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FX Weekly Report (27/07/2012): Euro gains despite Eurozone growth prospect fears

Markets surged this past week in trading and the Euro snapped a three-week losing streak against the US Dollar, Japanese Yen and British Pound. Following consecutive weeks of posting new two-year lows against the majors; the common currency flourished in the risk-on environment this past week, thanks in large part to comments by ECB President Mario Draghi.

By Gaurav Kashyap, Head of DGCX desk at Alpari ME DMCC

It was a tale of two halves for the Euro this week. The start of the week saw the currency slide further into the red as the reverberations of Valencia’s bailout request cast further doubt over Spain’s solvency. Spanish 10 year yields widened to record highs above seven percent and the Euro dropped to a new two year low against the US Dollar at 1.2040 as risk off sentiments remained firmly entrenched to kick start the trading week.

A host of growth related indicators from Germany and the Eurozone on Tuesday did little to ease concerns; German PMI data for manufacturing during July fell to its lowest level in three years, printing at 43.3 (Exp 45.1, Prev 45) while PMI data for the entire Euro-zone area was similarly weaker than expected at 44.1 (Exp 45.2, Prev 45.1). In such indices, a reading below 50 signifies a contraction and although it might be too premature to confirm that the Eurozone is officially entering into a recession, the recent slump in demand for German and Euro area goods re-sparked concerns over growth prospects for a region.

With growth data weakening across the board and Spain teetering on the brink of insolvency, one could have safely assumed that the Euro was well and truly on the way to test that June 2010 low of 1.1876. But so fickle and sentiment-driven is the market these days that a few comments from ECB President Mario Draghi was enough to reverse the market sentiment, bring back the risk on sentiments and with it, the Euro.

Positive ECB comments boost market sentiment

Markets roared back into life on Wednesday as risk appetite got a major boost following Draghi’s comments at an investor conference in London. In his comments, the ECB President Draghi pledged that the ECB is committed to saving the Euro, and that they were ready to do whatever is necessary to protect the EU from a collapse. Draghi, in his boldest comments yet, said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough.”

Draghi also addressed the issue of spiraling European government bond yields across the Eurozone periphery and said that controlling those widening yields also fall within the ECB’s mandate. The comments were very well received by the markets and the risk-on sentiment flourished throughout the rest of the week with higher yielding assets making strong gains to close out the week in the green.

European equity markets reversed their losses from earlier in the week, bond yields eased off their record highs to more manageable levels, Gold spiked more than forty dollars crushing through 1600 levels and closing the week at 1623, and the Euro roared back against the US Dollar, popping up 270 pips from 1.2050 to closing the week at 1.2320 levels. The reaction by the markets are curious and should be approached with caution as this shows just how fickle investor sentiment is these days.

Such a positive move simply on comments, with no concrete developments. It’s almost as though the markets have forgotten about the real troubles of Spain and Italy, which amount to close to two trillion Euros, or the slowing growth rate and sluggish demand which plagues the Eurozone. Draghi’s commitment may be reassuring to the markets, but they by no means provide answers to these issues. With the ECB convening next Thursday to announce their rates (which are expected to remain unchanged at 0.75%), Draghi could have set the precursor for a number of different plans he could announce during the ECB rate decision press conference, some of which include a possible extension to the LTRO program announced in December or an outright purchase of securities to ease jittery bond markets.

US, UK releases see GDP slow

Also of note on the economic calendar this week was the second quarter GDP releases for the US and the UK. US GDP slowed to 1.5% (Exp 1.4%, Prev 2.0%), on the back of weaker consumer spending and overall cuts in government spending. With the figure coming in slightly better than expected, it was a 25% drop from quarter one growth yet it remains to be seen if the figure will force the Fed’s hand when the convene next week.

Across the pond, the prospects for UK growth were much worse. Second quarter year-on-year GDP in the UK printed at -0.8% (Exp -0.3%, Prev -0.2%) confirming a recession in the UK. Following the announcement, the British Pound tanked to 1.5450 levels before recovering to close the week at 1.5745 on improved risk sentiments.

Looking at the week ahead, event risk will be high with the FOMC announcing rates on Wednesday (unchanged at 0.25%) followed by the BOE and ECB announcing their rates on Thursday (both expected to remain unchanged at 0.50% and 0.75% respectively). Along with the central bank rate decisions, we await Chinese PMI manufacturing data on Wednesday (Exp 50.4, Prev 50.2) and the US Nonfarm payrolls report on Friday (Exp 100K, Prev 80K).