Forex markets: Euro vulnerable and dollar not sufficiently trustworthy

Lug 20, 2012

Minute Read

Euro vulnerable and dollar not sufficiently trustworthy, but the real news of the week is sterling’s decoupling from the euro.. …..

For professional investors and advisers only

Three particularly important aspects emerged in the week which ends today:

1. Uncertainty at the global level – first of all over growth – is not allowing the dollar to fully benefit from its traditional status as a safe haven;
2. this could be the time at which the euro is most vulnerable;
3. sterling – and this is the real news – has started to decouple for the euro.

USD (nominal effective exchange rate) – This week the dollar retraced, after a full month on the rise. What has changed is the US growth scenario, which has weakened. If before the dollar could benefit from flight to quality, triggered by uncertainties over global growth and by the euro area crisis, the current mounting of doubts also over the trend of the US economy is dampening the greenback’s appeal.
Next Friday, 2Q 2012 US GDP growth data will be released. Expectations are for a modest slowdown. A more disappointing reading could penalise the dollar (against higher yielding currencies, not against the majors).

EUR – The euro, on the other hand, has put an end to the decline incurred in the first half of the month, which led it from EUR/USD 1.26 to 1.21. However, it stayed within a range of between EUR/USD 1.21 and 1.23, showing signs of a lack of resilience. This is a very vulnerable phase for the exchange rate, during which lows for the year could be hit. In fact, while 1.20 is our shortterm downside target, there is some risk of a temporary foray beneath that threshold (potential downside extends to the middle of the 1.20-1.15 range).
The approval of the EU programme for the bailout of Spanish banks is not considered as sufficient proof that the worst of the euro area crisis has been overcome. In the context of a summer market, and lacking important developments in terms of the crisis, there is little else that can help the single currency. Many important data releases are due next week (including the July PMI surveys and the IFO): disappointing data could place the 1.20 threshold under pressure.

GBP – The week’s real news is the decoupling of the pound from the euro. The pound appreciated despite most of the economic data released proving poor, and in spite of the fact that the Bank of England, as reported in the minutes of its latest meeting, considers the growth outlook to have deteriorated significantly in the past month, mostly due to the developments of the euro area crisis. However, the opening – last Friday – of the Funding for Lending Scheme by HM Treasury and the BoE, represents in our view an important factor of greater relative strength for sterling against the euro.

In recent months, on the other hand, lacking specific stimulus programmes for the UK economy, the factors penalising the euro area, and therefore the EUR/USD exchange rate, were also detrimental for the UK economy, and thus for the GBP/USD exchange rate. Now, the launching in the United Kingdom of a package designed to counter the euro area crisis, is having the effect, on the forex market, of minimizing the positive correlation between the GBP/USD and the EUR/USD, or even of inverting it (negative correlation), leaving open the downside front on the EUR/GBP cross rate. In actual fact, the EUR/GBP cross rate broke through the crucial support at 0.8000 already two weeks ago, but it has only been a few days since it breached the EUR/GBP 0.78 area. The technical target of the movement under way should be EUR/GBP 0.76, a low abandoned in 2008.

Next Wednesday, the first estimate of 2Q 2012 GDP growth in the UK will be published.
Consensus expectations point to another contraction (the third in a row). Our estimates are less pessimistic. A disappointing reading should in any case only penalise in part, and/or temporarily, the pound, also because it is already reasonably well priced in: in its minutes, the BoE openly acknowledged that it expects broadly flat growth this year. As regards the EUR/GBP cross rate, maximum downside could in any case express itself in the wake of a sharp potential drop in the EUR/USD to 1.20 or below, in the presence of a further deterioration in the sentiment of international investors with regards to the euro area.

JPY – The yen appreciated, distancing itself from USD/JPY 80 and entering the USD/JPY 78 area.

One of the factors that would most aid a permanent return of the exchange rate in the area above USD/JPY 80.00 would be the easing of concerns over the euro area crisis.

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