The FINANCIAL — August is quickly shaping up to become perhaps the most significant period of the euro zone sovereign debt crisis, with Spain, the region’s fourth largest economy, now on the ropes and gasping for breath.
The FINANCIAL — August is quickly shaping up to become perhaps the most significant period of the euro zone sovereign debt crisis, with Spain, the region’s fourth largest economy, now on the ropes and gasping for breath.
Madrid has been stumbling for some time now as investors demand record yields in return for taking on the risk of lending to the debt-strapped nation; however, it may well be events in Greece that tip Spain over the edge to become the most significant victim lying in Europe’s bailout pit. Greece is back on the market’s radar again. Athens must come up with a significant amount of cash this month in order to reimburse its bondholders—cash that may not appear from its international lenders who are yet to see concrete progress on the austerity measures that were attached to the nation’s bailout. The risk of Greece exiting the euro as early as this year and Spain passing its financial burden onto ill-equipped European authorities could see the euro sink below even the two-year lows that it reached against the US dollar in July. Of course, the European Central Bank may grudgingly step in to provide short-term support. That support could potentially come through another major liquidity operation in order to stop so many banks and regional authorities in Spain from leaning on the government for financial support, as this has already exacerbated Madrid’s troubles.
The more likely scenario, though, is that the ECB will deliver another interest rate cut at its next meeting on August 2nd to keep a focus on threats to economic growth. Admittedly, most analysts expect the ECB to simply signal another possible rate cut, but show growing concerns that debt troubles are seriously damaging the 17-member economy seemingly heading quickly towards recession. Germany is the main worry, since it drives a huge share of the area’s economic growth. Investors will look forward to August 14th, when Berlin will publish its second-quarter GDP result, which is expected to show a marked slowdown from the previous period’s uninspiring 0.5% growth. More monetary support from the ECB is therefore widely expected, and that is pushing the euro towards the wrong end of carry-trade activity.
A low-cost liquid currency used to chase higher-yielding units is clearly evident in the euro’s drop to new all-time lows versus the Australian dollar last month, and that trend could develop further in August. Economic worries should persist over the coming weeks, but it is really the fiscal crisis that is more likely to make or break the euro. On one hand, Spain’s current malaise may bring forward another wall of bearish euro bets. On the other, Germany could relent and lead another anti-crisis response from politicians who will be desperate to regain the market’s confidence. Euro zone finance ministers are not scheduled to come together in August, but any emergency meeting may raise hopes of a response and almost certainly give the beleaguered single currency a much-needed boost.
GBP: United Kingdom, Joe Manimbo, Senior Market Analyst — The 2012 Olympic Games in London should exert a temporary, but positive influence on the UK economy, boding well for the pound’s fortunes during the middle month of the third quarter. Since London is already a popular tourist destination, the London Games are not likely to give the economy a meaningful long-term boost. Rather, it will likely remain on a vulnerable footing, keeping central bankers on their toes. Estimates vary, but the revenue generated by the Olympics in ticket sales and travel-related expenses could be good for an added 0.3 percentage points in growth during the July-September quarter.
Sterling was poised for a generally positive start to August, having rebounded from the five-week lows to which it had fallen against the dollar in mid-July. It spent the first half of last month on its back foot after the Bank of England dented its allure on July 5th with a £50 billion boost to its asset-purchase programme, increasing it to £375 billion. The BoE’s bond purchases are designed to push down long-term borrowing rates, giving businesses and consumers easier access to credit to help spur the economy.
The view that the US central bank was next in line to loosen policy helped lighten the weight on the pound, but, until Britain climbs out of its second recession in four years, Sterling could be vulnerable to downside against the dollar. Sterling’s performance in August will hinge on the health of the US economy. The pound should find support if the world’s No.1 economy continues to sputter, which would increase pressure on the Federal Reserve to take further action to boost growth—action such as launching another massive round of bond-buying, or a so-called QE3. Against the euro, the pound could log another gold-medal- calibre performance in August, as the UK unit is considered a safer alternative to the common currency of the debt-saddled union.
The pound spent the better part of July at its strongest levels in more than 3.5 years against the euro, as European policymakers came up short in their bid to bolster investor confidence in their handling of the nearly three-year-old debt crisis. A continued upward march in government borrowing costs for Spain and Italy would intensify contagion fears, keeping the euro’s downtrend intact. To better determine how the pound will fare this month, investors will look to an August 1st policy decision by the Fed, and study key growth and jobs data on both sides of the Atlantic.
USD: United States, David Starkey, Senior FX Trader — July was a strong month for the Greenback, which benefitted heavily from a deteriorating Europe. The USD Index advanced to multi-year highs around the 84.00 handle as the European spending crisis looked to sink its teeth into a fresh victim: Spain. July also saw the economic situation in the USA deteriorate, spurring investors to pile money into less-risky assets like US treasuries, the yields of which hit all-time lows as markets sacrificed premiums for perceived safety. And finally, talk of QE3 took up its fair share of headlines as speculation ramped up following the release of June’s Fed Minutes. Looking forward, the USD remains at the mercy of Europe, just like every other financial asset. Should the situation there continue on its current path, the USD is likely to continue to outperform given the attractiveness of US government debt instruments in an unstable environment. From a technical perspective, the Dollar Index has lots of room to advance. There is little in terms of historical levels that offers much in the way of resistance. The descending frontier of a multi-year pennant formation around the 87.00 level will provide critical resistance over the medium term. Domestically, the same three deeply intertwined themes dominate the conversation when it comes to valuating the Greenback: the prospect of QE3, the fiscal cliff, and the domestic economic recovery (particularly in the housing and employment sectors). With the possibility of QE3 increasing post-Fed Minutes, so too have the chatter and rumour rallies. The reality is that despite the fact that some of the committee are starting to lean the way of additional stimulus, Chairman Ben (aka “The Beard”) Bernanke doesn’t seem convinced. That said, central bankers are somewhat like carriage drivers in that regard: they will tempt (or threaten) you with something until you become accustomed to the idea. That way, by the time the carrot (or whip) of cheap cash is doled out, investors won’t behave as frantically. They will simply bid up the stock markets and growth assets in an orderly fashion, as they have twice before. Turning to the recovery, July can be best described as anaemic; it’s easier to list indicators that didn’t miss expectations. Of the major economic indicators, only some of the weekly unemployment claims results and the producer price index were stronger than expected, and even then, only just. Everything else missed: non-farm payrolls, new and existing home sales, retail sales, the consumer price index, consumer sentiment, and ISM manufacturing. If GDP in the US is expected to stage any kind of a comeback, all of the above are going to need to be addressed. This leads us into the final topic of discussion, the fiscal cliff. As has been discussed at length, if all tax cuts are permitted to expire it will effectively kill any chances of real economic growth; meanwhile, a complete extension would push the deficit to unsustainable levels—middle ground is needed. What that middle ground may look like is sure to be a key (and entertaining) part of this November’s presidential elections. To sum everything up, if the global economy continues on its current path, the USD is well positioned to benefit. In almost any other scenario the USD will give back: QE3, containment in Europe, and advancing domestic recovery.
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