FOREX: Euro Gains May Be Short-Lived as EU Summit Looms Ahead

Talking Points

• EU Leaders’ Summit to Disappoint Absent Broad, Scalable Debt Deal
• Sarkozy, Merkel Announce Bilateral Agreement on Greece Aid Plan
• Euro Gains, Franc Falls as Traders Trim Bets Linked to EU Debt Crisis
• Aussie Dollar Sold as HSBC Says Chinese Manufacturing Shrank in July

A busy economic calendar is unlikely to distract traders from their singular focus on a meeting of European Union leaders in Brussels to iron out an agreement on Greece’s second rescue package. The Euro advanced overnight ahead of the summit after a joint statement from French and German governments said President Nicolas Sarkozy and Chancellor Angela Merkel reached agreement on squashing the debt crisis in the Mediterranean country after 7 hours of bilateral talks. Details of the arrangement will be presented at the summit. Historically, the Franco-German axis has been the focal point of EU policymaking, meaning the apparent existence of an agreeable plan between the EU’s top two countries is likely indicative of a de-facto region-wide consensus.

Importantly, Greece is hardly the most pressing issue for the Euro Zone. Indeed, the drama surrounding that country’s move towards further assistance – complete with a hard-won set of new austerity measures that nearly ended the tenure of Prime Minister George Papandreou – has been an afterthought for some time now amid fears the debt crisis will spread to countries too big to be bailed out. With that in mind, the most important takeaway from today’s summit will be the scalability of the Greek arrangement for other ailing periphery countries, most critically Spain and Italy. A one-off plan that addresses none of the vulnerabilities elsewhere in the region is likely to be met with disappointment by the markets, putting downward pressure on the single currency.

On the data front, the preliminary set of July’s Euro Zone PMI figures is set to show continued slowdown in manufacturing- and service-sector growth, which ought to reinforce expectations of a pause in ECB interest rate hikes for the time being. While the results are unlikely to produce significant fireworks with traders unwilling to commit directionally until the EU summit outcome is known, disappointing results could have somewhat of a delayed reaction in amplify the selloff if Euroland’s leaders fall short. UK Retail Sales figures round out the docket, with apparent scope for disappointment despite modest expectations for a flat year-on-year result after an analogous report from the British Retail Consortium revealed a 0.6 drop over the same period in a report published last week.

The Swiss Franc underperformed in Asian hours, mirroring the rally in the Euro as traders unwound bets linked to sovereign stress in the single currency area. The Australian Dollar slumped under the weight of disappointing economic data after a preliminary Chinese Manufacturing PMI reading from HSBC showed the factory sector shrank for the first time since February 2009, threatening the leading source of demand for Australian raw-materials exporters. A drop in Business Confidence and a selloff across Asian stock exchanges compounded selling pressure on the sentiment-sensitive currency.

Related: Japanese Yen Weaker as Exports Data Show Recovery Promise

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

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