FX Weekly Report (17-07-2011): Good week for safe haven assets

By Gaurav Kashyap, Alpari ME DMCC

Moody's puts Irish debt at 'junk', Euro closes lower on Italy, Spain fears

The Euro closed the week -0.46% lower against the US Dollar amidst fears that Italy & Spain were being dragged further into the region's financial crisis and ratings agency Moody's downgraded Irish debt to junk status. Yields on 10 year Italian bonds soared to their highest levels since the start of the Euro at 6% while Spanish 10 year bonds increased to 5.75%, levels alarmingly similar to Ireland last November when they requested a bailout.

With the threat of Europe's third largest debtor (Italy's total debts amount to approximately €1.8 trillion) inching closer to a default scenario, Finance Minister Giulio Tremonti was forced to initiate austerity measures through a combination of tax increases and spending cuts to ease bond investors. To further pile on the misery, rating agency Moody's downgraded Irish debt to junk status (from Baa2 to Ba1). The latest developments saw EURUSD hitting a four month low of 1.3837 before recovering to above 1.41 levels as the Dollar sold off rather aggressively following Moody's placing US debt's AAA under review and increased market perceptions that the Fed would look to additional QE measures.

US debate still centering on debt ceiling issue

In his semi-annual monetary policy report to Congress, Fed Chairman Ben Bernanke's cemented the market's views that economic & jobs growth in the US was uncertain, leading many market participants to perceive that this would lead to additional QE measures and as expected, the Dollar sold off and US equity markets got a nice boost. The Dollar slide was contained however as the Fed Chairman hinted that further stimulus measures were unlikely in comments from Thursday and inflation data from last week perhaps reaffirmed those views - YoY CPI data ex food and energy increased to 1.6% (v 1.5% prev).

With speculation surrounding QE3 remaining exactly at that - unconfirmed rumours - the US will poise itself this week for more debate regarding the upcoming debt ceiling issue. With more political posturing taking place amongst Democrats and Republicans, last week showed us that we are no closer to a solution regarding an event which would have shocking ramifications to the global economy.

The Republicans are content towards raising the debt ceiling by $2.4 trillion, through a combination of government spending cuts while the Democrats, who form the minority but are led by President Obama are looking for a more aggressive hike to the tune of $4 trillion, using a combination of spending cuts and tax hikes. The Dollar should remain well bought until a solution regarding the issue is announced, expected towards the end of the week (this time frame would give enough time for Congress to pass the law).

Eurozone summit key driver in EURUSD pricing

And finally, the latest European bank stress tests were announced this past Friday. The results showed that nine out of the ninety banks tested failed, with a total shortfall of €2.5 billion in capital. While the results were slightly better than expected (analysts were poised for up to 20 banks failing the tests) the markets reactions to the result were a bit mute, not surprising considering the larger issues on show here, namely Itay and Spain moving closer to a default. The Eurozone summit on Thursday will be a key driver in EURUSD pricing this week; Greece's second bailout will be on the agenda.