Fundamental Forecast for Euro: Bearish
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After closing higher against the US Dollar for four consecutive weeks, the Euro’s streak was snapped after it closed the second to last week of June as the third best performer among the majors covered by DailyFX Research. The EURUSD, after briefly topping $1.3400 early in the week, closed the week at 1.3122, down -2.20% from its high on Wednesday. Overall, the EURUSD finished lower by -1.71%, but the late week reversal is the more poignant price action to respect.
Given the recent price action in FX on the whole, it’s not shocking that the Euro remained a top performer. The renewed slide in higher yielding currencies and risk-correlated assets occurred after Wednesday, when the Federal Reserve signaled a slight shift in monetary policy, provoked a massive surge in US Treasury yields. This development has shaken the strength the Euro has found since early-June.
One of the main reasons the Euro has been stronger recently, of course, is due to the European Central Bank choosing to keep its key interest rates on hold at its June 6 meeting, as opposed to implementing a negative deposit rate, which was expected by a small, but significant portion of market participants. Accordingly, as per the most recent CFTC’s COT report (week ended June 18), speculative positioning turned bullish on the Euro, at 20030 contracts, from -84644, the most bullish positioning since the week ended February 19. Evidence is building, however, that this positive sentiment may be short-lived.
In light of the Fed rate decision and announcement that it intends to taper QE3 by mid-2014, anything that solicited attention from the Fed or offered premier return – from US Treasuries to emerging market equities – was hit hard. Our main focus is on Euro-zone peripheral debt of course, which is showing renewed signs of distress. The Italian 2-year note yield hit 1.995% on Friday, its highest level since late-March, and its 20-day rate of change hit +37.2%, the highest since the day after the Italian election when it was +42.7%. Meanwhile, the Spanish-German 2-year yield spread hit its widest levels since April 15. For context, the EURUSD closed that day at 1.3036; the EURJPY closed that day at ¥126.16 (today it closed at 128.15). From this perspective, the Euro still looks a little juiced here, and has some catch up to play with European credit – especially as Japanese bond market volatility remains and US Treasury yields surge higher.
The perfect storm, then, is gathering on the horizon for the Euro-zone crisis to reemerge in all of it glory. There are several irons on the fire right now across the currency union that could provoke the next wave of fear.
In Germany, Chancellor Angela Merkel is going to be increasingly reticent to offer any further fiscal assistance as the September elections approach. In the interim, the German Constitutional Court has to rule on the legality of the ECB’s OMT program, the financial safety net that ECB President Mario Draghi offered as his “whatever it takes” solution to save the Euro, first noted in late-July 2012. With several ECB members and the German government testifying favorably for the legality of the OMT program, it is highly unlikely that the GCC strikes it down, but rather puts a cap on the OMT program – say, €550B, approximately the size of one of the LTROs – which would prove to be Euro negative; sentiment regarding the safety net would be distorted.
In Spain, the country’s debt-to-GDP ratio was revised higher to 88.2%, a record high according to the Bank of Spain. That’s a +19.1% increase from the 1Q’12, when the ratio was 76.2%. Clearly, the government’s measures aren’t working. In France, the economy’s now projected to have zero growth in 2013, as the Unemployment Rate has pulled over 10%; Greek and Spanish Unemployment Rates are north of 25% now, and Youth Unemployment in the Euro-zone has eclipsed 60%.
Speaking of Greece, remember Alexis Tsipras, leader of Syriza and the man who nearly took Greek off the Euro? He’s back and vocal once more, and Greece is edging towards new elections now that the New Democracy-led government is splitting. The New Democracy-PASOK coalition retains only a slim majority to keep pro-austerity leadership in power, now that the junior coalition group the Democratic Left party has dissented.
There are definitely mounting reasons to be cautious on the Euro, and as long as the region struggles to recover, we suspect that the negative rate implementation discussion could jump off the shelf at the ECB, which would present renewed negative pressure on the Euro. This is entirely data dependent, and this week, the mediocre docket shouldn’t do much to bolster the case that the region is starting to improve.
The top event of the week is on Wednesday, when the June German labor market report is released. The economy is expected to have lost -8K jobs, and the Unemployment Rate will have stayed at 6.9%. While this isn’t Euro negative, it isn’t positive either. The other headline event, the preliminary June German Consumer Price Index report, should show higher price pressures over the past year, but disinflation – slower inflation – on the monthly side. The near-term reading is the draw, because it could be a sign of slowing economic activity in the 2Q’13.
With economic data on the whole rather mixed – neither majorly impressive nor disappointing – the Euro is at risk to get sucked into the undertow of the retreating tides of global risk appetite. With storms clouds gathering and the safe havens perking up, attention may turn from emerging markets and the commodity currency bloc to the Euro-zone once more, and we suspect these bearish fundamentals could begin to have their collective impact beginning this week.
— Written by Christopher Vecchio, Currency Analyst
To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com
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