The FX market is a capricious beast – yesterday the dollar was sold, today it’s been bought. A trend has been hard to find in these stop-start markets as traders struggle to see a clear path of where currencies go next. Interestingly, European stocks have bucked the trend set by the US markets yesterday and traded the first day of the new quarter in an upbeat style (yesterday, European markets were closed for Easter). This upbeat tone is in contrast to the FX world, which has seen a reversal in the dollar’s fortunes (it sold off yesterday and is strengthening today), the euro, GBP and yen are weak across the board, while the NZD and AUD have extended their gains from the Asia session.
Digesting European data
These markets can be difficult to wade through and organise the important information into a useable format, so let us help you out a bit. The first week of every month is full of important nuggets of economic and macro information. Earlier we had Eurozone PMI’s for Europe and the UK, Eurozone unemployment data for February and inflation data for Germany. Let’s take Europe and the euro first: the data was weak. From a fundamental perspective there is nothing to drive the euro higher. PMI’s across the region are declining and unemployment is at a record high. Ireland, considered the poster boy of this crisis, also saw a sharp decline in its manufacturing PMI, which declined from 51.5 in February to 48.6 in March. It seems that the Cyprus crisis hit sentiment, and not even the sharp decline in the euro could help exports.
The fresh record high in unemployment to 12% for the Eurozone as a whole (the regional rates vary widely), suggests that wage growth could be held at bay limiting the upside for inflation. This has one benefit: it could open the door for more policy action from the ECB. The central bank meets this Thursday and there are no expectations for a rate cut or another policy action. However, the continued rise in unemployment and decline in today’s PMI data increases the odds of a surprise rate cut. We will be sending out our ECB preview later this week, but overall, even without fresh policy action we expect Draghi to be dovish and potentially talk down the euro.
So what about the technical perspective?
This isn’t looking much more constructive for the single currency either. After an attempt at a relief rally after the Cyprus crisis and on the back of news that Italy’s President was putting together a team of “12 wise men” to govern the country, potentially a precursor to another technocratic government, the rally petered out ahead of 1.2890 - 200-day sma on the close and a key resistance level. Support levels include 1.2820 then 1.2750- the low from last week. At this stage we can’t see how Draghi can talk up the euro later this week, so we believe the risks are to the downside for the single currency on the back of this week’s ECB meeting. We like to express this with both EURUSD and EURAUD. A break below 1.2820 in EURUSD opens the way to 1.2750 then to 1.2660 – the low from November. In EURAUD, a break below the 1.2245 lows from last week could see a further extension of losses back to 1.20 in the medium-term.
Is Slovenia the next domino to fall?
The head of Slovenia’s central bank has been defending the financial needs of his country’s banking sector today. He was forced to admit, during a press conference, that Slovenian banks are borrowing “a lot” from the ECB, but he said that no bank needed emergency financial assistance. However, if they do, the central bank head was quick to point out that assistance would be given. A lot of people have looked to Italy as the next domino to fall, but in reality there could be a few other smaller countries to go first and right now Slovenia is in the firing line. The problem with Slovenia is a common one in the currency bloc: a weak economy, rising non-performing loan ratios and rapidly rising bond yields are usually the common path to a full blown crisis. Slovenia is considered more manageable than Cyprus as its banking sector is a mere 120% of its GDP, compared with 700% for Cyprus. However, another casualty so soon after Cyprus comes at a delicate time for the Eurozone as the market digests the concept of the “bail in”, and potential depositor haircuts. This could accentuate Slovenia’s problems if deposit flight sees money flowing out of the country.
Overall, Slovenia, like Cyprus, is too small to be systemic, but it could further erode demand for the euro, as investors ask how much further will this crisis go?
Rare good news for Spain and Italy ignored
The performance of the euro masks some “good” news from Italy and Spain. Unemployed people in Spain declined by 5,000 in February, while the Italian unemployment rate fell to 11.6% from 11.7%. However, the market is seeing this as more of an anomaly in an otherwise bleak economic landscape. Added to that, Spain is in further negotiations with the EU to increase its budget deficit target for this year to 6% of GDP from the 4.5% original target. This hasn’t hurt bond yields, the 10-year yield on Spanish government debt is back below 5%, and close to a three year low.
Elsewhere, the key data releases later are US factory orders, and there is a raft of Fed speakers later. Lockhart and Kocherlakota are the highlights. Watch out for any headlines on Italy and its 12 wise men. Also, the BOJ meeting, the first under new Governor Kuroda, starts tomorrow. We think USDJPY will range trade into the meeting, with 93.00 acting as good support, and 94.50 thwarting bulls until we get a better idea if Kuroda has bite as well as bark when it comes to aggressive policy action.
It is also worth watching the SPX 500 today. It fell back from record highs yesterday, and a bearish engulfing candle pattern suggests that the markets are trying to find a top. However, can the index muster a rally after the strong performance of European stocks? Q1 earnings season kicks off today; so far Chrysler has reported strong results.
Oh, and Cyprus’s finance minister resigned due to an “on-going investigation”, the euro was higher on this news, but only temporarily as Cyprus seems to be on the back burner this week.
One to watch: EURUSD - prior to the ECB