A NEW THEME FOR THE EURO DESPITE AN AILING ATHENS
ANOTHER week has passed by without a deal from Athens and the currency markets are clearly starting to suffer from headline fatigue. While the risks are quite serious, the markets continue to believe in an 11th hour deal – which is why the fallout in the euro has been relatively modest. Yet the longer the saga continues the more uncertainty it will invite. The situation will then enter into uncharted territory, as Greece will face the prospect of hard default opening up the risk of massive counter party losses.
Away from the drama in Athens, however, another theme is unfolding that may have much stronger consequences on currency trading as the year progresses. Last Friday’s Non-Farm Payroll (NFP) report blew out all expectations printing at nearly 50 per cent more than the consensus estimate and in the process may have changed the terms of debate in the currency market. US employment increased by 243,000 jobs versus 150,000 eyed, the unemployment rate declined to 8.3 per cent from 8.5 per cent forecast. Aside from instantly raising the odds of President Obama’s reelection on the Intrade website, the bullish NFP report also markedly reduced the chances of additional quantitative easing (QE) by the Fed.
Friday’s much better than expected labour data indicates that the Fed will not engage in further QE as the need for monetary stimulus has diminished. That means, all things being equal, the Fed’s balance sheet should remain relatively stationary. Meanwhile both the European Central Bank (ECB) and the Bank of England (BoE) are expected to continue easing aggressively as the year progresses. The ECB will expand its balance sheet through the LTRO with most analysts expecting an uptake of as much as €1 trillion (£829bn) at the next tender offer, while the BoE is expected to increase its QE program by £50bn in order to support the recovery in UK economy.
Although the Federal Reserve is hardly a paragon of fiscal virtue, in FX everything is relative. With G-3 interest rates expected to remain near zero for the foreseeable future, currency investors may be starting to focus more on balance sheet issues instead of risk flows.
In short, if the currency market is now in the process of changing its focus from economic growth to balance sheet integrity then the US dollar may become the beneficiary of this new dynamic.
This week the market will focus on both ECB and BoE monthly meeting announcements, both scheduled for Thursday. Neither central bank is expected to make any changes in interest rate policy, but traders will no doubt hang on every word of ECB President Mario Draghi during his monthly press conference at 1.30pm this Thursday. If he indicates that the ECB is prepared to maintain its LTRO facility for the foreseeable future, the euro could weaken further as traders begin to price in the massive balance sheet expansion. Meanwhile Greece still remains a nagging problem for the Eurozone and if the deal comes undone it could prove to be a perfect storm for the single currency as the week progresses.
For now the markets remain in consolidation mode with a $1.3000 level continuing to hold. The currency pair remains grossly oversold with the latest COT data showing only modest reduction in shorts from 172,000 to 158,000 and this skew in positioning is one of the primary reasons for its relative strength. However, that factor alone will not be enough to support the euro if the currency market begins to consider the balance sheet damage that a Greek default would entail.