ‘negative watch.’ Fitch’s even came to the damning conclusion that a comprehensive solution to the debt problem is “technically and politically beyond reach.” Standard & Poor’s are yet to wield their axe but are likely to do so in coming weeks, and this represents a major threat to the euro and risk appetite more generally.

Bond auctions in the eurozone are also in sharp contrast. Debt sales have been attracting diminishing demand and, alarmingly, this even applies to the core countries of France and Germany. Bond spreads are widening throughout the eurozone (Germany excepted) and further bond auctions this month will keep the pressure on the euro.

Greece remains the first head on the chopping block and its government has already stated this week that they will be forced to exit the euro in the event that they do not receive a second bailout by March. We can expect nerves to build steadily ahead of this deadline.

The prospects for the UK economy, despite a couple of encouraging growth figures from the UK services and construction sectors this week, are distinctly gloomy. Flat to minimal (around 0.5%) growth seems likely this year, and the risks of a recession are very significant. However in truth, developments in the eurozone will have a greater say over the UK’s recovery prospects than domestic policy.

Risks for this pair are quite clearly to the upside from our standpoint; the uptrend may be stalled by bouts of profit-taking on sterling’s rallies, but we see this pair climbing a further cent towards €1.22.

Sterling/US dollar

Sterling has been trading within a three cent range of $1.54 - $1.57 since late November and although this pair has threatened a move to the downside several times, sterling has managed to maintain sufficient support.
The US recovery is finding some real transaction at present, we haven’t seen such consistently positive economic data flow in almost a year. US manufacturing, consumer confidence and employment gauges are all on the up. The labour market, which remains both the US government and the US Federal Reserve’s number one concern, in particular appears to be making some progress, with January’s key monthly employment change figure hitting an eight month high.

In comparison to slowdowns in economies such as the UK, the eurozone, China and many others, the upturn in the US is attracting plenty of investment besides safe-haven flows. Often strong US data will weaken the dollar but at present, the opposite is true. In addition, the upturn in the US is diminishing the case for further quantitative easing from the Fed, which again is a positive for the US dollar.

Safe-haven flows are still the number one driver of the greenback’s strength however. The eurozone situation continues to peg back risk appetite and we are confident it will do so for many months to come. With fears of central bank intervention hanging over the yen and particularly the swiss franc, demand for the US dollar is high.

With market confidence on a noticeable downtrend, we see this pair breaking its current range to the downside in coming weeks. A move towards $1.53 is our bet.

Caxton FX one month forecast:
GBP / EUR 1.22
GBP / USD 1.53
EUR / USD 1.26

Richard Driver
Senior Analyst – Caxton FX


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Morning Report

Richard Driver, Analyst Last week finished with yet more positive US data, with the unemployment rate dipping to its lowest level since March 2009 and probably more significantly, 200k jobs were added to the payrolls. There was further poor eurozone data to ensure that the euro/US dollar pair headed yet lower. Today’s session will see Merkel and Sarkozy meet to iron out further details on the fiscal compact on budget discipline that was agreed at last month’s EU Summit. A press conference will also follow and will no doubt dominate the headlines.
STERLING/EURO: Having climbed by over a cent last week, this pair continues to edge higher as the eurozone’s weak growth outlook heightens concerns. Despite some better than expected UK services and construction figures last week, sterling is not making the current gains over the euro down to a change in sentiment towards the domestic economy. It is intensifying concerns surrounding the eurozone’s growth and debt that is the key driver here. Further data releases and bond auctions this week provides further scope for euro losses. Sterling is trading at €1.2050 this morning and the outlook remains pretty bright for this pair. It is a sparser week in terms of UK data, which means the focus will be on the eurozone more than ever, which judging by last week isn’t a positive thing for the single currency.	FORECAST
STERLING/US DOLLAR: Sterling found it tough going against the USD last week, but is benefiting from support at these multi-month lows. Current levels close to $1.54 broadly represent the bottom of a trading range that has been in place for several months. UK gilts were the top performing government bonds in 2011 and this has given sterling plenty of support, even against the stronger US dollar. However, not even this factor was able to guard against a two cent weekly decline for this pair. The US recovery is really picking up some pace now. The greenback is the pick of the currencies at present, and with the US economy outperforming the UK, we may see this pair break its trading range to the downside.	FORECAST
EURO/US DOLLAR: Further lows are being posted by the pair, with strong US data triggering a rally in the greenback. The euro’s sharp downtrend against the US dollar remains in place and there are no signs of it bottoming out just yet. US employment data was excellent on Friday and the non-farm payrolls data revealed exactly double as many extra jobs than initially expected. The positive US news did not weaken the USD as was the case throughout 2011, rather it strengthened it considerably. This pair is now trading at $1.2750; performance today depends on comments made by Merkel and Sarkozy today. Investor confidence and German industrial production may put the euro on the defensive early on.	FORECAST
STERLING/AUSTRALIAN DOLLAR: This pair remains fairly range-bound; though a poor Australian retail sales figure may see sterling make some gains today. For the first time in five months, the Australian retail sector failed to grow in December. This is exactly the sort of data that will convince the Reserve Bank of Australia to cut its interest rate once again (in addition to the two 0.25% cuts at the end of 2011). Eurozone nerves remain elevated and are doing a good job of suppressing risk appetite, regardless of Friday’s strong US jobs figures. Sterling is trading at 1.51 this morning and risks are still to the upside this week. Eurozone bond auctions throughout this week should trigger some safe-haven sterling gains.	FORECAST
STERLING/NEW ZEALAND DOLLAR: Sterling is struggling rather more against the New Zealand dollar, despite losses in Asian stocks. Unlike the aussie dollar, the kiwi dollar is outperforming the pound at present, probably because the market is less fearful of a Reserve Bank of New Zealand rate cut than from the RBA. This pair is trading at a ten-week low under 1.97 now, but we are sticking to our position that sterling will bounce against the kiwi dollar before long.	FORECAST
STERLING/CANADIAN DOLLAR:  Remarkably, the Canadian dollar failed to kick on after the excellent US jobs figure, not helped by a poorer domestic figure. Data revealed that the US economic picture is going from strength to strength and Brent crude prices are still elevated towards $114 per barrel, but sterling actually made gains over the Canadian dollar on Friday. The domestic Canadian economic picture is far less impressive, with the unemployment rate rising to 7.5% and fewer jobs being added to the payrolls in December than expected. Sterling is trading at 1.5875 this morning, and we are still looking for further upside for this pair. Eurozone concerns are likely to intensify further this week and the loonie may feel the pressure as a result.	FORECAST
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