It didn’t look very pretty for the euro at the start of the week as EUR/USD probed down to a 1.28 handle. The week kicked off with the Swiss adding Portuguese state debt to the list of unacceptable collateral. A number of commentators pointed out the similarities between the Portuguese debt crisis and the timeline of the Irish one. A bad Portuguese auction mid-week would doubtless see the men from the European Central Bank and the IMF visiting Lisbon at the weekend. Spreads on Spain, Italy and now Belgium were widening rapidly. But the fall was arrested by Japan joining with China in declaring support for eurozone debt; or as one contact put it: “Japan has decided to diversify its crap JGB holdings by buying shite European bonds, spreading its reserves about a bit.” However, why Japan sees that as a better use of funds than reflating its own economy no one seems able to answer; with China it is less of a mystery – the authorities have to put their money somewhere and diversification away from dollars is a stated objective, Europe is a main market and support of its debt also underpins the euro, benefiting Chinese terms of trade. But one can’t help but wonder how it will all turn out with both the US and Europe in hock to China.
Anyway, it was all eyes on the Portuguese auction on Wednesday followed by issuance from Spain and Italy on Thursday. Apparently the market was surprised that the auctions went better than had been expected. Not only that, there was also said to be good foreign demand for all the auctions – what a surprise, no guessing from precisely where.
So with the addition of hawkish comments from ECB president Jean-Claude Trichet one shouldn’t have been surprised that there was a squeeze up in the euro. But more than five big figures is quite a move. Comments on the CitiFX Wire give the impression that the market might be in the process of giving up on the downside: “If we were to break 1.3435 and stay above there I would abandon my ‘sell the rally’ tone for EUR/USD and accept we need to be buying dips as given the speed of the move the liquidation looks nowhere near done”. Paul Day at Market Securities sees it similarly: “...very heavy buying going through. The daily TD Prop UP Momentum is at 1.3468. Though that should act as a resistance in the first instance, but a qualified break suggests a move higher to 1.4069/86”
But the rally was not just against the dollar of course. Positions in everyone’s top tips for the year also suffered a major retracement. EUR/SEK and EUR/NOK both gave back post-Christmas gains with a 1% move up; EUR/SEK, now trying to regain a foothold above 9.0000, has left participants less certain of the short-term direction.
All in all then a continuation of the mayhem of the previous week; looking forward, despite the technical picture, it is difficult to see the euro sustaining the move up without clarification on the size and application of the European Financial Stability Facility (EFSF). The optimistic view is that such news could come next week as a result of the meeting of the European finance ministers. It has been supposed that Germany is opposed to any meaningful change in the EFSF but Ulrich Leuchtmann at Commerzbank sees it differently. Leuchtmann concedes “that the upper limit of the EFSF volume would have to be raised by approximately €200 billion” from its current €440 billion. Also, to prevent further contagion, the terms of the existing Irish and Greek bailouts should become less punitive: “it would be necessary to optimize the existing bailout measures for Greece and Ireland in such a manner that the risk premiums for the countries “saved” would actually fall”. But the Commerzbank analyst appears to believe that such measures might be on the agenda next week: “Schäuble should have further measures up his sleeve. But for good reason he is not interested in discussing these publicly as yet. But that also means: news on the EFSF reform is likely to have a notable effect on the euro exchange rate.”
Indeed, barring further accidents it would mean that eurozone concerns will abate. But it wouldn’t mean that the mayhem is over: Paul Day’s 1.4069/86 level might be in play faster than anyone thinks. Goldman Sachs is with the euro optimists too: “Our view has long been that European sovereign tensions will ultimately abate on a combination of better fiscal coordination, support from the strong eurozone countries for the periphery, solid growth in the eurozone.” The bank put out a short-term recommendation on Thursday to go long EUR/USD objective 1.3700, stop loss 1.2850.