German Courts hold the Eurozone to ransom as decision on bond buying program is expected this week

Week Commencing Monday 10th June 2013

This week in Brief

  • German Constitutional Court decided whether ECB bond buying scheme is legal in Germany. If ruling is against OMT, expect massive repercussions within Germany and the wider zone.

  • UK Manufacturing Production likely to end the spell of good luck the UK economy has been experiencing of late. We expect this to have a knock on effect on the Pound, especially against the Dollar.

  • US Retail sales is expected to grow modestly along with the UoM consumer sentiment index, continuing to signal an improvement in the US economy.

Market Themes & Current Events

The UK Construction sector has returned to growth after 6 months of contraction, helped by a dramatic increase in the number of new real estate projects under development. The Construction Purchasing Managers' Index rose to 50.8 in May from 49.4 the month before. This welcome release sees the only remaining UK sector in contraction blast back into growth, and bodes well for Q2 GDP figures which many believe will now exceed market expectations. Diving into the figures, the PMI survey found that house building in May was at its fastest pace for 26 months, despite the amount of spending on commercial and civil engineering projects continuing to fall. Even more optimistically, when asked construction firms said they were optimistic about the future, with 40% of the firms questioned expect to see a rise in output over the next 12 months. This comes the day after news that the manufacturing sector grew at its strongest pace in more than a year, and the all-important service sector continued to expand at an impressive rate.

Across the channel, the European Central Bank has revised down its Eurozone growth forecast as it voted to hold rates at its new historic low of 0.5%. The ECB now expects the euro area to contract by 0.6% this year, having earlier predicted a GDP fall of 0.5%. Mario Draghi, the president of the EBC, commented in the monthly news conference that he still saw “considerable downside risks” for the economy, but insisted a gradual recovery would begin in 2014. The Eurozone's GDP shrank 0.2% in the first quarter, making the first 3 months of the year the sixth quarter to experience a recession. The rate announcement came shortly after figures showed unemployment in France rose to 10.8% in the first quarter of the year , and the German Bundesbank downgraded Germany growth projections to a mere 0.3%.

Latvia will become the 18th country to use the euro after being approved for membership by the European Commission. The country will start using the currency at the beginning of 2014 after meeting the criteria for membership, including low inflation and long-term interest rates, as well as low public debt. In a move designed to reduce the countries dependency on Russia and strengthen its ties with Western Europe. The ECB also gave its blessing to Latvia ahead of the Commission's announcement, but warned high foreign deposits in its banks were a risk to financial stability. EU finance ministers are expected to sign off the accession in July.

Finally, across the pond we saw US employment rise by slight more than expected, with 175,000 jobs created in May. However, this figure was not enough to stop the unemployment rate rising by 0.1% to 7.6%, with many analysts viewing any figure under a 200k increase a disappointment. This has stoked fears that the US government’s austerity program might be harming the economy. The latest figures mean that it appears unlikely that the Federal Reserve is about to rein in the bond buying programme, which is aimed at lowering interest rates and boosting employment.

Sterling Outlook

This is a quiet week for Sterling, with only Manufacturing Production and the Claimant Count producing any figures of note. Starting with Manufacturing Production on Tuesday, we expect the indicator for April to shrink to 0% growth from 1.1% in March. This figure has the tendency to be overlooked at times, however it is the ability to shift into or out of growth which brings about the movement here. Given that many analysts are expecting this release to fall to parity, traders will be taking note as to whether we will move back into negative growth. We then move to the Claimant Count, which is predicted to show a more moderate fall in the amount of claims from -7.3k to -6.8k. It is worth noting however that 8 out of the last 10 releases have come in better than expected, so we therefore speculate that the risk is to the upside on this one.

Despite the Pound taking advantage of the strong UK PMI numbers (alongside weak US and EU numbers), we do believe this could be a temporary move. The UK economy has a long way to go to inspire confidence in the markets, and this will continue to be reflected in Sterling’s power to appreciate. Against the US, increased talk that the Federal Reserve will end QE is Dollar positive and is likely to regain some of its lost ground. The Euro should continue to trade the range, and significant support remains at the key 1.19 level.

US Dollar Outlook

Again, we have a equally light week of events in the US, where retail sales and consumer sentiment figures provide the only figures of note. We expect Retail Sales to rise from 0.1% to 0.4% in May, as Friday’s strong NFP figure has brought a stronger picture of the US economy. Despite the increase, the sector will remain under continued pressure from the new tax regimes implemented by the Obama administration, and growth is likely to continue to be tepid. Moving to Friday’s UoM Consumer Sentiment figure, we forecast a rise in this figure from 84.5 to 84.9. This continues in line with our theme that sentiment is returning to the American high street, and despite its modest increase, adds to moves indicating an improving economy.

After a thrashing by the Pound last week, it is normal that traders seek some form of profit taking, especially with a light UK calendar. With this in mind, I expect GBP/USD to drop back into the lower 1.5250 – 1.5450 region and remain range bound for the short term. The same is true against the Euro, with 1.30 remaining in the crosshairs.

Euro Outlook

This is an extremely quiet week for the Eurozone with only the German Constitutional Court Ruling worth watching. The hearing is taking place to determine whether the bond buying scheme run by the ECB is legal in Germany.  The outcome of this event could decide validity of the scheme going forward given Germany’s power within Europe. Consequently, the markets are likely to be watching this event for possible political shock-waves.

The Euro continued to send mixed messages, with recessionary and integration issues remaining a drag on the single currency. In the absence of further data this week, we expect most EUR pairs to remain reasonably range bound. The only worry for the markets would be a negative ruling in the Constitutional courts, which would almost certainly destabilise the ECB’s current fiscal direction.  


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