IG Markets forex thoughts

IG Markets forex thoughts.

EUR/USD

Sovereign yields continued to be the bane of the euro bulls’ lives, as Fitch came out in European trade and suggested what everyone already knew - that Spain will miss its deficit targets by some way. Comments from the Austrian Finance Minister suggesting Italy may need a bailout at some stage also didn’t help sentiment, although Mario Monti did refute this later on in the session. It is hard enough holding Spanish debt at present, given the fears it will miss deficit targets, lack of growth, unemployment and subsequent austerity that will only inflame these problems, but there is concern if the bank bailout/loan comes from the ESM, you will be subordinated as well; all-in-all not a very compelling case to hold Spanish debt. It also seems the change in sentiment we saw on Monday is really based on the fact that Spain refuses to accept the real cause of the problems that real estate losses, which could increase anywhere between 15 % and 35%, will place greater strain on a country which already has limited growth prospects. Spanish ten- year yields did push to 6.83%, but as risk appetite came back into the market, they subsequently found buyers and closed at 6.70, helping EUR/USD trade from 1.2443 to re-claim the 1.25 handle.

There does seem to be growing condemnation of the way this crisis is being handled by officials, and again Germany put to bed any idea of a banking union (i.e. Eurozone-wide supervision of lenders, deposit guarantees and contributions from the financial industry) re-iterating its view that there has to be fiscal union and a belief that eurozone country’s balance sheets are under control before they commit their tax-payer funds to help stem the crisis.

In Germany later today, the German political leaders will discuss the fiscal compact, however it will be interesting to see if we hear more about a European Redemption Fund (ERF), something that was put forward a while ago by the German Council of Economic Experts which has been getting more and more airtime in recent days, given the German opposition has supported this idea. It is a complex beast, but as Goldman Sachs summed it up, ‘the ERF is a type of Eurobond, but, unlike Eurobonds it would be temporary (25 years), it would mutualise all sovereign debt above 60% of GDP into a fund guaranteed jointly by Eurozone governments’. It is obviously much more in-depth than that, but some are calling this a ‘game changer’, but like all things, it needs to be signed off by the German government. We may see a continuation of the ‘melt-up’ we are seeing in the short term, however we will need to see a close above 1.2624 (January 13 low), and subsequently 1.2668 (38.2% retracement of May sell-off) to really scare off the shorts.



AUD/USD

AUD/USD followed risk sentiment as always in European/US trade, with price action looking decisively like the pair wants to make another crack at parity. European bond spreads continue to blow out, with Spain’s ten-year hitting 6.83%. However, the late session pullback to 6.70%, mixed with comments from Fed member Charles Evans that he is in ‘favour of any accommodative policy’ were enough to push to pair higher as trade wore on. Anyone who says they know how the next couple of weeks are going to go is wrong; we just don’t and the implications of the unknown should keep risk relatively contained, but it does feel that traders are longing for answers, and shorts are concerned that if a significant policy change is announced, they will be left nursing some steep losses. As we have seen over the last week or so, parity seems to be a psychological barrier at which the Aussie struggles to close above. We feel that the real key though is whether pair can close above 1.0028 (50% retracement of the April to May sell-off); if this were to occur, a quick move to 1.0133 could ensue. The trade we feel is more compelling though is short EUR/AUD. We have highlighted this before, but the close below the April 16 low, not to mention the 100-day moving average and 50% retracement of the February to May rally, has opened up a potential move to 1.2476 (61.8% retracement of the mentioned move). The OIS market is still pricing in an 81% chance of a July cut, which we feel is optimistic, while recent statistics suggest there is only about $3 trillion of AAA-rated bonds globally, down from $17 trillion a year ago. Australia’s share of this is pushing up to 10%, effectively making Aussie bonds more attractive for those who need to hold AAA bonds in their portfolio; therefore, many of these purchases will mean buying of AUD.

www.igmarkets.com.au

© Scoop Media