FX investors cautious of shorting euro ahead of EZ deal

The main focus this week was the EU summit that took place last Sunday. Yet the details expected regarding the tackling of the current eurozone crisis were expected to be presented in a second summit scheduled for late yesterday.

In the former part of the week hopes continued to prevail ahead of yesterday’s much anticipated eurozone crisis deal. The main discussion was expected to revolve around three issues namely: 1) Bank recapitalisation; 2) EFSF leveraged capacity; and 3) Haircuts for private holders of Greek debt.

Ahead of the meeting some generic details started coming out. Earlier issues raised by France (and opposed by ­Germany) on whether to employ the European Central Bank as a leveraging agent for the EFSF seemed to have abated.

With regards to bank recapitalisation, European officials identified an amount of around €100 billion that should be enough to shore bank’s balance sheets. As for more firepower for the EFSF, German officials had been quoted as saying that the EFSF is to be leveraged to €1 trillion. News reports indicated that the German Parliament would be voting on the leveraging of the EFSF yesterday.

The main function of the European Financial Stability Facility (EFSF) is to provide loans to eurozone members that are experiencing economic difficulties. It issues bonds to finance loans to the countries and the loans are than guaranteed by other states in the eurozone, each country guarantees varying percentages of the loan but in the end they would cover 100 per cent of the loan when summed up.

The issue that apparently needed more clarity seemed to be the extent of the haircut that will be demanded (presumably still voluntarily) on private holders of Greek debt. On this matter eurogroup chairman Jean Claude Juncker mentioned that the private bond holders may face losses between 50 per cent and 60 per cent.

Despite the event risk, given it would not be the first time eurozone leaders disappointed investors, the euro held well its gains against the US dollar. It was unlikely that Forex investors would be willing to add short positions especially if the outcome was a positive one.

At week start the euro was down only a marginal -0.14 per cent and maintained its gains against the dollar, Swiss franc and the Japanese yen. The dollar was hesitant; it shed an average 0.31 per cent when seen against the majors – with the biggest losses coming from against the Australian dollar.

The EUR/USD rose to six week highs last Monday, yet the currency pair kept within a 138pip range in the days prior to yesterday’s summit. EUR/USD traded in the range of 1.3822 - 1.3960 up to the time of writing. Where do we expect it to go from here?

For the current week we expect the currency pair to extend the move higher towards 1.4087 region – which level corresponds to the 100-day moving average. A break above 1.4022 would signal an accelerated move up.

In the United Kingdom British Prime Minister David Cameron had to face political headwinds on issues raised with regards to Britain’s EU membership. The British Parliament debated calls for a referendum on this issue last Monday after media reported that around 60 per cent of UK citizens wanted a referendum on EU membership.

The British Parliament finally rejected calls for an EU membership referendum but the Prime Minister will have to deal with the fact that over a quarter of his party had in fact voted in favour of an EU membership vote.

Against the single currency the British pound remained close to flat, currently trading at 0.8683 after opening at 0.8693 at week start. Price trading for the EUR/GBP was quite volatile and in the range of 0.8674 – 0.8725. In the former part of the week the British pound shed a marginal -0.05 per cent against the majors although it lost only to the Aussie and the Canadian dollar.

On the data front Purchasing Managers Index data from the eurozone last Monday continued to raise concerns on the prospects of growth, as they came in weaker than the previous and the expected levels; although industrial new orders for the eurozone surprised to the upside.

Upcoming FX key events:
Today: Eurozone Business Climate Index, US GDP and US PCE.
Tomorrow: US Consumer Spending, Swiss KOF Leading Indicator and University of Michigan Consumer Sentiment.

FX technical key points:
EUR/USD is bearish, target 1.2850, key reversal point 1.41.
EUR/GBP is neutral.
USD/JPY is neutral.
GBP/USD is bearish, target 1.5125, key reversal point 1.6150.
USD/CHF is neutral.
AUD/USD is neutral.
NZD/USD is neutral.

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Mr Muscat is a senior trader at RTFX Ltd.