A rosier outlook for the Eurozone

The markets are fairly quiet today as a combination of some Asian markets being out on holiday and a dearth of economic data releases from the major markets have left investors on the side lines.

After Friday’s major moves post-payrolls, slightly calmer conditions at the start of the week are to be expected. There are some themes emerging in FX - a strong euro, yen and Swiss franc versus a weak pound and dollar. Commodity bloc currencies are also doing well led by the Aussie and the Kiwi dollar. The Cad is the laggard as it gets dragged lower by weak US economic prospects and a slight recovery in the dollar after last week’s rout.

Political news also boosted the single currency. Firstly, there was the report on Friday that the European Union/European Central Bank and International Monetary Fund had vindicated Greek efforts on complying with the conditions of its first bailout. There was very little detail on the actual audit, but it paves the way for the release of the next tranche of bailout funds due at the end of this month. Eurogroup chairman Jean-Claude Juncker also sounded optimistic that a second bailout would be forthcoming for Greece in order to bridge its financing needs for the next two years.

So for now Greece’s financial problems have been put to bed. The second political issue was Portugal’s elections. The incumbent Socialist government was ousted in a decisive victory for the centre right. The Social Democrats secured the largest percentage of the vote and are set to form a coalition with the Conservative Popular Party. The new Prime Minister has said he will go even further to implement austerity reforms to secure the EU/IMF/ECB bailout funds.

So far the markets seem to be taking Passos Coelho at his word. However, Portugal’s PSI 20 stock index is lower in line with other European markets, as stocks come under pressure amid signs of faltering global growth.

French central bank president Christian Noyer spoke about Europe’s bank stress tests today, another risk event for euro-based assets.  The results of these stress tests may be delayed until July; they were originally expected to be reported in June. Noyer reiterated the strength of the tests relative to last year’s and he also said the tests were crucial due to the links between government debt and bank debt, especially in the weak peripheral nations. These tests will be crucial to underpin support for the single currency in the medium-term, especially since Spain’s domestic banks are likely to require further capital and may need further government support that could hit economic confidence in the Iberian nation’s sovereign debt.

Elsewhere, tomorrow’s speech by [Federal Reserve chairman] Ben Bernanke at 2045 BST will be closely watched to see how worried he is about the deterioration in the US growth outlook and the jobs picture in particular, the unemployment rate jumped to 9.1 per cent in May. The markets will be looking out for any signs that QE3 is back on the table. However, in his last press conference Bernanke said the bar was very high for more stimulus. If he fails to suggest the Fed will act as another backstop to a flagging economic recovery then we think this would be negative for risk. Alternatively, if he suggests the opposite then we would look for a dollar sell-off.

Ahead today, markets may be jumpy in the lead up to a plethora of central bank meetings including the Bank of England, European Central Bank (ECB), Reserve Bank of Australia and Reserve Bank of New Zealand. The ECB is expected to point to a rate hike next month when it meets on Thursday due to inflation pressures. There was further evidence of this today when producer prices for the currency bloc were released for April, on an annualised basis prices rose by 6.7 per cent, more than the 6.6 per cent expected.

The Philadelphia Fed member Charles Plosser (a voting member of the Federal Open Markets Committee) is talking at a conference in Helsinki this morning. He is a noted hawk and said that 'somewhat tighter' monetary policy is possible by year end. This helped lend some support to the dollar, which has been under pressure since 10-year bond yields fell below 3 per cent on Friday.

Plosser said the bar for more QE is 'very high' and he pointed out that the US government has a 'fiscal problem' and the government’s fiscal path is 'unsustainable'. Although he said that QE2 helped the US economy, he did point out that it would be very hard for the Fed to withdraw monetary stimulus without creating adverse effects for the economy. So it’s unlikely to be a comfortable growth trajectory for the US over the medium-term.

The pound is under pressure today as the International Monetary Fund is set to deliver its bi-annual verdict on the UK economy. This comes at a delicate time for the government’s fiscal consolidation programme as fears rise that growth is not strong enough to withstand Chancellor Osborne’s cuts.

Kathleen Brooks is research director at Forex.com

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