Risk recovers but outlook for euro remains grim
The euro managed to take a breather on Tuesday, lifting its head above water after plunging across the board in the previous three sessions. Commodity currencies also advanced as risk appetite improved despite Standard & Poor’s downgrade of the European Financial Stability Facility (ESFS) to AA+ from AAA.
S&P’s latest downgrade came in the wake of the agency’s downgrades of nine euro zone nations including France and Austria who were stripped off their AAA status. The CEO of the EFSF, Klaus Regling, in response to the downgrade said the facility’s investor base was well-diversified and outlined that it still holds AAA ratings from two other agencies. However, ECB President Draghi warned that such a move would eventually have its ‘consequences’.
Germany, one of only nine AAA countries globally, not on a negative outlook left, quickly rejected any possibility of raising its guarantees for the EFSF, saying that current funding was adequate. The Finance Ministry also said that it saw no need to act on the European Stability Mechanism (ESM).
Euro plummets on S&P downgrades
The single currency fell very sharply across the board late on Friday as rumors started surfacing of S&P’s action, which were not confirmed till close, but by then the damage had already been done. Italy, Spain, Portugal and Cyprus each suffered a two-notch cut, with Italy now falling to BBB+ only three notches above ‘junk’. Other countries cut by one notch apart from France and Austria were Malta, Slovenia and Slovakia.
The single currency was already under pressure on Friday, following a lukewarm Italian auction. The Italian debt sale attracted satisfactory demand but was nowhere near as impressive as the Spanish bond sale the previous day, in which the Spanish Tesoro sold double the initial target of €5 billion in three-year paper. EUR/USD plummeted more than 250 pips on Friday to a 17-month trough at 1.2624. EUR/JPY also extended its decline and fell to an eleven-year low of 97.04 at the start of this week.
Pound dubbed ‘semi-safe haven’
The pound has also been favored by recent events surrounding the euro zone periphery. Given the United Kingdom’s relatively stable ratings status, compared to the euro zone, and gilt markets continuing to provide adequate liquidity. Sterling has been sought by forex investors as an alternative to the US dollar. In fact it has been dubbed a “semi-safe haven” as traders are increasingly seeking it for protection from the sovereign debt crisis.
EUR/GBP continues its downward trend from its one-year peak of 0.9083 in July 2011. It lurks close to a 16-month low hit earlier this month at 0.8222. The pair is expected to continue its current trend, and trade lower towards the 0.8000 level. Support is seen lying around the recent low levels at 0.8220 and 0.8160.
Sentiment buoyed by strong economic data
Risk appetite nudged higher on Tuesday and higher-yielding assets rallied across the board. Risk was buoyed by strong Chinese GDP data and stronger numbers from Europe. Both Spanish and EFSF bond auctions were relatively successful and the euro pushed higher. The German ZEW was strong, with the economic sentiment indicator printing -21.6 versus consensus for -49.4 while the current situation index improved to 28.4 against a forecast for 24.0. Economists were saying that ECB liquidity, lower yields and better US data boosted sentiment.
In separate bond auctions on Tuesday the EFSF sold €1.501 billion of six-month bills at an average yield of 0.266 percent, while Spain sold €4.88 billion in short term treasury bills, at the higher end of the €4 to €5 billion target range. Borrowing costs fell for Spain to 2.049 and 2.399 percent compared to the previous 4.05 and 4.226 percent for similar maturities.
The single currency was also supported with talk of a possible intervention in EUR/JPY after Japanese Finance Minister Azumi said he had not yet made a decision on the matter. However, the single currency was losing some of its initial strength by the time of writing as the outlook remained bleak with risks of a Greek debt default and prospect of more interest rate cuts by the European Central Bank hanging over it. EUR/USD pared some of its gains at the time of writing. It dipped down to 1.2711 from a high of 1.2809.
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