Will EURUSD fall below 1.30?

This is the key question for currency traders right now. The fundamental back-drop looks challenging for the euro. Although the Merkel/ Hollande rift seems overdone to us, Greece is the real problem. The leader of the New Democracy party announced late last night that he had failed to form a coalition government. The baton is now passed to the leader of the radical left wing Syrizia party, which now has three days to form a government. If this fails then another round of elections is on the cards for June. However, these elections could coincide with Greece running out of money, which makes them a much riskier prospect than the elections held last weekend.

Election deadlock

However, why has the euro not fallen through the floor? Back in 2010 the mere mention of the word bailout caused EURUSD to dip below 1.20 at one stage, so why the resilience now? It could be down to a couple of reasons. Firstly, as some commentators have pointed out the anti-austerity parties are not anti-Eurozone membership. Thus, the election deadlock in Athens does not necessarily mean that the break-up of the euro is imminent. If anything, Greece is more likely to be kicked out of the currency union, and even some EU officials have hinted that it is Greece’s “decision” to stay in the currency bloc. Potentially a currency union without Greece could be more stable than with Greece remaining a member.

A sustained break of 1.30 is still possible in our view but the problem is the US. If the US was producing 200k+ jobs per month then EURUSD could be testing the 1.26 lows from January. But because the US only created 115k jobs in April the prospect of more QE remains firmly on the table. Other euro crosses are also being kept high by pockets of weakness in the Aussie and the Kiwi. This leaves EURGBP and EURCAD as two potential crosses that could come under more downward pressure. EURGBP has had a nice downtrend, and a test of 0.8000 looks likely in view, however this pair is already at a multi-year low so expect it to meander lower rather than fall through the floor.

The risk of policy stasis

EURCAD has been range-bound in recent months, and for this pair to resume its earlier downtrend we need to see the BOC continue to sound hawkish and the Eurozone to see credit risk surge. The head of the Bundesbank Jens Weidmann’s wrote in today’s FT about why the ECB shouldn’t cut rates or pump more liquidity into the markets as it increases moral hazard and funding banks that are essentially unsound threatens the stability of the central bank. There are many views about whether to act or not act. We believe the Bundesbank’s view is likely to increase credit risk in the region and thus weigh on the euro. If the ECB expands its balance sheet this may not actually be euro negative, as we saw at the start of this year when the euro recovered even though the ECB offered 1 trillion euro of cheap loans to banks, as it reduces credit risk in the region and causes peripheral bond spreads to narrow.

Policy stasis at both the ECB level and the government level is the largest threat to the future direction of the single currency, in our view. Greece and Spain makes things more complicated. The EU authorities may need to loosen fiscal rules to stop Greece defaulting (on EU taxpayers) in the coming months, while Spain may need to bring in external financing to back up its banking sector. On the latter point we could hear more on Friday when there is a chance that Spain will announce the creation of a “bad bank” to hold the failing real estate loans clogging up Spanish banks’ balance sheets after yesterday’s announcement that Bankia would be re-capitalised with national funds. It’s hard to predict how the market will react to this, right now Spanish bond yields are rising, but they remain below the key 6% level.

Aussie – balancing its books and relying on the RBA

Elsewhere, the Aussie has been under pressure as it is getting hit by the decline in overall risk sentiment and the latest Budget, which was presented today. The Treasury announced that it will cut spending for the first time in 42 years as it tries to bring the fiscal deficit back into surplus in 2012/13 financial year. The Treasurer said that tight monetary policy will give the RBA room to cut interest rates further, which weighed heavily on the Aussie. A daily close below 1.0120 could open the way for a more sustained move lower to 1.0035 – the 62% Fib retracement of the July 2011 high to Oct 2011 low.

German industrial production was much stronger than expected for March coming at 2.8% vs. 0.8% expected. Look out for a host of ECB speakers this afternoon, including ECB head Draghi at 1330 BST. Headline risk is also worth watching out for especially from Greece and Spain’s banking sector.

Source: Forex.com

08.05.2012