special report

EURUSD – Short-covering remains the dominant driver of Euro price action, with spot prices still showing a strong inverse correlation with the IMM measure of net speculative short positions on 13-week percent-change studies. Bets against the single currency have now fallen below their one-year average but the market remains skewed to the short side by historical standards, hinting the pace of readjustment may slow but should remain as a supportive factor for the time being.

This seems especially true considering the ease with which the Euro shrugged off the deeply flawed results of EU bank stress tests released last week. By any measure, the aim of the exercise was to show that European banks are adequately capitalized to withstand a sovereign default within the EU or its immediate periphery. Interestingly, the Committee of European Banking Supervisors (CEBS) that administered the tests apparently ignored the majority of banks’ holdings of sovereign debt. Indeed, CEBS said it only took account of losses on those government bonds held on lenders’ trading books – a small minority of their total holdings – most of which sit on their banking books (meaning the bonds are intended to be held to maturity rather than actively traded). Banks need to write down losses from these long-term holdings only in the event of serious doubt about the government’s ability to meet its obligations, which is precisely what would occur in a default scenario.

On balance, it would appear the stress tests were not nearly rigorous enough to truly instill confidence in the European banking sector, a reality that would be expected to have weighed heavily on the exchange rate, but this has not materialized so far, suggesting short-covering has delayed the day of reckoning for the near term.

German retail sales and unemployment reports as well as region-wide CPI figures headline the economic calendar.

Source: Bloomberg

GBPUSD – Short-term monetary policy continues to be in focus, with the correlation of spot prices and the spread between the two countries’ 1-month Libor rates holding at a firm 0.6. The week is fairly light on economic data, hinting the path of least resistance favors gains as the currency rides last week’s unexpectedly strong GDP figures. That said, consumer lending figures may prove of note as traders size up the economy’s ability to produce self-sustained recovery as the government lurches toward austerity. Finally, City minister Mark Hoban may stir volatility as he delivers a speech to top bankers and business people on Monday outlining details of the plan to scrap the Financial Services Authority – the UK’s heretofore top financial regulator – and hand its powers over to the Bank of England, as well as details on the coalition government’s tax system reform efforts.

Source: Bloomberg

USDJPY – The direct near-term correlation with risk sentiment has weakened considerably, leaving prices to track their long-term catalyst: the yield on the US Treasuries. This puts the spotlight on US data as investors size up the health of the world’s top economy and its implications for the rates outlook, with the spotlight on Friday’s preliminary second-quarter GDP report. Expectations call for annual growth rate of 2.5 percent, down from 2.7 percent in the three months though March. A slowdown should not prove too damaging in and of itself considering it has likely been priced in given the soft tone apparent in recent leading indicators, so a print in line with or close to expectations may actually prove to boost yields and the pair along with them. Alternatively, a downside surprise is likely to weigh on both. The earnings docket is significant as an indirect driver by way of shaping US growth expectations heading into the end-of-the week release.

Source: Bloomberg

USDCAD, AUDUSD, NZDUSD – The commodity bloc remains closely tied to risk sentiment, with the correlations between prices and the MSCI World Stock Index actually stronger compared with a week ago (AUD: 0.92, NZD: 0.86 and CAD: 0.88) on 20-day percent-change studies. This keeps the onus on the US earnings season and what investors are able to derive from it by way of an outlook on the sustainability of the global economic recovery.

The economic calendar is fairly busy. Australian CPI is expected to tick higher, topping the RBA’s target level with a print at 3.4 percent in the year through the second quarter. However, the central bank has said it expects a temporary uptick “due to the effects of increases in tobacco taxes announced earlier in the year and significant increases in prices for utilities,” hinting the outcome may not do much for rate hike expectations in the immediate term. Meanwhile, New Zealand’s rate decision is expected to produce an increase, with a Credit Suisse gauge of priced-in expectations showing a 96 percent chance of a 25bps hike. Finally, Canada’s GDP report is set to show the economy resumed growth in May after stalling in the preceding month.

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

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