Euro Sellers May Overlook Firm German GDP as Risk Aversion Continues

Key Overnight Developments

• US Dollar Extends Gains, Japanese Yen Near Decade High on Risk Aversion
• New Zealand 2-Year Inflation Outlook Sees First Drop in Over a Year, Says RBNZ

Critical Levels

The Euro and the British Pound fell against the US Dollar as risk aversion gripped currency markets in overnight trade (see below). The single currency slid to a six-week low while the UK unit lost its grip on the 1.55 figure to hit the lowest in a month against the greenback. We have opted to enter short EURUSD but remain flat GBPUSD for the time being.

Asia Session Highlights

The US Dollar and the Japanese Yen outperformed, with the former setting a monthly high while the latter surged to the highest in nearly a decade against an average of their major counterparts as stocks sank in Asian trade, boosting demand for the safety-linked currencies. The MSCI Asia Pacific regional benchmark stock index fell 0.7 percent amid increasingly acute fears that the global recovery is faltering. This time around, traders were apparently spooked by the coming US Existing Home Sales report, which promises to deliver the largest drop in six months and further underscore faltering growth in the world’s largest consumer market. Discouraging words from Bank of England policymaker Martin Weale didn’t help matters either after he was quoted in the Times newspaper as saying the UK faces a “real risk” of a second recession.

The Reserve Bank of New Zealand’s 2-year Inflation Expectation gauge of future price growth printed at 2.6 percent in the third quarter, amounting to the first slowdown in over a year and reinforcing increasingly determined bets calling for the central bank to hold interest rates unchanged at the next policy meeting in September after two consecutive hikes in June and July.

Euro Session: What to Expect

The final revision of German Gross Domestic Product figures is set to confirm the economy added 2.2 percent in the second quarter from the three months through March. Markets are likely to look past the headline figure however to focus on the components of the report as traders size up the durability of recovery in the Euro Zone’s largest economy, particularly with the onset of headwinds from the EU’s debt-reduction efforts increasingly close at hand.Expectations call for an encouraging release: Private Consumption is set to grow for the first time in a year while Capital Investment snaps a two-quarter losing streak to add 3.8 percent, the most since the three months ending June 2006; Exports are forecast to soar 7.9 percent, marking the largest quarterly increase in at least 19 years.

While this seems to point toward resilience, it is important to note that much of Germany’s rebound in the aftermath of the 2008 meltdown has been driven by overseas sales, the prospects for which look decidedly bleak of late amid increasingly ominous signs of a worldwide slowdown in the second half of this year. Indeed, the Baltic Dry Index of international trade activity fell to the lowest in 15 months in July while JPMorgan’s Global PMI gauge showed worldwide economic activity grew at the slowest pace since February over the same period. This coupled with a sharp drop in the MSCI World Stock Index as well as broad-based deterioration in interest rate hike expectations (as tracked by Credit Suisse) across the G10 hints not only is a soft patch likely ahead, but traders have recognized it and are actively pricing it into financial markets.

On balance, this hints that even a relatively robust GDP report may be seen as too lagged a reading to derail the risk aversion now gripping currency markets and weighing on the Euro. Indeed, US stock index futures are down 0.3 percent in late Asian trade, pointing to continued losses for risk-correlated currencies against the safety-linked US Dollar and Japanese Yen.

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