Euro should weaken, but don't expect too much of it

On Friday, there was no clear directional trend for the major dollar cross rates. There was no guidance from the US and European investors were in wait-and-see modus ahead of the Greek referendum. EMU eco data were ignored. Investors took note of the last poll that predicted a tie between the “Yes” and the “No”. EUR/USD was little changed in the 1.11 area and traded in a 30 ticks range. The pair closed at 1.1114, up 28 ticks versus the previous close. USD/JPY lost a few ticks and closed at 122.79, a 28 ticks loss compared to Thursday’s close. While in the Bund there may have been a small safe haven bid, the euro’s micro gains may have been due to some investors closing carry trades funded in euro. However, as the moves were very small and gradual, we wouldn’t over interpret them.

Overnight, Asian markets reacted on the “No” outcome of the Greek referendum (for full coverage, see our Flash report) and on the measures taken by the Chinese authorities to shore up the crashing Chinese equity markets (see news headlines). Asian bourses are down slightly more than 2% (Japan), more in volatile China (-4.5%), while losses in most other Asian bourses are more limited. The T-Note future is one point higher on safe-haven flows. EUR/USD opened around 1.0980 from Friday’s close at 1.1114, touched a 1.0969 low in early Asian trading and climbed since to about 1.1070. The yen profited from its safe haven status. USD/JPY opened sharply lower at 121.70, but moved up to 122.60 where it still trades. So the impact of the referendum is qualified as modestly.

Today, the “No” at the Greek referendum will dominate trading. We don’t expect already important turns on the political side. The eco calendar is thin with the US Non-manufacturing ISM and the EMU Sentix investors’ sentiment (see higher for more details). The Sentix is no market mover, but the Non-manufacturing ISM may have some effect on the dollar. A very strong figure may raise expectations for a September rate hike, even as the payrolls have cooled such expectations to some extent.

A priori, the increased probability of a Grexit is intrinsically a euro negative. Indeed, it puts (some) doubt about the long term viability of the euro. It might convince big investors and central banks to lower their exposure as the status of second reserve currency will be questioned. However, recent price action shows that risk-off sentiment and lower core bond yields are often at least as negative for the dollar as for the euro. The immediate fate of the euro will probably depend more on expectations on further ECB actions. If the ECB would increase its QE programme or take other measures to ease its monetary policy stance, the euro should weaken versus the dollar, unless contagion would convince the Fed to delay its lift-off. It that case, the euro weakening may be more moderate or even negligent. The yen might profit from the risk-off sentiment as it is the safe haven by excellence. However, also here we think that the strengthening of the yen may remain contained.

In a longer term perspective, EUR/USD still trades in the 1.0819/1.1467 consolidation range. We maintained a sell on upticks approach for return action lower in this range. We are well aware of the risks of a Grexit and given a higher probability of additional ECB easing, the 1.0819 may be tested in the days/weeks ahead. The 1.1534 February correction top remains our line in the sand to maintain a USD positive bias MT term and this resistance became now much stronger. On the downside, the 1.0819 level (27 May low) is the first high profile reference. A break below that level would open the door for a retest of the 1.0521/1.0458 area. A sell-on-upticks approach around 1.1280 area is preferred. Uncertainty on Greece might continue to cause erratic swings.

No substantial gains for sterling at opening.

In technical trade, the euro drifted marginally higher in early European dealings on Friday and the move also helped EUR/GBP to sustain north of the 0.71 big figure. The UK services PMI rebounded much more forcefully than expected, from 56.5 to 58.5. This points to ongoing strong growth in UK domestic demand, which was already the main driver for UK overall growth of late. Remarkably, sterling hardly reacted to the strong PMI. EUR/GBP and cable were confined to a tight range, but in late European trading sterling started to lose ground against both the euro and the dollar. EUR/GBP ultimately closed at 0.7138, up from 0.7110 on Thursday, while cable fell to 155.70 from 156.09 previously. We suspect the moves were technical in nature and in EUR/GBP maybe linked to the failed test of the lows earlier last week.

Today, the UK New car registrations and the EMU sentix investors’ sentiment survey will be released, but we don’t expect these to influence sterling trading. Sterling will get its clues from the way the majors will be trading.
Sterling recently often had some safe haven ‘aureole’ when the dollar and the euro had both their ‘issues’, but this isn’t visible at the start of trading. EUR/GBP opened lower in the Far East, but has recouped these losses trading at 0.7109, which is still below Friday’s 0.7140 close though. The downside in sterling is well protected, both against the euro and the dollar, but whether sterling will rapidly go to its highs against the euro is less obvious, also as it couldn’t really profit from the strong PMI last week.

We had a cautious sell-on-upticks approach and expected EUR/GBP to drift lower in the 0.7483/0.7014 range. Sterling momentum remains constructive, but we turned more cautious on sterling as EUR/GBP neared the range bottom. We keep the working hypothesis that high profile news is needed to push EUR/GBP sustainably below 0.70. The day-to-day EUR/GBP momentum turned neutral this week.