FOREX: Euro at Risk as EU Debt Crisis Summit Fails to Impress

Talking Points

• EU Officials’ Debt Crisis Summit Offers Little Hope for Lasting Solution
• Chinese PMI Shows Manufacturing Grew for the First in Four Months
• Mixed Sentiment Trends Cloud Outlook for US Dollar, Major Currencies

The major currencies were little changed overnight as disappointing news from the weekend’s EU debt crisis summit were offset by encouraging economic data. An estimated Chinese Manufacturing PMI reading from HSBC showed the factory sector in the world’s second-largest economy expanded for the first in four months, growing at the fastest pace since May. Meanwhile, Japanese Exports grew at an annual pace of 2.4 percent in September, more than doubling estimates calling for a reading at 1 percent.

Reviewing what happened in Brussels over the weekend, Euro Zone policymakers seemed to make little progress toward what was being billed as yet another “comprehensive” solution to the sovereign risk malaise that continues to plague the currency bloc. The broad outline of what was needed was well-established heading into the summit. Officials had to: acknowledge that Greece is bust and initiate restructuring, formulate a plan to recapitalize banks that take heavy losses on holdings of Greek debt, and give a tangible cash-backed commitment to ensure other EU members will not be allowed to fail to prevent contagion.

On balance, European leaders seemed to fail on all three accounts. On the Greek default, moving ahead with restructuring was ruled out in favor of the familiar tactic of asking banks nicely to take some losses on their bond holdings so a portion of the debt can be retired or pushed further back into the future. On bank recapitalization as well as a cash backstop for other troubled countries, the issue of funding remained unresolved.

Germany effectively nixed the French proposal to give the EFSF bailout fund a banking license, which would have enabled it to borrow in unlimited amounts from the ECB. Furthermore, banks will only be allowed to fall back on the EFSF if private and national government efforts to bring them up to snuff are unsuccessful. This implies that the still only €440 billion-strong EFSF would only come into play after a fire-sale of bank assets and sharp increase in national debt levels, which is hardly encouraging. The Euro didn’t produce a dramatic reaction to the sit-down as traders reserved judgment until seeing the outcome of another summit to be held on October 26, but so far the tone of negotiations appears decidedly negative for the single currency.

Looking ahead, economic growth indicators including the Chicago Fed National Activity Index as well as third-quarter earnings reports from global business cycle-sensitive companies including Eaton Corporation and Caterpillar Inc will be in focus as risk appetite trends remain the primary driver of currency market price action. S&P 500 stock index futures are flat, pointing to conflicted sentiment and clouding the outlook for the safe-haven US Dollar against its top counterparts. The preliminary set of October’s Euro Zone PMI readings is likewise on tap, with forecasts calling for further slowdown in manifesting- and service-sector growth.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

To contact Ilya, e-mail ispivak@dailyfx.com. Follow me on Twitter at @IlyaSpivak

To be added to Ilya's e-mail distribution list, send a note with subject line "Distribution List" to ispivak@dailyfx.com