Euro Dragged Lower on Greece Uncertainty

The dollar looks set to begin the week higher against the majors and EMs over lack of progress in Greece. European stocks are down 0.6%, with the EuroStoxx 600 trimming its 6-month high; EZ banks down 1.3%. German manufacturing orders higher in December; soft Australian retail sales support further RBA cuts.

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  • The dollar looks set to begin the week higher against the majors and EMs over lack of progress in Greece
  • European stocks are down 0.6%, with the EuroStoxx 600 trimming its 6-month high; EZ banks down 1.3%
  • German manufacturing orders higher in December; soft Australian retail sales support further RBA cuts
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The dollar looks set to begin the week higher after the momentum from Friday’s jobs report fades and the market refocuses its attention on Greek. In particular, the dollar moved higher in Asia and into the European session prompted by the failure of Greek political leaders to reach an agreement on EU/IMF demands for further austerity. While an agreement was struck in principle, the devil, as is often the case, is in the details. The key sticking point in Greece and between it and the EU/IMF is wage cuts. EU/IMF demanding 25% cut in wages and an end to the 13-14th month bonus payments. As a result, the euro is currently down 0.75% to 1.306, with sterling also down 0.3% to 1.57 amid the stronger dollar tone.

No PSI deal seems likely today, as Greek Finance Minister Venizelos will reportedly meet with the Eurogroup finance ministers on Wednesday. He warned that the PSI is now the easiest part of the aid package and that Troika demands for greater austerity are the more difficult point. All signs point to an eventual PSI deal, but what is now more uncertain is whether Greece’s coalition government can agree on an additional 1.5% of GDP in savings as demanded by the Troika before it can receive the next tranche of aid from the IMF/EU. These funds are needed by mid-March, when a huge slug of debt matures (over EUR14 bln) and must be rolled over. Some coalition members have already signaled unwillingness to pass more austerity measures, and so it seems Greek disorderly default risks will remain elevated even if PSI agreement is reached. Price action today would seem to support this view of elevated euro zone risks, as the euro has sold off despite stronger than expected German factory orders. Netherlands already sold debt, while France is on tap to auction EUR8.5 bln in bills later today. Besides the 1.3030 low from last week, 1.30 is the 38% Fibonacci retracement of the January rise in EUR/USD. Break of 1.30 area sets up a test of 1.2929, the 50% level.

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A light data calendar this week will likely keep the focus on policy and news developments with the ECB, BoE and RBA all scheduled to meet this week. First, we expect the ECB to remain on hold this week as the central bank is likely to want to assess the impact of the upcoming LTRO’s before taking further steps to ease financial condition. However, with the EZ economy as a whole still likely to contract in the coming months we expect the ECB to ease policy further in March. Second, markets may see the last dose of QE from the BoE this week. We expect the BoE to announce a £50bln expansion to its asset purchase program at this week’s meeting, supported by the recent drop in inflation expectations and weakness in the money supply data. However, we would highlight that given the recent improvement in data the probability for further QE may have lessened over the past few weeks and therefore there is a small risk that policy makers choose to not expand asset purchases. This would be marginally positive for sterling. We suspect that QE is almost nearly discounted by markets by now and therefore we suspect that the announcement of QE may only cause a knee-jerk reaction in sterling. Looking ahead, we nevertheless expect uncertainty over policy developments in the EZ to be a near-term positive for sterling against the euro. Third, and finally, the RBA is likely to cut by 25bps at today’s meeting. Although the market is pricing in a little more than a 50% chance of a cut and overwhelming majority of economists expect a 25bps cut. Weakness in labor market, tightening of financial conditions, and the fragile global environment are likely the key factors. Yet, we continue to expect the AUD to be driven by external, rather than domestic factors. Resistance near recent high of 1.0794; support expected at 1.062.

The central banks of Korea, Indonesia and Poland all meet on Thursday and are all expected to leave rates unchanged.We see very little chance of a surprise from any of the three. For the most part we expect all three central banks to remain in wait and see mode. If anything, the greatest risk is for a 25bp cut by the BI or another widening of the band. Recall that the BI decided to lower the bottom end of the interest rate corridor by 50bp in January, which effectively amounts to targeted easing. The BI’s easing policy is likely to continue focus on increasing interbank liquidity and reducing sterilization costs as growth appears to be holding up. Otherwise, we expect the Polish central bank to keeps rates on hold at 4.5%, in line with market expectations. In China, some investors were again disappointed by the lack of RRR cuts by the PBoC, which is managing liquidity through repo operations instead. Chibor rates fell sharply in response and are back to mid-December levels. We still think RRR are forthcoming, but as we have warned before, the timing is uncertain.

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