Euro Falls

Unhappy New Year for the Euro

The euro slid to a four month low against both the dollar and the yen over the weekend, trading well below the 1.30 handle against the Greenback as traders worried about government bond auctions scheduled for this week. Various stress barometers in the Eurozone spiked over the last week, with yields on Portuguese and Spanish debt escalating sharply while credit default swaps on Western European debt surged. Portugal will offer bonds for sale on Wednesday, with Spain and Italy to follow on Thursday. With $43 billion in relatively risky instruments for sale, markets are expressing concerns that low demand at these auctions could lead to a further rise in borrowing costs, potentially causing another debt crisis in the common currency area.
Unless a fundamental change occurs, the year ahead is strewn with potential crisis triggers. Sovereign issuers across the European Union will be forced to roll over an unprecedented amount of debt in the face of declining creditworthiness, lowered demand and rising inflation expectations. At the same time, the political union is facing entrenched skepticism about its cohesiveness as growth rates among member countries diverge dramatically. Euro bulls may be out to pasture for some time yet.
The British pound rose to a four month high against the euro while declining slightly against the dollar as investors bet that the Bank of England would begin tightening monetary policy long before the European Central Bank. Economic growth appears to be accelerating and inflation is running close to 3.5%, well above the central bank's 2% target. Although much of this inflation has been generated by taxation increases and commodity price rallies, traders have begun pricing in a benchmark lending rate hike by the third quarter of this year.
US Economy Improves, Dollar Surges
Friday's Non-Farm Payroll report saw a 103,000 rise in the number of new positions, and a revised increase of 71,000 for the previous month. The unemployment rate ticked down to 9.4% from 9.8%.
Market expectations had coalesced around the 150,000 mark, meaning that many traders were disappointed by the headline number. However, the gain was the third in as many months, leading markets to believe that the recovery is stable and beginning to accelerate.
The US economy continues to struggle as housing market weakness, ongoing deleveraging and low consumption weigh on activity. Employment is growing, but not quickly enough to keep pace with population growth. Full employment remains a distant prospect.
However, in currency markets everything is relative.
In the year's first week of trading, the US dollar saw the largest five day gain since last summer as traders weighed the alternatives and found them lacking. Given the parlous state of credit markets in the European Union, weak growth in Japan, and rising concern about emerging market risks, the Greenback is seeing a boost from domestically driven optimism in addition to a flight to safety response.
Looking forward, Friday's release of December retail sales numbers by the US Commerce Department will be very significant for markets. This will be another consumer sentiment barometer, with large implications for the US economy as well as exporting nations such as Canada. As with last Friday's employment report, any disconnect between expectations and reality will provide fuel for volatility.
CAD and MXN Gain on Economic Optimism
Strengthening in the American economy is tremendously positive for Canada and Mexico, both of which rely on US markets for much of their export revenues. The two currencies outperformed over the last week, moving up against most of the majors, largely in sync with the US dollar. For Canada in particular, an improvement in US demand could support the manufacturing industry and would potentially help to offset the negative impact being delivered by the strong Loonie.
Oil prices are up this morning to $88.85 a barrel after an Alaskan pipeline that carries almost 15% of US was shut following a leak. The impact on the Canadian dollar has been muted thus far, as traders estimate a relatively quick return to production. Traders seem to have lost some of their appetite for the fuel, trimming long positions last week and keeping futures well contained.
The Canadian dollar is locked into an unbelievably tight trading range against the US dollar, moving fewer than 100 basis points a day (on average) over the last two months. Foreign exchange traders miss the excitement, truth be told, but for corporate hedgers, the lack of volatility is a welcome respite from the wide swings seen over the last two years.
However, a note of caution is called for. Just as winter conditions inevitably follow the Canadian summer, volatility will eventually return. Just as many drivers enter each winter unprepared, many organizations will be unprepared when exchange rates move sharply once more. Consequently, this is one of the best possible times to open internal discussions about currency risk management. Implementing an effective currency trading framework now will prove invaluable when the roads become slippery once again.
Have a great week!