'The current steps by the ECB may not be enough to prevent a prolonged economic downturn in Europe' - David Song, DailyFX

  David Song

PROFILE:
• Current Job:  Currency Strategist for DailyFX.
• Career: Graduated from the Zicklin School of Business with a Bachelor of Business Administration degree majoring in finance.

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David Song studied macroeconomic policies under a visiting scholar at the Federal Reserve Bank of St. Louis while attending the Zicklin School of Business at Baruch College, and graduated with a Bachelor of Business Administration degree majoring in finance. During his undergraduate program, David acquired a strong understanding of technical analysis from a former-president of the Market Technicians Association, and incorporates both fundamentals and technicals in his analysis. After starting at DailyFX.com, David authors the daily briefings for the U.S. Open as well as the Trading the News report.

Do you believe that the OMT program, launched by the ECB last week, will effectively stabilize the situation in the EU?

The European Central Bank’s Outright Monetary Transactions (OMT) program has helped to alleviate heightening finance costs across the periphery countries. However, the non-standard measure will only help to buy more time as the governments operating under the monetary union struggles to get its house in order. As European officials become increasingly reliant on monetary support, the ECB may come under increased pressure to shore up the ailing economy, and the central bank may have little choice but to implement a range of tools over the coming months as the region remains at risk for a prolonged recession.

Do you expect Greece to prepare an austerity plan which will satisfy the Troika and which will allow for the release of the next tranche of the bailout before the country runs out of money?

Greece is certainly struggling to secure the next tranche of its bailout payment as the Troika – the EU, ECB, and IMF – questions EUR 5.6B of the EUR 11.6B austerity package. We may see the budget-cutting measures come under increased scrutiny as the region looks for an extension in meeting its deficit target. In turn, the group may put increased pressure on the Greek government to get its house in order and may play a more direct role in implementing the austerity program as the heightening threat for contagion continues to undermine the stability of the monetary union.

The U.S. Congress is running out of time to address the ‘fiscal cliff’ and the lack of a near-term solution may encourage the Federal Reserve to expand monetary policy further as the withdrawal of fiscal support dampens the outlook for growth and inflation. However, as the slowing recovery raises the threat for a double-dip recession, we should see U.S. officials make a greater effort to encourage private-sector activity. Congress may look at new public incentives to foster economic activity amid the ongoing weakness in the labor market.

Indeed, the EURUSD continued to retrace the decline from earlier this year, with the pair making a run at the 1.3200 figure. The relief rally is likely to be short-lived as the fundamental outlook for the euro-area remains bleak. As the region faces a deepening recession, the current steps by the ECB may not be enough to prevent a prolonged economic downturn in Europe and the central bank may move towards a zero-interest rate policy (ZIRP) as growth and inflation falter. As the near-term rally in the EURUSD remains overbought, the pair looks poised for a technical correction, but the single currency may face additional headwinds over the near-term as European policy makers struggle to restore investor confidence.

Speculation for a currency intervention have certainly resurfaced as the USDJPY slipped below the 78.00 figure, but the Bank of Japan may continue to rely on its asset purchase program as it aims to achieve the 1% target for inflation. Although Japanese Finance Minister Jun Azumi pledged to take ‘decisive action’ against the persistent strength in the local currency, positive real interest rates in Japan have made the Yen very appealing in the low-yielding environment. The central bank may refrain from intervening in the currency market as the measure appears to be having a diminishing effect.