Political turmoil raises fears over Europe’s recovery

Political tensions from the eurozone, in particular in France and the Netherlands, dominated market headlines at the start of the week. Risk appetite opened on a sour note, as the political turmoil raised doubts about the ability of eurozone nations to push through with planned budget cuts. Weak private sector data given by purchasing managers’ surveys from Europe’s two largest economies and the currency bloc also weighed on sentiment, and renewed worries about Spain intensified concern over the eurozone debt crisis.

Renewed worries about Spain intensified concern over the eurozone debt crisis- Emman Xuereb

At the end of last week, risk appetite was driven higher by upbeat PPI and IFO numbers from Germany and better than expected retail sales from the United Kingdom. Sentiment was also lifted by strong US corporate earnings. Higher-yielding currencies rallied strongly and “safer” bets like the US dollar and the Japanese yen were under pressure.

EUR/USD rallied to its highest level since early April last Friday, to 1.3225. The pair then sold-off aggressively at the opening on Monday, tracking riskier assets and Asian equities lower, as the initial indications from the French elections left many doubts on who will emerge on top. The first indications showed right-wing voters will be a determining factor in this year’s vote, after National Front leader Marine Le Pen received around 18 per cent of the total vote. President Nicolas Sarkozy will now have to adopt a more nationalistic approach to appeal to right-wing voters if he wants to reverse the first round deficit. At the end of the first round, Sarkozy was playing catch-up to Socialist candidate Francois Hollande with 27.1 per cent of the votes compared to Hollande’s 28.6 per cent.

Results from the IMF/World Bank meeting over the weekend also emerged, with the outcome that the groups pledged more than €430 billion in support for the economic crisis, without earmarking them directly to the eurozone.

EUR/USD continued to edge lower on Monday, weighed by slumping eurozone manufacturing and services activity and rising Spanish yields. News that Dutch Prime Minister Mark Rutte tendered his government’s resignation continued to pile the pressure on the single currency and risk sentiment in general. The news that the Dutch government reportedly collapsed over budget cuts disagreement increased tensions, as the Netherlands is seen as one of the bloc’s most stable nations, and raised fears the eurozone could struggle to push through austerity measures and may stay in recession longer.

The pair trimmed some of its losses on Tuesday but gains were subdued and EUR/USD remained locked in its recent range. It has been range bound for most of the past month between 1.3000 and 1.3200 as latest employment data suggested the rate of growth in the US jobs sector is slowing, which has kept dollar gains in check. At the time of writing the Federal Reserve started its two-day FOMC meeting. The Fed has been reluctant to shed more light on whether or not it will embark on further quantitative easing, but forex investors will nonetheless be keeping a close eye on this meeting, given the still-fragile US economic recovery, and to capture any hints on future Fed policy.

USD/JPY will also be in the limelight in the coming days as the Bank of Japan is scheduled to announce its rates tomorrow. Contrary to the Fed, which is not expected to make any changed to its policy, the BoJ may announce an increase to their asset purchases programme, which should make the Japanese yen depreciate against its major rivals. The USD/JPY is still holding steady, but is looking fragile especially since hawkish expectations on future Fed policy have been subdued lately. The pair however may rally strongly if it manages to close above its 100-week moving average, now by 81.37.

The Australian dollar fell to a two week low against the dollar on Tuesday, hurt by an inflation report which showed consumer prices were lower than expected in the first quarter. The Aussie was half a per cent lower against its major peers, as its headline inflation figure dropped sharply to 1.6 per cent y/y versus a forecast for 2.2 per cent. AUD/USD fell to 1.0247, extending its drop from Monday where it closed below its 200-day moving average by 1.0374. With Tuesday’s CPI data, and also Monday’s lacklustre producer prices data, a rate cut in the next policy meeting by the Reserve Bank of Australia is now highly anticipated and some are even expecting a 50 basis point rate cut to be spread evenly between the May and June RBA meetings.

Upcoming FX key events:
Today: Italian Bond Auction, German CPI & US Pending Home Sales.
Tomorrow: BOJ Interest Rate Decision, Italian Bond Auction, US GDP & US Michigan Consumer Sentiment.

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 bullish, target 1.6300, key reversal point 1.5900.
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 Xuereb is a trader at RTFX Ltd.