Euro hits a new low as risk aversion peaks

Week Commencing Monday 23rd July 2012

Overriding Market Themes

The Euro has hit an 11 year low against the Japanese Yen amid fears that the debt problem in Spain is worsening. The Euro fell to a historic 94.71 yen in the Tokyo session this morning, which represents levels not seen since November 2000. News from Valencia on Friday kick started this latest round of risk aversion as the region requested assistance from the central government for financial help from a newly created Spanish rescue fund. This resulted in Madrid’s borrowing costs, already at near record highs; to shoot up to levels well above the 7 percent level regarded as unsustainable in the long run. The developments in Spain have raised fears that the Eurozone debt crisis is worsening and spreading to the zone’s biggest economies. 


Back in Blighty, The UK Government borrowed more than expected in June, leading many to question whether it will meet its deficit reduction target this year. Public Sector Net Borrowing, which exclude interventions such as Bank Bailouts, was GBP 14.4 Billion last month, considerably up from the GBP 13.9 Billion in June 2011. The market digested these figures rather badly as many analysts (including ourselves) believed that the figure would be much lower, at roughly GBP 13.4 Billion. Much of the overshoot was down to a smaller surplus in local government finances that last year as central government grants were either reduced or deferred. It seems that the painful road of austerity is a longer road to walk than many believed back in 2010 when the government originally set out their plan to repair the countries budget deficit. Many believe that at this rate, we may see austerity measures in place until late 2020! 


Continuing on dear old England, the IMF continued to state that it is worried about the state of the UK recovery and thinks the government should rethink some of its budget cuts if things get any worse. This poses an interesting question, how can the Treasury manage a small but albeit drastic U-turn without the financial markets punishing them through massive European like rises in Gilt prices or losing the coveted AAA status? Such hypotheticals are obvious impossible to answer definitively, but fiscal indicators such as deficit and government debt levels appear to be weakly related to government bond yields for advanced economies, especially those that have monetary independence.  Perhaps countries with their own currencies don’t have to worry as much as they have been as markets appear to be pretty unbothered, especially if the loosening came with steps to cut government spending in the longer term. 

GBP This Week

A light week for Sterling as Preliminary GDP is the only release of note, which I expect the release showing a GDP contraction of -0.2% percent for the quarter. The preliminary release is the earliest release (before the Revised and Final release in the coming months), and thus tends to have the most impact, so watch for some significant Sterling volatility moving into Wednesday afternoon. I continue to expect the Pound to continue to struggle to gain momentum against the US Dollar as investors continue to worry about the impact a further Euro-crisis would have on the already struggling UK Economy, although European investors will likely to continue to seek the safety of UK Gilts. Expect some significant resistance levels on GBP/EUR at the 1.29 and 1.2975 levels as traders look to close out long Sterling positions as we approach 1.30.

USD This Week

Quite a busy week for the Dollar as US New Home Sales kicks the week off with a suspected increase of roughly 4,000 homes sold last month. Thursday’s Core Durable Goods Orders, which details the change in the total value of new purchase orders placed with manufacturers for durable goods, should decline slightly too just about zero. Unemployment Claims should also come in slightly lower but the big mover will be Pending Home Sales for the month, with a decline in the number of homes under contract to drop from 5.9 percent in June to just less than 1 percent in July. The weekends with US Advanced GDP for the quarter, which should post slightly lower than the 1.9 percent figure release in the previous quarter. 

EUR This Week

German Flash Manufacturing PMI leads the week on Tuesday, with a small increase expected but the index still firmly in decline, indicating that the German economy

continues to struggle to find its footing as its orders from other European nations continue to decline. We also have the German IFO Business Climate release on Wednesday, which should decline slightly from the previous months figure of 105.3. As always, the focus on the Eurozone continues to be the ever sovereign credit conditions faces by its member states. We will continue to listen for news regarding peripheral states and their continued march towards budget consolidation. With the Euro under such pressure, positive EUR news will likely cause considerable upside for the currency, so be wary of long-reaching political statements or press statements.

In Other News

Bradley Wiggins smashed through the Tour de France, sealing Britain’s first tour victor on Sunday finishing ahead of his Sky team mate Chris Froome. Bradley, not set on celebrating his win on the arduous 2,000 mile race, has set his sights on the Olympics, adding to hopes that the UK will slam in even more Gold’s this time than in Beijing 4 years ago. The English cricketers could certainly use a page out of his book after an awful start to their second innings at the Oval, with the current score at 102-4. We need an inspired effort from the middle order and let’s hope the tail will wag.   


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