Euro back above 1.4000 but for how long?

The market doesn’t seem ready to see EUR/USD convincingly break below 1.4000 yet and some bargain hunters have pushed the single currency to a high of 1.4116 this morning. But while the dollar looks like it has turned a corner, it has yet to gather any real momentum and we could see this back-and-forth between euro sell-off then euro bargain hunting for some time yet.

The trigger to the recent decline in the single currency were fears about the financial positions of Spain and Italy – the former due to the recent elections that had the potential to upset fiscal consolidation plans and the latter after a downgrade of its sovereign debt outlook by a credit rating agency late on Friday. We would argue that there still is differentiation between the stronger and weaker peripheral nations and the market isn’t pricing in the chance of any bailout for Spain or Italy in the medium-term. However, the markets’ gaze has settled on these larger states and any financial or fiscal misdemeanours will be punished in the debt and FX markets alike.

The markets are likely to remain jittery for the next month since the next quarterly tranche of funding for Greece is likely to come across some problems. If Greece isn’t complying with its bailout conditions then funds will be halted – causing an Argentina-esque situation, whereby public sector wages are not paid and default is the only option. That would have a disastrous effect on the markets in our view and is something the European Union and International Monetary Fund authorities would try to avoid, however Greece has to play ball.

The announcement from Athens yesterday that it was privatising several state assets along with another €6 billion of further cuts to help achieve the 7.5 per cent deficit target for this year may be enough to protect the next tranche of funds. But the key risk now for Greece is that after this latest round of cuts and asset sales reform-fatigue does not set in at the highest levels of political power.  Earlier today the Greek opposition suggested that the extra fiscal consolidation measures will hurt growth, which spurred a 40 pip fall in EUR/USD – so the cross remains extremely sensitive to any further deterioration in the financial situation now faced by Athens.

But while the peripheral woes continue in the background, Germany continues to do well. Contrary to the markets’ opinion, the German IFO survey of industrial sector confidence did not decline this month as expected and instead remained stable at 114.2, the same level as in April. The resilience of Germany’s industrial sector in the face of a strong euro and high commodity prices has been remarkable and suggests that growth may remain strong for the rest of the year. The euro has up until recently traded higher on the back of Germany’s economic rebound, so today’s data, coupled with the final reading of first quarter GDP that confirmed Europe’s largest economy grew at a 1.5 per cent pace in the first quarter of the year, is likely to provide a near-term boost to the single currency. Resistance comes in at 1.4180 – a cluster of hourly moving averages.

The pound has had less success than its European neighbour. It dropped on the back of news that UK banks are at risk of a credit rating downgrade as the government withdraws its support for the banking sector. Now the UK’s largest banks are on review for the next three months by Moody’s to see how strong they are without the crucial government crutch for support. Moody’s did stress that the review was not due to a deterioration of the banks’ or the government’s financial position. UK banking sector stocks came under pressure this morning but have since found their footing.

Borrowing data from the UK was much worse than expected in April. The government borrowed £10 billion versus expectations of £6.5 billion, the largest for any April since 1993, due to a reduction in income tax revenue and an increase in government spending. This heaps pressure on the UK government and its deficit reduction plan, although stronger government spending at the start of second quarter may boost GDP growth, which has been fairly dismal of late. While domestic data may weigh on the pound, it is likely to be more effected by what happens to the dollar and the euro and is likely to show some strength when we are in a risk-on scenario.

EUR/CHF reached a record low yesterday, but has since staged a small bounce after the Swiss National Bank’s (SNB) vice president Thomas Jordan stressed deflationary risks from the strong franc. This eroded some enthusiasm for the Swissie after Jordan hinted there could be further rate hikes this year. A pull back in the Swissie is about right, especially as stocks are performing well. But it is the ultimate safe haven in FX right now, so it is vulnerable to further upside especially if the situation in Europe’s periphery starts to deteriorate.

Ahead today there is some housing data out of the US and some Fed speakers. A speech from James Bullard [president and chief executive of the St Louis Fed] yesterday was fairly dovish, which set the dollar up for some weakness today. This shows that the Fed could scupper the 'turn' in the dollar that some are expecting by keeping interest rates at record low levels until housing and employment pick up. Overall, the markets are not likely to move up or down in straight lines for some time to come.

Kathleen Brooks, research director at Forex.com, gives her views on the news and events affecting currency markets.

To receive more relevant articles like this one, why not sign up to our weekly newsletters, click here