Political turmoil raises fears over Europe’s recovery
Political tensions from the euro zone, in particular in France and the Netherlands, dominated market headlines at the start of the week. Risk appetite opened on a sour note, as the political turmoil raised doubts about the ability of euro zone nations to push through with planned budget cuts. Weak private sector data given by purchasing managers’ surveys from Europe’s two largest economies and the currency bloc also weighed on sentiment, and renewed worries about Spain intensified concern over the euro zone debt crisis.
At the end of last week, risk appetite was driven higher by upbeat PPI and IFO numbers from Germany and better than expected retail sales from the United Kingdom. Sentiment was also lifted by strong US corporate earnings. Higher-yielding currencies rallied strongly and ‘safer’ bets like the US dollar and the Japanese yen were under pressure.
EUR/USD rallied to its highest level since early April last Friday, to 1.3225. The pair then sold-off aggressively at the opening on Monday, tracking riskier assets and Asian equities lower, as the initial indications from the French elections left many doubts on who will emerge on top. The first indications showed right-wing voters will be a determining factor in this year’s vote, after LePen received around 18 percent of the total vote. Sarkozy will now have to adopt a more nationalistic approach to appeal to right-wing voters if he wants to reverse the first round deficit. At the end of the first round, Sarkozy was playing catch-up to Hollande with 27.1 percent of the votes compared to Hollande’s 28.6 percent.
Results from the IMF/World Bank meeting over the weekend also emerged, with the outcome that the groups pledged more than €430bn in support for the economic crisis, without earmarking them directly to the euro zone.
EUR/USD continued to edge lower on Monday, weighed by slumping euro zone manufacturing and services activity and rising Spanish yields. News that Dutch Prime Minister Rutte tendered his government’s resignation continued to pile the pressure on the single currency and risk sentiment in general. The news that the Dutch government reportedly collapsed over budget cuts disagreement increased tensions, as the Netherlands is seen as one of the bloc’s most stable nations, and raised fears the euro zone could struggle to push through austerity measures and may stay in recession longer.
FOMC to shed more light on QE3
The pair trimmed some of its losses on Tuesday but gains were subdued and EUR/USD remained locked in its recent range. It has been range bound for most of the past month between 1.3000 and 1.3200 as latest employment data suggested the rate of growth in the US jobs sector is slowing, which has kept dollar gains in check. The Federal Reserve started its two-day FOMC meeting today and is scheduled to announce its policy decision tomorrow. The Fed has been reluctant to shed more light on whether or not it will embark on further quantitative easing, but forex investors will nonetheless be keeping a close eye on this meeting, given the still-fragile US economic recovery, and to capture any hints on future Fed policy.
BOJ may add to monetary stimulus
USD/JPY will also be in the limelight in the coming days as the Bank of Japan is scheduled to announce its rates on Friday. Contrary to the Fed, which is not expected to make any changed to its policy, the BoJ may announce an increase to their asset purchases program, which should make the Japanese yen depreciate against its major rivals. The USD/JPY is still holding steady, but is looking fragile especially since hawkish expectations on future Fed policy have been subdued lately. The pair however may rally strongly if it manages to close above its 100-week moving average, now by 81.37.
RBA likely to cut rates
The Australian dollar fell to a 2-week low against the dollar on Tuesday, hurt by an inflation report which showed consumer prices were lower than expected in the first quarter. The Aussie was half a percent lower against its major peers, as its headline inflation figure dropped sharply to 1.6 percent y/y versus a forecast for 2.2 percent. AUD/USD fell to 1.0247, extending its drop from Monday where it closed below its 200-day moving average by 1.0374. With Tuesday’s CPI data, and also Monday’s lackluster producer prices data, a rate cut in the next policy meeting by the Reserve Bank of Australia is now highly anticipated and some are even expecting a 50 basis point rate cut to be spread evenly between the May and June RBA meetings.
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