Euro ends week on a positive noise as Spain moves closer to a full bailout
06/Aug/2012 • Currency Updates•
FX markets were on a holding pattern earlier in the week, waiting for the all-important central bank meetings in the US, Europe and the UK. The Federal Reserve made it clear that it is on wait-and-see mode, announcing no new measures. The real volatility started Thursday, when the ECB initially disappointed expectations hopes for concrete actions, which send the Euro plunging. However, markets reversed sharply on Friday, as the Spanish Government appeared to soften its stance against asking for a full bailout and markets reconsidered their view of the ECB promise to play a more constructive view on the crisis. Away from currencies, risk assets generally ended the week up, buoyed by expectations of more ECB involvement to end the European crisis and a better-than-expected labour market report out of the US.
Last week meeting of the MPC brought no change in policy, as we and the consensus expected and therefore no communication either. Macroeconomic data continued their depressing run of disappointments. This time it was the manufacturing sentiment index (PMI) that came in much lower than expected, down to the lowest level since early 2009, and consistent with sharp contraction in the UK factory sector. Consensus expectations are that GDP will rebound moderately in the third quarter, mostly due to the timing of the jubilee holiday in the second quarter.
However, the manufacturing report has increased the downside risks on UK growth. This time, FX markets reacted to the macroeconomic gloom and Sterling had a very tough time. It failed to participate on Friday’s Euro rally, and it ended the week down against both the Euro (1.2%) and the dollar (0.5%), which has lately been a rare occurrence.
The ECB did not announce any new concrete policy measures on its monthly meeting. However, it made it clear that it is ready to adopt a more constructive role in solving the crisis. Once countries appeal to the EFSF or the ESM for help, and agreement is reached on the conditionality of the bailout, the ECB will conduct open market operations on that country’s bonds with the goal of bringing down yields. This supports our view that the European crisis is moving towards a more chronic stage, where the concern switches from short-term liquidity to national solvency. There is still absolutely no mention of any easing on the brutal austerity that countries have to agree to before they are eligible for ECB help. Until the need for demand policies is addressed, therefore, we see no reason to modify our bearish view of the common currency.
The string of disappointing macroeconomic reports out of the United States finally came to an end last week with a somewhat better-than-expected payroll report. The US economy created a net 163,000 jobs in July, although rounding issues increased the unemployment rate from 8.2 to 8.3%. This information means that we will not be revising our target of 2012 growth in the US from its current range of 1.5% to 2.5%, far from catastrophic, but insufficient to make a dent in the US problem of structural long-term unemployment. In other news, the recovery of the housing and construction sector from very depressed levels continues. Construction spending is now up 11.8% saar over the last three months, a healthy showing that will continue to provide some support to US economic growth.