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Lingering Portuguese Problems Weigh on Euro amid Light Docket

Lingering Portuguese Problems Weigh on Euro amid Light Docket

Christopher Vecchio, CFA, Senior Strategist
Lingering_Portuguese_Problems_Weigh_on_Euro_amid_Light_Docket_body_Picture_1.png, Lingering Portuguese Problems Weigh on Euro amid Light Docket

Lingering Portuguese Problems Weigh on Euro amid Light Docket

Fundamental Forecast for Euro: Neutral

The Euro was the second worst performer last week, as the two sticky issues developing for the single currency – the Portuguese political schism and the new influence of the European Central Bank’s “forward guidance” strategy – matured into full-fledged bearish influences. The worst performing Euro-cross, the EURJPY, closed down by -2.33% at ¥129.66, while the US Dollar, the second best performer against the Euro, saw the EURUSD closed down by -1.55% at $1.3067.

Midweek, following Federal Reserve Chairman Ben Bernanke’s comments regarding the timing of the Fed’s tapering of QE3, the EURUSD had climbed briefly over 1.3200, and it appeared that the market was ready to look past the ECB’s new dovish policy given the more immediate concern over the US Dollar’s recent strength. Yet with such a weak close to the second week of July, and a light economic docket ahead that offers little opportunity for relief, we nevertheless shift our bias to neutral.

Last week we noted that “the big picture is that peripheral yields are up sharply from early-May, before the Fed’s “taper” talk heated up,” and indeed this remains the case now that the mini-Portuguese political crisis decided to jump the shark rather than dissipate into the background. There were signs that it had been stemmed but now the main opposition party, who leads in the polls, wants to only participate in a coalition government under the current prime minister if the bailout terms with international lenders are revisited. As recently as October 2012 the Socialist party had signed on to the IMF’s “Letter of Intent.”

What will likely happen, as has been the case across the Euro-Zone periphery during these past few tumultuous years, is that the anti-bailout party will have enough influence to see that international loan conditions are loosened so as to make it appear that austerity is on its way out. Unlikely the case, but an agreement to keep PM Pedro Passos Coelho in charge of the government is still the most probably outcome.

Such an outcome will likely boost the Euro, as the Fitch Ratings’ downgrade of France’s sovereign rating from ‘AAA’ to ‘AA+’ with a ‘stable’ outlook produced a Euro rally during thin trading conditions on Friday. (This fits in with the idea that when price doesn’t respond in the way it theoretically should – heightened credit risk in Europe’s second largest economy would seemingly be a negative for the Euro – it might mean that sentiment has shifted in the opposite direction; in this case, bullish.)

Taking a look at the docket, the calendar is once again light this week although Euro-Zone inflation data on Tuesday may generate volatility. However, given the ECB’s introduction of forward guidance, rates will remain low for the foreseeable future, making any near-term inflation data less important. The only event on the calendar that might otherwise generate interest are the Euro-Zone and German ZEW surveys for July on Tuesday, but those too are likely to be non-events. Accordingly, with fundamental pressures pulling in both directions and few catalysts offering sincere guidance, we hold a neutral view. - CV

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.