Forex: Euro, Greece, China and NFPs...

• Forex: Euro, Greece, China and NFPs...
• AUD: Impact of Chinese Rate Cut
• USD/CAD Surges as Oil Declines
• NZD Drops on Risk Aversion
• Dollar: Growth versus Safety
• GBP Rallies as Investors Convert Euros to Sterling

Forex: Euro, Greece, China and NFPs...

We have spoken to many traders today and they are thoroughly confused by the performance of the euro. With senior Greek government officials saying that tomorrow's payment to the IMF will not be made, the euro should be trading much lower. However instead of falling it ended the day sharply higher against the U.S. dollar.  In fact, EUR/USD rose close to 3% intraday from a low of 1.0955 to a high of 1.1278.  While some investors may welcome a potential Grexit, we do not believe that the turnaround in the currency represents the market's satisfaction with the imminent default.   Some investors are still hopeful that a deal would be reached eventually given the supportive comments from Eurozone officials. We've heard from many European policymakers this morning and they are either trying to downplay the impact of the Greek crisis or saying that a deal is still possible including EU's Oettinger, French Finance Minister Sapin, President Hollande and Spain's De Guindos. We haven't heard much from Merkel but according to Schaeuble, the Greek government won't be able to destroy Europe. There is still a small chance that a deal could happen but with less than 24 hours to go before the June 30th deadline, mountains need to be moved for an agreement to be made. However even if Greece officially misses the IMF payment tomorrow, Managing Director Christine Lagarde won't classify Greece as defaulted for a few more weeks.   At minimum, they will wait for the referendum to see if the Greek people will accept the deal. 

The euro is also being supported by intervention from the Swiss National Bank who is buying EUR/CHF to actively weaken the Swiss Franc.  Many investors also unwound their long euro positions going into the weekend and on Sunday evening but once the initial move faded, the unwind of short euro carry trades filled the gap in the currency. When the FX market opened on Sunday, the single currency dropped from 1.1150 to 1.0955 after Greek Prime Minister Tsipras called a referendum on the new bailout deal on Friday evening.  At the time, many investors dumped euros on the fear that a default and Grexit would drive EUR/USD to 1.05.  Talks completely broke down over the weekend on the back of this radical and incoherent move from Greece. In response, Eurozone Finance Ministers refused to extend the bailout beyond Tuesday. On Sunday, the Greek government moved forward with this plan by setting a date for the referendum (July 5th) and shortly after the European Central Bank refused to increase the level of Emergency Liquidity Assistance despite waves of withdrawals. In turn, the Greek government was forced to close banks for the next week, institute very low withdrawal (USD$66) limits, transfer restrictions and close the stock market, triggering widespread fear that a default and Grexit would be next.  

So in a nutshell, the 3 reasons for the turnaround in the euro are the following: 

1.     Hope that a Deal is Still Possible or at least that an extension would be provided to cover referendum period
2.     Swiss National Bank buying euros
3.     Gaps filled on unwind of euro carry trades 

The Greek government's willingness to walk into the fire is a dangerous proposition for Europe and the global markets. We have already seen steep sell-offs European equities and the uncertainty in the coming days will lead to further weakness. So while the EUR/USD recovered, the decline in stocks and rise in bond yields is consistent with our view that the euro should be trading lower.  We have sold euros on this bounce and expect another move below 1.10.

In addition, the market's appetite for risk has been completely changed by this latest chapter in the Greek debt crisis so not only do we expect EUR/USD to trade lower, but other high beta currencies could see further losses as well. If the sell-off gets out of hand, we could see the ECB step into the market and buy bonds but that would require a far more volatility.  Aside from the financial crisis that Greece now faces, the other big uncertainty is the referendum.  A yes vote would humiliate Mr. Tsipras and most likely lead to steps remove him from office but also prompt a deal with creditors.  Political uncertainty is bad but a no vote would be worse because it would put Greece on the path to Grexit. In the long run, that may be positive for the Eurozone but in the short term, it would mean contagion for markets around the world. 

AUD: Impact of Chinese Rate Cut 

While investors were focused on Greece and the euro, the other big development over the weekend was the surprise rate cut by the People's Bank of China. Frustrated by the deep sell-off in the equity market, the PBoC responded with its fourth lending rate cut in 7 months. Rates were shaved by 25bp and the reserve requirement ratio was cut by 50bp.  Cutting the interest rate or the reserve requirement ratio independently is significant but the last time both rates were reduced at the same time was in 2008.  Chinese stocks have been hit hard in recent weeks. Since their June 12 peak, the Shanghai Composite Index is down more than 20%.  Investors are nervous about slower growth at home and uncertainty abroad. Unfortunately the PBoC's move failed to halt the slide in Chinese stocks and had only limited impact on the commodity currencies. The volatility in Chinese equities and the risk aversion created by the Greek crisis poses a serious risk to Australia and New Zealand because the move is reactive and not proactive. Meanwhile, the Canadian dollar was hit the hardest today.  Lower oil prices offset the rise in raw material and industrial product prices. New Zealand business confidence is scheduled for release this evening followed by Canadian GDP numbers on Tuesday.  While these reports are important, risk appetite will be the primary driver of the commodity currencies. 

Dollar: Growth versus Safety 

How the U.S. dollar trades this week will depend on whether the market cares more about growth or safety.  The U.S. dollar is a safe haven currency and if the crisis in Greece deepens more than it has already, investors will sell high risk currencies and buy safe haven currencies.  The two most popular safe haven currencies are the dollar and the Japanese Yen. We have already seen both of these currencies move higher on the back of the uncertainty in Greece. This month's non-farm payrolls report is extremely important but how the Greek crisis plays out could have an even more significant impact on the greenback because it could affect the Federal Reserve's plans for tightening.  If for example U.S. stocks fall 10% in reaction to deteriorating conditions in Greece, U.S. policymakers will have to reconsider raising rates in September.  Even if the Greek crisis does not directly affect the U.S. economy, the impact on European markets has and will continue to spillover to U.S. equities. Stronger than expected U.S. data this week would only make the dollar more attractive but the dollar will see its strongest gains against risk currencies and not the yen.  With NFPs, there will be less focus on the absolute amount of job growth and more focus on the unemployment rate and average hourly earnings but how much it impacts USD/JPY will depend on risk appetite. 

GBP Rallies as Investors Convert Euros to Sterling 

The British pound ended the day unchanged against the U.S. dollar.  U.K. mortgage approvals and consumer credit fell short of expectations but investors shrugged off the release because the risk of holding euros has made sterling increasing attractive. While the Bank of England is next in line to raise interest rates, no one expected them to do so this year.  As a result, the outlook for the currency has not changed significantly with the crisis in Europe. Instead, investors are shifting their funds from euros to sterling on the fear that a Grexit could lead to more volatility in the currency. UK first quarter GDP and current account numbers are scheduled for release on Tuesday. Stronger numbers are expected and an upside surprise on D-Day for Greece could mean renewed weakness for EURGBP.