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EUR Optimism To Fizzle As EU Tries To Buy Time, More GBP Losses Ahead

EUR Optimism To Fizzle As EU Tries To Buy Time, More GBP Losses Ahead

David Song, Strategist

Talking Points

  • Euro: ECB Supports Bank Recapitalization Through ESM, Italy Calls On Germany
  • British Pound: Struggles To Find Support, BoE Warns Of Euro Breakup
  • U.S. Dollar: 1Q GDP, ADP Employment Disappoints - All Eyes On NFPs

Euro: ECB Supports Bank Recapitalization Through ESM, Italy Calls On Germany

The Euro rallied to an overnight high of 1.2427 as European Central Bank President Mario Draghi and board member Ignazio Visco discussed widening the use of the permanent bailout fund, while European CommissionEconomic and Monetary Commissioner Olli Rehn said the group would ‘consider proposing an extension’ for Spain to meet deficit target amid the ongoing turmoil in the region. In response, a spokesman for the EU argued that the European Stability Mechanism cannot be used to directly recapitalize commercial banks ‘with existing instruments,’ and we may see European officials make further attempts to buy more time as the ECB sticks to its current policy.

As the heightening threat for contagion continues to cast a dour outlook for the region, Italian Prime Minister Mario Monti encouraged Germany to take additional steps to restore investor confidence, but we may see a growing rift within the EU as the anti-austerity movement picks up. In turn, we are likely to see the governments operating under the fixed-exchange rate system call for additional monetary support, and the Governing Council may little choice but to carry its easing cycle into the second-half of the year as the region faces a growing risk for a prolonged recession. Although the EURUSD remains oversold, we are looking for a break and a close above the 10-Day SMA (1.2570) to see the rebound gather pace, and will wait for the relative strength index to climb above 30 to see a meaningful correction in the exchange rate.

British Pound: Remains Oversold, BoE Has Scope For More QE

The British Pound advanced to 1.5525 amid the rebound in risk sentiment, but speculation for more quantitative easing may continue to drag on the exchange rate as the fundamental outlook for the U.K. remains clouded with high uncertainty. Bank of England board member Charles Bean argued that the central bank has the ‘the scope to do more asset purchases’ as the economy slips back into recession, but it seems as though the Monetary Policy Committee will carry its wait-and-see approach into the second-half of the year amid the stickiness in underlying price growth. Although the BoE saw a renewed risk of undershooting the 2% target for inflation, central bank officials may soften their dovish tone for monetary policy as they expect to see a more robust recovery in the second-half of the year, and the central bank may shift gears in the coming months as above-target inflation continues to dampen the BoE’s credibility on price stability. Like the EURUSD, the GBPUSD looks poised for a rebound as it remains oversold, but we need to see the RSI come off of oversold territory in order to see a correction take shape. Until then, we may see the GBPUSD continue to give back the advance from earlier this year, and the pair may ultimately come up against the 50.0% Fibonacci retracement from the 2009 low to high around 1.5270 as it struggles to find support.

U.S. Dollar: 1Q GDP, ADP Employment Disappoints - All Eyes On NFPs

The greenback is struggling to hold its ground on Thursday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) tagging a low of 10,224, and the short-term pullback may turn into a larger correction amid renewed speculation for QE3. Although we’re expecting to see faster job growth in May, the downward revision in 1Q GDP paired with the weaker-than-expected ADP employment does not bode well for the highly anticipated Non-Farm Payrolls report, and a dismal print may spark a sharp selloff in the reserve currency as it increases the Fed’s scope to ease monetary policy further. However, as the core Personal Consumption Expenditure index, the Fed’s gauge for inflation, holds above the 2% target, the stickiness in price growth may spur a growing rift within the FOMC, and central bank officials may continue to soften their dovish tone for monetary policy as the economy gets on a more sustainable path. In turn, we will maintain a bullish call for the USD heading into June, and we will look to buy dips in the greenback as the USDOLLAR maintains the upward trend from earlier this year.

--- Written by David Song, Currency Analyst

To contact David, e-mail Follow me on Twitter at @DavidJSong

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