Monday, May 24, 2010

Is Spain Next?

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By Mike Conlon | May 24, 2010

Over the weekend, the Euro debt crisis took an unexpected turn for the worse as the Spanish central bank took over a savings bank after a planned merger had failed.  While in and of itself this is not a big deal, viewing it through the context of overall EU financial health has made the bounce in the Euro short-lived.  The Euro is lower again to start the week, as last week’s short-covering rally has been reversed and the longer-term trend for the common currency is still down.

There’s not a ton of market-moving news on tap this week, with GDP figures due out from the UK tomorrow and the US on Thursday.  Other than that, there are some smaller events that will provide color to the overall economic picture which will either help re-affirm or correct market sentiment.

Perhaps the biggest news is that US Treasury Secretary Geithner is in China and is advocating that China adopt a more free-floating currency.  Because of the Yuan peg to the US dollar, China has been allowed to experience very rapid growth through artificial means that have allowed their goods to remain cheaper around the globe.  However, with the crisis in Europe looming, US dollar strength could cause Chinese Yuan strength via the Dollar if the Euro continues its slide.  With European austerity measure taking place (Germany included); this could slow world demand which would slow China’s growth as well.

So while there have been some “clues” that perhaps China is ready to make changes to Yuan policy, I’m not certain it will take place if their economy slows due to slower exports as a result of a strong dollar buoyed by risk-aversion and global austerity.

This all adds up to risk-aversion in the market today in a continuation of the major trends, but it’s possible that we could see a reversal as US markets open for the week.

In the forex market:

Aussie (AUD):  The Aussie is lower on risk-aversion as fears out of the EU and a potential slowdown in China are reducing demand for higher-yielding assets.  The Aussie is the worst performer this month, down some 10% vs. the US dollar as risk aversion has dominated the marketplace.

Loonie (CAD):  The Loonie, on the other hand, is showing strength this morning as oil is back in the $70 range, showing signs that we may get a reversal this morning.  The Loonie is not really a carry trade destination as it doesn’t provide the yield differential of the Aussie or Kiwi; however it is affected by commodity prices (particularly oil).  The Canadian rate decision is due out in early June so there still is some speculation that they could be the next to hike.

Kiwi (NZD):  The Kiwi is lower for the same reasons as the Aussie, getting hit a bit harder as it does not have as great a rate differential as the Aussie.  Same risk, less reward.  However, should the markets begin to stabilize, then we could see the Kiwi move faster to the upside.

Euro (EUR):  The Euro is lower as the bank of Spain took over a regional lender causing investors to question whether or not the debt crisis is spreading.  There has been a major property bubble in Spain so many banks are holding bad debt which could come to the surface if Spain needs to access the bailout money to stabilize its banks.  In addition, Germany has adopted its own austerity measures, essentially trying to lead by example.  Considering that the market is looking for any excuse to sell the Euro, expect the longer-term downtrend to continue.  The Euro is lower across the board.

Pound (GBP):  The Pound is lower this morning going into tomorrow’s GDP reading as the UK is walking a fine line between trying to grow its economy without incurring inflation, and cutting its public debt.  The new government announced 6 billion Pounds in spending cuts in hope of sending a “shock-wave” through government departments.  While not an enviable position to be in (although EU members may disagree), the government feels these actions are necessary to avoid its own sovereign debt crisis.

Dollar (USD):   The Dollar has been higher on risk themes, and US existing home sales are due out later this morning.  Consumer confidence figures are due on Tuesday, followed by US GDP on Thursday.  These figures will show whether or not the US economy has been jump-started enough to sustain recovery in light of the EU debt crisis and could send fears of further problems down the road.  Expect the Dollar receive support through flight to safety trades if risk-aversion remains high.

Yen (JPY):  The government in Japan said that the economy is picking up steadily leaving its assessment unchanged for a second month in a policy statement today from its monthly economic report.  However, growth in Japan has been driven by world demand and stimulus measures, so it is not a self-sustained recovery.  Like the Dollar, expect the Yen to trade on risk themes until at least Thursday, when a slew of economic data points are due out.

Will overnight risk be counter-acted by the US markets today?  Stock markets are opening lower, though commodities are trading higher.  Risk in the overnight session can sometimes be overcome by decent news from the US.  Existing home sales could be that number if they come in better than expected.

So while the overall mood of the market has been risk-aversion for some time, any pockets of economic strength could help stabilize the situation and perhaps show signs of recovery.

Until that time, expect continued selling of the Euro which will have an effect over all other markets as historical correlations begin to break down.

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

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