What lies behind the euro’s resilience?

Ahead of the week’s start, throughout the weekend, Chinese official Manufacturing PMI and news of an agreement for the eurozone’s firewall heralded investor sentiment. Chinese PMI (Purchasing Managers Index) surprised to the upside coming out at 53.1 compared to the previous 51.00 and beating consensus of a 50.8 reading.

Many analysts have attempted to explain what has held up the euro so much- Rudolf Muscat

The figure was positive on two fronts; firstly it gives the Chinese manufacturing sector a better footing into growth region (50 delineates contraction from growth), thus easing concerns over global economic growth; and secondly it relieves the initial gloom depicted by the preceding private sector flash estimate released just about a week ago.

How did this reflect on the Forex markets? Apart from contributing to an overall somewhat milder improvement in risk sentiment – the AUD was a major beneficiary. The Aussie enjoyed an 80-pip rally; the AUD/USD opened at 1.0439, late last Sunday, after closing at 1.0358 on Friday. We must keep in mind that China is Australia’s most important trading partner and a key driver of Australian resource exports.

After Sunday’s higher open the AUD/USD eventually eased lower to 1.0366, only to be caught once again by the headwinds of the RBA’s interest rate decision early Tuesday morning. The RBA left the cash rate unchanged at 4.25 per cent, as was widely expected. Initially as the interest rate decision hit the wires the AUD/USD rose briefly to 1.0465 but the spike was very short lived and price trading for the currency pair soon dipped towards 1.0373.

Eurozone finance ministers came to an agreement over the firepower of the total bailout facility that would act as a firewall to avoid further contagion. The combined capacity for both the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) will be that of €800 billion; while in itself the agreement is a positive move forward, the figure tended towards the least ambitious option and failed to be a market mover. The amount agreed upon was the minimum required for the eurozone to keep tapping support from the IMF.

In the former part of this week the euro was weaker across all of the majors and found itself into negative territory. The single currency remains flat against the CHF and loses mostly to the Japanese yen, where it sheds 0.96 per cent. Against the USD, losses for the euro remained contained and it was losing 0.14 per cent in the former part of this week.

Despite the overall weakness the euro has remained quite resilient. After lows hit last January at 1.2624 (2012 lows) the EUR/USD was held back just ahead of 1.3510 (the 38.20 per cent retracement of the May 11 – Jan 12 move lower) – but since then remained contained above the 1.30 levels. In fact since mid March the currency pair has traded in the range of 1.3133 – 1.3385.

Many analysts have attempted to explain what has held up the euro so much. I will try to highlight some of these ideas. A general tendency has been an easing of concerns revolving around the eurozone debt issues; a previously heavily sold euro recovers some strength as portfolio managers unwind some of these heavy short (sell) positions. Yields paid by member nations for debt instruments have overall eased significantly from the alarming seven per cent levels; and despite criticism that it is not a long term solution the ECB’s LTRO (or simply put loan tenders) have proved to be very effective so far.

Another explanation for holding the EUR/USD from going significantly lower – maybe the Central Bank policy behind the two currencies. The Federal Reserve has so far remained quite dovish, despite acknowledging improvements, it has pledged to remain supportive to the US economy and has never taken the option of further easing off the table. While further easing seems unlikely it nonetheless remains an option to consider. A more accommodative Fed pushes future rate hikes further away and this impacts the USD negatively.

The ECB on the other hand is to some extent limited on how much to cut rates, because despite the overall weaker data policymakers must keep in mind that so far the German economic recovery remains strong. While on one side the members of the periphery seem unable to avoid bleaker data the Bundesbank on the other hand is demanding exit strategies. The ECB is likely not to cut rates any further and may opt to remain on hold over the coming year.

Upcoming FX key events:
Today: BoE Asset Purchases Target and Rate Decision, Canadian Employment.
Tomorrow: US Non Farm Payrolls.

Technical key points:
EUR/USD is bearish, target 1.2500, key reversal point 1.3750.
EUR/GBP is bearish, target 0.80, key reversal point 0.8550.
USD/JPY is bullish, target 85.00, key reversal point 78.00.
GBP/USD is neutral.
USD/CHF is neutral.
AUD/USD is bearish, target 1.015, key reversal point 1.07.
NZD/USD is bearish, target 0.80, key reversal point 0.8350.

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Mr Muscat is a senior trader at RTFX Ltd.