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Euro Diverges From Risk, Will Stress Test Lead To Re-Coupling?

Euro Diverges From Risk, Will Stress Test Lead To Re-Coupling?

2010-07-19 20:14:00
John Rivera, Currency Analyst
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EUR/USD

The Euro remains resilient despite a Moody’s downgrade of Ireland’s credit rating and speculation that Germany's Hypo Real Estate has failed the bank stress tests. The single currency rallied in early trading as markets became confident that the stress tests would ease concerns over the banking sector. Positive equity markets could be supplying support for the EUR/USD despite the pair seeing its correlation with risk weaken to 41% from 48% a week ago. The Euro/dollar has shown the increasing ability to diverge from risk trends as dissipating concerns over European member’s ability to raise capital has generated support while U.S. growth concerns have weighed on the broader market. We could see the pair re-couple with risk, if the scrutiny of European lenders shows that several lack sufficient capital to withstand another shock to the system, sparking a flight to safety across all assets classes.

PD-10-07-19-01

ECB Interest Rate Expectations

The ECB nearly halted their most recent round of bond purchases was being viewed as a sign that the sovereign debt issues in the region are improving. Governing Council member Christian Noyer on Monday urged EU nations to press ahead with deficit cuts to restore investors' confidence. One concern is that Spain’s reliance on ECB funding will raise concerns as the country is considered at the most risk of becoming the next Greece. Although the picture in the Euro-zone has improved, the declining outlook for global growth has sunk yield expectations with overnight index swaps now pricing in only 32 bps in tightening over the next twelve months, a dubious sign for the Euro. Discuss this and trading ideas join the EUR/USD forum.

PD-10-07-19-02

FOMC Interest Rate Expectations

A sharp fall in U.S. consumer sentiment 66.5 from 76.0 according to the University Michigan survey has added the dimming outlook for U.S. interest rates with markets now looking for added stimulus measures as the economy is showing signs of slowing down. The impact from government stimulus program and the inventory cycle have started to dissipate and consumers remain hesitant to spend with a fragile labor market. The NAHB housing market index slipped to 14 from a revised lower 16 in July reflecting a declining confidence in the sector which will make it difficult fro policy makers to raise rates. A week full of housing data will give a complete picture of the sector and if the releases point toward weakness then we see the FOMC look to add to their asset purchases which would push out a potential rate hike until 2011 at the earliest.

PD-10-07-19-03

Risk

U.S. equity markets regained their footing following Friday’s sharp decline, as a positive outlook for earnings inspired bullish sentiment. IBM and Goldman Sachs are the next blue chip names to report with their results potentially impacting broader sentiment tomorrow. U.S. housing data and a Bank of Canada rate decision are other event risks that should be monitored. A medium term descending channel points toward more losses for the Dow which could weigh on the EUR/USD. Discuss this and other fundamental data in the Economics Forum.

PD-10-07-19-04

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: instructor@dailyfx.com

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