An impressive rally in risk assets and higher-yielding currencies followed the announcement of an agreement on Friday between European leaders, to take emergency action to curb the rising borrowing costs of Italy and Spain. European equity markets continued to rally at the start of the week; however the European single currency slipped on downbeat manufacturing data and as the limited nature of the policy initiatives taken on Friday were more carefully scrutinised over the weekend.
Borrowing costs for heavily indebted Spain and Italy eased following the EU summit, relieving some pressure. Spain’s benchmark 10-year yields eased to 6.27 per cent from its June peaks of 7.147 per cent while Italy’s 10-year benchmark yields were down to 5.72 per cent from its highest in June at 6.215 per cent.
At the summit of eurozone countries in Brussels on Friday, leaders agreed that the area’s rescue funds could be used to stabilise bond markets without forcing countries to adopt additional austerity measures and reforms. The European Stability Mechanism (ESM) would have the ability to lend directly to banks in order to stabilise markets without increasing a country’s deficit. Despite the communiqué only referring to the “EFSF/ESM being used in a flexible and efficient manner to stabilise markets”, Italian Prime Minister Mario Monti later made it clear that this in fact implied sovereign bond buying.
EUR/USD surged higher following the announcement from the summit. The pair rallied to 1.2693 on Friday, after hitting a three-week low by 1.2407, the previous day. Early on Monday, the single currency pared its gains versus the greenback, and EUR/USD eased off to 1.2568. The initial excitement was dampened as it became clearer that imminent purchases seem unlikely until outstanding issues around conditionality are fully ironed out and German Chancellor Angela Merkel suggested that it may take “perhaps a year” until countries will be able to start using European funds to directly recapitalise banks.
Further dampening hopes that a solution may at long last been found were comments by the Finnish government, which said that Finland and the Netherlands are opposed to the ESM buying bonds in the secondary market.
At the start of the week, downbeat manufacturing data out of Europe, China and the United States threatened to stall the risk recovery. Euro- zone manufacturing PMIs, a gauge of manufacturing activity in the region, remained below the 50 mark indicating contraction, while China’s manufacturing PMI also edged lower. The jobless rate in the common currency area also inched higher to 11.1 per cent.
The ISM manufacturing PMI from the US was also worse than expected at 49.7, the lowest in almost three years, and also threatened to hurt risk appetite. US markets opened lower on Monday but reversed their losses as investors focused on speculation that central banks will have to do more to spur growth and revive their fragile economies. On Tuesday, European stocks were higher and Asian shares rose for a fifth straight day. The yen fell sharply as forex investors cut demand for safety and favoured riskier currencies, as central banks were seen easing monetary policy, while employment figures from the US on Friday will give more hints on future Fed policy.
The European Central Bank is widely expected to cut rates in its policy meeting next Thursday to help curb the sovereign debt crisis. China may also decide to cut its rate at the next meeting, with a state owned newspaper saying that the time was right for a cut of the banks’ reserve-requirement ratios (RRR).
Last month, the Federal Reserve extended their “Operation Twist” programme until the end of the year, but many market analysts now believe that continued weakness will push the US central bank to embark on another round of quantitative easing. The US jobs report on Friday will be a perfect gauge for the Fed ahead of their FOMC meeting at the end of this month, and a declining non-farm payrolls figure may well prompt policymakers to embark on a fresh round of stimulus.
The Reserve Bank of Australia kept its cash rate unchanged at 3.50 per cent on Tuesday, in line with consensus. Forex investors had a limited reaction to the announcement. AUD/USD initially dipped from its session high of 1.0284 to 1.0257, but soon recovered to trade close to its day’s high. Gold found support on the renewed expectations for more Fed easing. Gold usually benefits as a hedge against rising prices as ample money supply and low interest rates sow the seeds of future inflation. XAU/USD was up more than 0.80 per cent on Tuesday, to $1,612.60.
Upcoming FX key events:
Today: BoE Interest Rate Decision & Asset Purchases Target, ECB Interest Rate Decision & News Conference.
Tomorrow: UK PPI, US Non-Farm Payrolls & Unemployment Rate & Canadian Net Change in Employment.
Technical key points:
EUR/USD is bearish, target 1.2000, key reversal point 1.3000.
EUR/GBP is bearish, target 0.78 key reversal point 0.81.
USD/JPY is bearish, target 77.00, key reversal point 81.50.
GBP/USD is neutral.
USD/CHF is neutral.
AUD/USD is neutral.
NZD/USD is neutral.
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Mr Xuereb is a trader at RTFX Ltd.