Dollar, Yen May Fall Further as EU Leaders Turn to Growth Agenda

Talking Points

• Dollar, Yen Drop as EU Anti-Crisis Measures Top Market Expectations
• Aussie, NZ Dollars Outperform Amid Broad Recovery in Risk Appetite
• Sentiment to Maintain Support as EU Leaders Turn to Growth Agenda

The US Dollar and the Japanese Yen slumped overnight after EU leaders delivered an unexpectedly forceful response to the region’s debt and banking crisis following the first day of negotiations at a summit in Brussels, boosting risk appetite and sapping demand for the go-to haven currencies. The stocks-linked Australian and New Zealand Dollar outperformed adding as much as 1.6 and 1.4 percent respectively against the greenback.

Policymakers agreed to create a joint bank supervision scheme, to be established by the end of the year. Once that is operational, the EFSF/ESM bailout funds will be given authority to recapitalize banks directly without funneling funds through the governments of member states (which otherwise increases sovereign debt levels).

Finally, the terms of Spain’s bank rescue will be amended such that the EFSF/ESM funds will not gain seniority status. This would have given them priority to get paid out ahead of the country’s other creditors in the event of default and restructuring (which would discourage private buying of Spanish bonds, driving borrowing costs higher).

Looking ahead, S&P 500 stock index futures are pointing firmly higher, suggesting the risk-on mood is likely to carry forward and continue to keep haven currencies under pressure against their major counterparts. All eyes remain on Brussels as the second day of the summit gets underway, with the focus now likely to shift toward measures aimed at boosting regional economic growth.

As we discussed previously, agreement on this front is likely to prove easier, particularly as the latest batch of economic data shows slumping growth in the periphery is making its way to the Eurozone core (namely, Germany and France). The recession in the currency bloc and its consequences for other economies is the most significant headwind facing global performance this year. Consequently, a convincing set of pro-growth measuresthat helps soften the downturn ought to prove further supportive for sentiment.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

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

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