Foreign Exchange News
7 August 2014

ECB and Euro Under Pressure as Conditions Deteriorate

EUR/USD 1.3372
GBP/USD 1.6838
GBP/EUR 1.2592 (0.7941)
EUR/CHF 1.2150
GBP/CHF 1.5300
GBP/AUD 1.8179

The global risk environment still remains in a tentative place. There are a large number of scenario’s currently being discussed but each have their own part to play. European stocks fell to three month lows as tension on the Ukraine/Russia border continue to rise. Russia has some 20,000 troops lined up on the Ukrainian border as Europe and the US sanctions continue to impact the Russian economy, with Russia now imposing counter sanctions on European and US imports. Further concerns across Europe were driven by the bailout of Portuguese lender Banco Espirito at the weekend, while data released yesterday indicated that Italy has slipped back into recession.

Stocks in the US were little changed, trading just off two month lows, the selloff in US equities comes despite Q2 earning releases tending to be firmer than guided and a Q2 US GDP print of 4%. This may appear to be counter intuitive to many investors however the improving growth in the US economy would suggest the Fed may look to return to normal monetary policy, this means QE is likely to end in October, with rising interest rates for the US next on the Feds agenda. Stocks may be in for a larger correction given the excessive gains they have made over the last two years on record low interest rates. Needless to say the USD continues to be a benefactor as US treasuries benefit from safe haven demand and also improving yield expectations on bonds, all increasing demand for USD.

The Euro has had plenty of event risk across the wires so far this week. Geopolitical tensions are an obvious concern for the region but the re-emergence of persistent issues should ring some alarm bell in the ECB. Another bank bailout, Italy (Europe’s third largest economy) falling back into recession, contagion concerns, CPI inflation falling back to .4% (versus a 2% target)- this is a lot of negative news weighing on the region and bound to be on the ECB’s mind when they meet later today.

The concern for the EUR is if we see heavy selling of peripheral debt, positions that have built up steadily over the last two years bringing Eurozone yields to record lows, despite a fragile environment. The ECB is not expected to announce any changes to policy, but a heightened sense of concern from ECB members on the region’s growth, or any updated comments on potential asset purchases will likely be negative for the single currency. EURUSD traded to fresh 9 month lows and our initial target of 1.3300 is now well within sights, we are likely to see a EUR bounce from the 1.3300 area as there are plenty of corporate orders to sell USD at those levels.

GBP continues to be under pressure from weakening data. We have been swinging from the rafters all year arguing that GBP strength and interest rate expectations were overdone, especially when up against the USD. The last two weeks have seen a number of key data points miss to the low side, yesterday’s industrial and manufacturing production figures were no different, all missing to the downside of expectations. The NIESR GDP estimate also declined to .6% from .8%. It is important to note that the economy is still growing, these area’s are still expanding, just not as fast as we saw through 2013 and Q1 2014.

This puts the BOE in a somewhat precarious position. There are plenty of indicators suggesting they could raise rates, concerns on the housing market, improving employment and GDP figures etc, at the same time the BOE do not want to hamper recovery or rock the boat by raising rates too soon. The BOE take to the stage today but we expect no change of policy with rates held at .5%, we are very unlikely to get any further info from the BOE today and will have to wait for the minuets in two weeks. GBPUSD continues to be supported above 1.6800, with plenty of USD sellers and GBP buyers all the way down to 1.6750. Should we see dissent amongst MPC members however, GBP might find some scope to rally.

The USD has remained steady this week, following two weeks of firm strength. The risk off environment has favoured the greenback but we have yet to see a real continuation of last week’s moves. The last two weeks have certainly seen a reversal in USD fortunes but we need to see something more tangible from the US should we wish to see a real USD rally begin. A larger move to risk aversion in markets coupled with a continuation of strong data from the US should help lift the USD. The rest of the week remains light on US data and as such risk appetite and central bank action is likely to dominate moves in USD pairs.

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