Euro-zone structural fears will remain an important short-term focus as underlying tensions persist. There will be continuing fears that restrictive fiscal policies will intensify recession conditions in peripheral economies and exacerbate bad loans within the banking sector. There will be strong pressure for further ECB support and there will also be growing political pressure for a shift in underlying policies towards a more growth-orientated strategy. This would, however, risk major tensions with the Bundesbank. The Euro will still gain important support at times, especially with potential capital repatriation.
The Euro was again able to prove resilient during the week even with continuing fears surrounding the structural outlook and there was market frustration that the Euro had not weakened further which triggered a covering of short positions.
The Euro-zone PMI data was weaker than expected with sharply weaker readings for the French PMI services and German manufacturing data. Although the services data was stronger than expected, the net outcome was a decline for both readings with the manufacturing index at the lowest level since July 2009.
The data tended to contradict more optimistic German business surveys, unsettling markets, and there was further peripheral economic unease. As well as the PMI data, the Bank of Spain confirmed that there was a further GDP contraction for the first quarter, maintaining fears over the economic outlook and the banking sector. There were rumours of ECB price checking during the week.
Politically, markets were unsettled by the French election result as the strong polling outcome for the National Front reinforced market fears that support for current economic policies was continuing to weaken. The Dutch government also tendered its resignation after failing to agree budget cuts as the Freedom party withdrew its support, maintaining fears over regional instability. More positively, there was speculation of 2013 budget agreement later in the week
A series of relatively small-scale Euro-zone bond auctions provided some net Euro support in the middle of the week. There were solid bid/cover readings for the latest Spanish bill auction while there was a decline in Dutch yields which eased fears over the impact of political stresses. From a wider perspective, there was greater evidence and speculation that pressure for a change in austerity policies was intensifying.
The Euro was subjected to renewed selling pressure late in the US session as Standard & Poor’s cut Spain’s credit rating by a further two notches to BBB+ which also triggered some fresh unease over Friday’s Italian debt auctions.
Yen:
The Bank of Japan will inevitably remain an important focus in the short-term with pressure for additional policy responses. There will be additional pressure for a competitive currency to help protect the industrial base, especially if there is any weakness in the Chinese yuan. There will still be defensive demand for the yen at times, especially if global growth fears intensify. From a longer-term perspective, there will be a lack of confidence in the economy and currency.
The dollar found solid buying support on dips, although it was unable to make significant progress as yield support remained weaker and was unable to make any attack on the 82 region as the yen was resilient on the crosses.
There were further uncertainties surrounding the Bank of Japan policies ahead if Friday’s policy meeting. The government pushed for further monetary easing, but there were also reports from sources that the central bank would resist major new measures. Underlying risk appetite held firm as equities rallied and this dampened immediate yen demand.
The Bank of Japan announced a further expansion of JPY10trn in the asset-purchase programme to JPY40trn. There was also a JPY5trn cut in a domestic credit-purchase fund which caused some initial confusion on the headline announcement and triggered high yen volatility. The dollar pushed to highs around 81.40, but it was unable to sustain the gains and retreated back to below 81. The Japanese data was mixed with a stronger than expected increase in retail sales while the industrial production rebound was held to 1.0% for April. |