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FX Weekly Report (29/06/2012): Markets up on Euro announcements, but rally to be short-lived

The currency markets were locked in a tight range for the majority of the week as participants stayed on the sidelines in anticipation of developments from the EU Summit which wrapped up on Friday.

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

Following a rather well perceived and positive outcome at the closure of the Summit, higher yielding assets and commodities were re-energized to close the week on a very bullish note. The Euro closed the week at 1.2667 against the Greenback, gaining almost 1.80% on Friday alone, after testing 1.24 levels just the day before.

But perhaps the star performers on the week were in the commodity segment with Gold making significant strides to close the week $29 higher at 1597 while the West Texas Intermediary crude contract was even more impressive, surging $7.27 to close the week at $84.96. It was the biggest one-day gain in the energy contract in three years.

Eurozone outcome well-received by markets

Barring a rather dull four days of trading, markets kicked into fifth gear following the strong signs solidarity and commitment emerging from the EU summit in Brussels.

With Italy and Spain putting Chancellor Merkel under pressure to agree to concessions, the outcome was well received by the markets. It was agreed that the European Financial Stability Fund would act as a mechanism to recapitalize Spanish banks in the interim, with the European Stability Mechanism to take over those bond purchases upon its launch, and that too without gaining any senior status over private debt owners.

The move brought a sense of clarity to the markets in regards to how the funding would take place, this following a period of uncertainty when the recapitalization worth €100bn of the Spanish banks was announced two weeks ago. The lack of transparency during the original announcement and how the Spanish government would funnel these funds kept risk sentiment well in check and yields on the Spanish 10-year above 7.00%. But with the most recent announcement, Spanish banks will get recapitilized without the Spanish government taking more debt on their books. So in essence, Spanish banks get their funds without the Spanish government increasing their debt load.

Also stoking the wave of risk appetite was the decision to use bailout funds more flexibly in an effort to keep European bond markets in control, following spiraling yields on Italian and Spanish bonds. With Italy and Spain the biggest beneficiaries of the announcement, Merkel’s parliament strongly backed the vote – giving the markets a vote of confidence that Germany stands behind the Euro for the long haul. Also agreed at the Summit was a fiscal union and a growth pact worth €120bn in a bid to create jobs and stimulate growth and demand in the region.

Rally expected to be short-lived

Despite the buoyant closing on Friday, several doubts still remain. As with most political procedures, the agreed measures will take a fair amount of time to implement with the first round of action due to come on July 9th when the EFSF begins its purchase of Spanish bonds. Assuming there are no roadblocks or change of heart from Merkel and Germany, the simple fact remains that the current firepower of the ESM and EFSF is €500bn while the debt needs of Italy and Spain combined are closer to €2 trillion.

The announced measures will no doubt bring short-term confidence back to the markets and will have a dumbing effect on jittery European yields which will buy the EU some more time; but serious questions still remain and therefore Friday’s rally will be short-lived and will provide shorting opportunities in the trading session next week when the dust begins to settle.

Key growth indicators expected

Next week promises to bring more fireworks with a stacked economic calendar, particularly from the Eurozone. Several key growth related indicators are expected, the headline release being Monday’s Eurozone Purchasing Manager Index for manufacturing (Exp 44.8, Prev 44.8) followed by Eurozone purchasing manager index composite (Exp 46.8, Prev 46.8) and Euro-zone retail sales (Exp -1.0%, Prev -2.5%) on Wednesday.

The growth figures will precede the ECB’s rate decision on Thursday where they are largely expected to cut rates to 0.75% after holding at 1.00% at their previous meeting. Also announcing this week is the Bank of England who are expected to remain unchanged at 0.50% with a £25bn increase to their asset purchase target expected. If such a move materializes, we can expect major selling pressure on GBP crosses. The Reserve Bank of Australia is expected to keep rates unchanged at 3.50% when they convene on Tuesday.

Across the pond in the US, it will be Monday’s ISM data for manufacturing (Exp 52, Prev 53.5) and Friday’s Nonfarm Payroll reading which will drive US equity markets. Coming off the back of three consecutive months of lower jobs growth, Friday’s payrolls are expected to come in at 90K, up from last month’s reading of 69K.