You would be forgiven if you thought that the European mess was presently over. Markets had expected ‘le plan’, chalked out by France to roll over Greek’s debt (340b euros), coupled with Greek fiscal cuts, to put a lid on things. However, fate had different plans. End of the trading week, and we are up right where we started. Although the predicament is not as serious as Greece, but certainly has the potential to exacerbate into something far more sinister for the euro.
On Monday, Moody’s credit rating agency stomped down on Portugal by cutting the country’s rating to junk status, outlining its concerns about the country’s looming liquidity squeeze. The news shadowed EUR/USD for the remainder of the week, plummeting euro two per cent against the dollar all the way from 1.4560 to 1.4250.The downgrade is significant in itself, but the move has re-ignited concerns not only about Portugal but about other European confederates approaching the IMF for a bailout.
ECB has come out with gladiatorial force condemning the rating decision, categorically slamming oligopolistic clout of the rating trio. This uncharacteristic criticism might be to lend support to the euro, which has during last week eroded most of the gains made against the dollar post-Greek episode, and now appears to be heading towards short term support at 1.4100 during next week. But on close scrutiny, one realises that screams of anguish are much more personal to ECB. The bank has huge exposure to Portugal’s sovereign debt on its balance sheet. The downgrade would in principal force ECB to apply a haircut on the country’s debt to account for the decline in value, which they possess in-lieu of the bail-out funds and have extended to Portugal. Some estimates suggest that factoring in low rating of Ireland, Greece and now Portugal (please look away if you are squeamish) translates to a loss of around 100 billion euros for the ECB, which in contrast makes Lehman-loss seem like play money. In total the bank’s exposure to the struggling European economies duly named PIIGS is 444 billion euros.
The rate hike to 1.5 per cent helped widen the yield differential, but failed to support the European unit, firstly because the rate hike was already factored in by the market, and secondly, because it is seen as putting further pressure on countries like Greece, Portugal and Ireland. The Bank of England on the other hand kept rates at a record low of 0.5 per cent. Cable (as the GBP/USD cross is referred to), true to its personality of late, remained erratic through the week, but rose slightly against the dollar after a highly disappointing US non-farm payroll numbers. In addition, rising unemployment and shaky growth figures coming out of UK are also expected to keep the currency on weak footing in short to medium-term.
Traders who had earlier switched to USD from the weaker EUR threw in the towel after US unemployment numbers and jumped to relatively safer Franc over the weekend, pulling dollar down to 0.8361.The US data also ensured gold’s uninterrupted rise to 1542 at close from its open at 1493. Start of US corporate earnings season next week, along with political squabble on the debt ceiling, is expected to keep USD very much in focus. However, in the coming weeks all eyes are expected to unequivocally stay on Europe.
From a trading perspective, it would be wise to short EUR/USD as the bearish trend is expected to continue on Monday. However, Tuesday can potentially change the mood somewhat with encouraging German price index, although it is still advised to sell EUR/USD into rallies unless some major supporting news comes to surface, but watch out for major support at 1.4100. Cable (GBP/USD) on the other hand is expected to stay slightly volatile and range bound between 1.6130 and 1.5910, but overall it remains oversold and is expected to remain so.
USD is expected to consolidate against Swiss Franc in the coming days, but it is advisable to sell in sharp moves towards major support at 0.8300.
Yen could break out of its range bound snooze of June after BoJ monetary policy statement on Tuesday; major support is attached at 80.26.