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FOREX: Euro May Rise on Franco-German Accord But Deep Flaws Remain

By , Currency Strategist
06 December 2011 08:15 GMT

Talking Points

  • Dollar, Yen Rise as Asian Stocks Slump After S&P Threatens Eurozone
  • Aussie Dollar Underperforms as RBA Cuts Rates Citing Europe Threat
  • S&P 500 Futures Hint Sentiment Trends Still Clouded Before EU Summit
  • Franco-German Accord May Stoke Risky Assets But Deep Flaws Remain

The US Dollar and Japanese Yen outperformed overnight as Asian stocks declined, boosting demand for the safe-haven currencies. The MSCI Asia Pacific regional benchmark equity index fell 1.4 percent following news that Standard & Poor’s put 15 Eurozone countries including Germany and France on negative credit watch, saying they may move forward with downgrades depending on the outcome of the EU leaders’ summit on tap this week. The ratings giant ominously warned that “systemicstresses in the Eurozone have risen in recent weeks to theextent that they now put downward pressure on the creditstanding of the [currency bloc] as a whole.” Not surprisingly, S&P expressed particular concern with the apparent ineptitude of Eurozone politicians.

The Australian Dollar underperformed as headwinds from risk aversion were compounded after the Reserve Bank of Australia cut interest rates by 25bps to 4.25 percent. The statement accompanying the announcement was relatively neutral in its assessment of domestic conditions, with RBA Governor Glenn Stevens saying the bank expected inflation to stay on-target in the 2-3 percent range through 2013 while real-economy borrowing costs have descended to their 15-year average. With that in mind, policymakers’ decision to issue a “modest” reduction in the headline interest rate seemed to stem from external factors. Stevens seemed particularly concerned with a “material slowing in global growth” on the back of the Eurozone debt crisis, warning that “trade in Asia [is now] seeing some effects of a significant slowing in economic activity in Europe.

Looking ahead, initial negative sentiment following the S&P ratings action may fade, not because it is insignificant but because the markets were likely already convinced of the existential importance of the December 8-9 EU leaders’ summit to sovereign stability in the Eurozone without the added threat of a mass downgrade. Indeed, S&P 500 stock index futures are now flat having traded down as much as 0.97 percent overnight, hinting risk appetite trends have shifted back to neutral at least until another headline offers further guidance. Alternatively, the door may now be open for the markets to fully price in the apparent establishment of a joint Franco-German position on fiscal integration of the Eurozone that emerged after yesterday’s meeting between Angela Merkel and Nicolas Sarkozy. The two leaders agreed to push for automatic sanctions of countries of countries that violate budget limits, a requirement for Euro area countries to pass legislation mandating balanced budgets, and an accelerated creation of the permanent European Stabilization Mechanism (ESM) by 2012.

On balance, the agreement looks hardly encouraging and may not be enough to compel the European Central Bank to expand its bond-buying efforts and bring the full strength of its balance sheet to bear on regional borrowing costs. The automatic sanctions have a loophole, allowing a majority vote of Eurozone member states to overrule them, which leaves the door open for more political haggling of the kind that has been so loathed by the markets over recent months. The requirement of balanced-budget legislation for Euro area membership may push some countries to leave the currency bloc, creating further instability. Finally, the completion of the ESM next year is essentially meaningless. The proposed size of the facility has been tipped to be around €500 billion, not meaningfully more than the current EFSF that it’s designed to replace, meaning it would hardly amount to a game-changer for the currency bloc’s stability. Taken together, this argues for a negative reaction from risk appetite that weighs on stocks and boosts the US Dollar, although the very existence of a Franco-German accord may be enough to satiate hopeful investors for now.

Asia Session: What Happened

GMT

CCY

EVENT

ACT

EXP

PREV

0:01

GBP

BRC Sales Like-For-Like (YoY) (NOV)

-1.6%

-0.5%

-0.6%

0:30

AUD

Current Account Balance (A$) (3Q)

-5637M

-5600M

-7419M

0:30

AUD

Australia Net Exports of GDP (3Q)

-0.6%

-0.6%

-0.5%

3:30

AUD

Reserve Bank of Australia Rate Decision

4.25%

4.25%

4.50%

Euro Session: What to Expect

GMT

CCY

EVENT

EXP

PREV

IMPACT

8:00

CHF

Foreign Currency Reserves (NOV)

-

242.7B

Low

8:15

CHF

Consumer Price Index (MoM) (NOV)

0.0%

-0.1%

Medium

8:15

CHF

Consumer Price Index (YoY) (NOV)

-0.3%

-0.1%

High

8:15

CHF

CPI - EU Harmonised (MoM) (NOV)

-

-0.1%

Low

8:15

CHF

CPI - EU Harmonised (YoY) (NOV)

-

-0.5%

Low

10:00

EUR

Euro-Zone GDP s.a. (QoQ) (3Q P)

0.2%

0.2%

High

10:00

EUR

Euro-Zone GDP s.a. (YoY) (3Q P)

1.4%

1.4%

High

10:00

EUR

Euro-Zone Household Consumption (QoQ) (3Q P)

0.3%

-0.2%

Low

10:00

EUR

Euro-Zone Gross Fixed Capital (QoQ) (3Q P)

0.6%

0.1%

Low

10:00

EUR

Euro-Zone Government Exp (QoQ) (3Q P)

0.1%

-0.1%

Low

11:00

EUR

German Factory Orders n.s.a. (YoY) (OCT)

1.9%

2.4%

Medium

11:00

EUR

German Factory Orders s.a. (MoM) (OCT)

1.0%

-4.3%

Medium

Critical Levels

CCY

SUPPORT

RESISTANCE

EURUSD

1.3355

1.3467

GBPUSD

1.5584

1.5714

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

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

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06 December 2011 08:15 GMT