An austerity-growth Armageddon for the euro

Monday’s economic docket was relatively uneventful and the US was on holiday as they celebrated Memorial Day. In the absence of data, at week start sentiment drifted on news headlines – investors welcomed some sober news however. Over the weekend opinion polls from Greece (ahead of June 17 elections) showed that the left-wing Syriza bloc lost the lead they held for most of the time since the May 6 polls and that they had been surpassed by New Democracy.

Why is this important? Because Syriza is anti-bailout while New Democracy is pro-bailout. In fact of the three parties that attracted the majority of votes at Greece’s last election (Syriza, New Democracy and Pasok), only Syriza is anti-bailout. As discussed in last week’s weekly commentary the cost of a Greek exit is far larger than them staying aboard. Interestingly enough ekathemirini.com reports that nine in 10 Greeks want to remain in the eurozone.

Greece was not the only market mover, however. Last Friday the president of Spain’s Catalonia region called on the central government for financial assistance after declaring they were running out of financing options – this eroded support for the euro pushing the EUR/USD to lows last seen back in July 2010, as it embraced daily lows of 1.2496.

Europe’s debt challenge is keeping investors edgy; the 10-year benchmark for Spanish debt is seeing fresh highs close to 6.5 per cent. Spanish yields over benchmark 10-year German bunds are at record highs as well – yet the European Central Bank has reported that it has made no new purchases under its Securities Market Programme (SMP) for an 11th week.

Over the weekend a Financial Times article also helped to fan optimism as it elaborated on new Spanish solutions to recapitalise banks; by issuing sovereign debt directly to the banks so that the ECB may than offer cash against collateral of the same bonds.

On a weekly time frame the EUR/USD has continued through the bearish channel delineated by highs of September 2011, October 2011 and May 2012 and lows of October 2011 and January 2012. Given the weaker fundamental data out of the eurozone and the region’s austerity growth Armageddon we would expect the bearish bias to remain predominant. In the coming weeks to the downside the currency pair may be eyeing 1.20/1.1876 while upward moves should not breech 1.29/1.30 – the upper line of the bearish channel.

The build up of short euro positions may inevitably lead to short term bounces higher as some overstretched portfolios will have to pause for breath if the downtrend cools – simply put those investors that are heavily short will be forced to buy back some euro if the EUR/USD temporarily stops going lower or consolidates. The process of buying back, or short covering, could lead to short term corrections higher in the price for the EUR/USD.

Late Monday Reuters reported that Greece handed over €18 billion to its four largest banks, in efforts to replenish their capital base. The funds were in the form of bonds from the European Financial Stability Facility (EFSF). The replenishing of the capital base allows the bank to regain access to ECB liquidity – last week the ECB had stopped providing liquidity to some Greek banks due to the depletion of their respective capital bases.

So far this week the GBP/USD has traded in the range of 1.5655 – 1.5717; while the EUR/GBP was traded in the range of 0.7983 – 0.8037. Throughout most of May the GBP shed 3.46 per cent to the USD but was stronger against the weaker euro, where it gained 1.84 per cent.

The British pound is now being seen as a mild safe haven – but in reality while it offers a good alternative to euro outflows the fate of the eurozone will have a significant impact on the UK and the GBP, so the currency might come out as undecided at times.

Ahead of us next Friday, US Non-Farm Payrolls for May will be much awaited as investors keep an eye for the health check of the labour market of the world’s largest economy – the US economy is expected to have created 150,000 new jobs after the 115,000 already registered in April.

Upcoming FX key events:
Today: German Unemployment, Eurozone Flash CPI, US ADP & GDP Annualised & Chicago PMI.
Tomorrow: EZ & UK PMI, US Non-Farm Payrolls & ISM Manufacturing.

Technical key points:
EUR/USD is bearish, target 1.2000, key reversal point 1.3000.
EUR/GBP is is bearish, target 0.78 key reversal point 0.81.
USD/JPY is bullish, target 85.00, key reversal point 78.00.
GBP/USD is bearish, target 1.5550, key reversal point 1.59.
USD/CHF is bullish, target 0.9780, key reversal point 0.9370.
AUD/USD is bearish, target 0.9600, key reversal point 1.0150.
NZD/USD is bearish, target 0.7370, key reversal point 0.79.

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Mr Muscat is a senior trader at RTFX Ltd.