FX majors stick to range-trading

The big story this morning comes from a report in a UK newspaper that the EU authorities and the European Central Bank (ECB) don’t share the same view on how to resolve Greece’s debt crisis. While the EU is considering a 'soft' restructuring including extending the maturities of Greek debts, the ECB thinks that this is unworkable as it may erode fragile support for other peripheral nations such as Spain.

This is a key worry for the ECB. While Irish, Greek and Portuguese bond yields continue to remain stuck at elevated levels, Spanish bond yields have also been trending higher. Next week sees Spanish local elections, which are a key litmus test for public support to harsh fiscal austerity measures implemented by the government over the past year. If the public show resistance to the cuts this could unsettle bond investors even further, which would likely weigh on support for the single currency.

The euro has come under pressure since the start of the European session after once again failing to break through 1.4300, which is the level to beat for now. 1.4220 is holding as good support and this suggests we are back to choppy ranges as we near the end of the week. Sovereign concerns are thwarting EUR/USD’s attempts to rally back towards 1.4300, but they are not causing an outright collapse in the single currency like they were this time last year.

The markets are still willing to give the various branches of the EU authorities the benefit of the doubt that they will come up with a workable solution to the crisis and the problems won’t spread to Spain. After all, the markets expect a degree of wrangling and argument between the multiple branches of authority so a clash between the EU and ECB at this stage is not that worrying. The market may also be cheered that the true extent of Greece’s problems are out in the open with time to spare before Athens is due to return to the capital markets. All of this is helping to protect the single currency on the downside.

It’s not just the euro that is choppy; investors can’t make up their mind about the dollar either. The greenback recovered its composure after the release of the Federal Open Market Committee (FOMC) minutes last night. It was revealed that FOMC staff members gave a presentation on strategies for normalising monetary policy. What was surprising was the depth and detail of the presentation that led some to suggest normalisation may be closer than we think.

The options presented to the Fed included firstly, raising interest rates or decrease its holdings of long-term securities or a mixture of both. However, to protect economic growth 'the Committee could accomplish essentially the same degree of monetary tightening by selling assets sooner and faster, but raising the target for federal funds rate later and more slowly' or vice versa.

The minutes made it clear that no decision has been taken by the FOMC on when to start this 'normalisation' process. So the Fed is keeping its powder dry.

What we do know is that the first step towards policy normalisation will be to cease re-investment of agency and mortgage-backed securities the Fed has held on its balance sheet since the peak of the financial crisis. Only after that would it stop reinvesting principle payments on Treasury securities, which the Fed has bought as part of its quantitative easing progress.  Ceasing reinvestment would mark a 'modest step' towards policy tightening, the Committee discussed. However, most FOMC members preferred to use interest rates as the preferred tool for monetary policy.

On the economy the FOMC said that the economic recovery was proceeding at a 'moderate pace' although slower than had been anticipated earlier this year, and that conditions in the labour market were improving even though the unemployment rate remained elevated. On the inflation front, the minutes addressed the risk of elevated commodity prices and the recent pick-up in core inflation; however it judged that the medium-term inflation outlook remained subdued.

The minutes support the recent rebound in the dollar, but since we don’t know the timing of normalisation and the Committee’s continued concern over the outlook for growth, upside in the greenback may well be limited.

The [ound had a bit of a bounce, although its attempt to reach 1.6200 lacked conviction this morning. Retail sales last month expanded at a 1.2 per cent annualised rate, easily beating the 0.8 per cent forecast. But April’s data will be distorted by the super holiday, so today’s figures may well be overstating the strength of the hobbled UK consumer. After yesterday’s Bank of England minutes when two of the members who voted for rate hikes sounded more dovish than they have of late the risks are to the downside for the pound in our opinion.

Japan’s economy is back in a technical recession after a negative reading for first quarter growth released overnight. This was expected after March’s natural disaster. Data is also expected to remain weak into the second quarter before rebounding due to the re-build effort in the second half of this year.

The yen is under pressure along with other safe havens as investors continue to favour riskier assets. The Aussie, Cad and Kiwi dollars are all rallying, while the euro is slightly weak and the pound and dollar remain mixed. Oil is trading in a range along with other commodities, as this asset class gets pushed around with sentiment towards the dollar. Stocks are in the black for the second straight day.

Kathleen Brooks is research director at Forex.com

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