During the last week the EUR/USD rate saw a little change. The single currency started the week at $1.2971 and after going as low as $1.2880, it finished at $1.3004 on Friday, marking a weekly increase of about 0.3%.
The week included some interesting political and economic events, with Greece being the main focus of the markets. On Monday the Eurogroup gave its political approval of the next disbursement of financial aid to Greece. The formal decision is expected to be taken on December 13, after national parliaments of the Eurozone countries approve the deal. The German Bundestag gave its approval on Friday. According to plan the debt-to-GDP ratio of Greece has to be no more than 124% in 2020 and decline substantially below 110% in 2022. The country's debt-to-GDP ratio for 2011 was 170.6% in December 2011.
According to a Reuters article from Saturday, December 1, the German Chancellor Angela Merkel said that a further "haircut" in Greece debt might be considered as an option but not before 2014/2015, and only if the Greek government is able to support its spending without taking additional debt.
On the economic front the EU CPI marked a surprisingly big decrease to 2.2% (from 2.5%) which is its lowest level since December 2010. The business climate in Europe also improved. In the U.S. durable goods orders showed better than expected values and the GDP increased to 2.7%, a bit below the consensus level of 2.8%. The gross domestic purchases index fell to 1.4% from a previous value of 1.5% which speaks of significantly lowered inflationary pressures on the U.S. economy.
The U.S. fiscal cliff continues to put pressure on the markets. A Bloomberg article suggests that even if a political decision is not available before January 2013, U.S. Treasury Secretary Timothy Geithner has means to mitigate and postpone its negative effects on the U.S. economy. In a recent interview Warren Buffett said no one would expect the U.S. to "commit a suicide" and a solution will be found. In the long term however, there could be economic consequences on the micro level even if a political solution to put the U.S. debt on a more sustainable level is found. Thus, we believe the danger is improperly dubbed as a "cliff." Calling it a "fiscal slope" might be more appropriate because any efforts to reduce the debt levels combined with increases of some of the taxes will affect the American economy in a much more smoother way than a "cliff" would suggest. Despite the short- to near-term hardships this could bring, as a long-term effect it would produce a healthier economy.
The Week Ahead
The current week faces two important economic events - the ECB interest rate decision and the data on U.S. unemployment. The market consensuses on both indicators are that there will be no change. The Consensus Optimism Index (COI) which we calculate, is currently at 34%, after going as high as 51% in the previous week.
The index presents the proportion the positive consensus estimates take in all the estimates for the respective week. A value above 50% represents an optimistic mood in the expectations rather than pessimistic. The weekly change in index's value could be used as a tool to assess the markets moods. It should not be neglected however that the EUR/USD rate actually moves rather on the real data and on how that data differs from the expected one.
To take advantage of their own expectations of the EUR/USD exchange rate the investors could open a direct position in the FOREX market or use some of the available ETFs which provide access to it. The CurrencyShares Euro Trust (FXE) is one of the options. This ETF tracks only the price of the euro measured in U.S. dollars. The fund has an expense ratio of 0.40%. If investors expect the euro to appreciate, a long position in the fund could be used. It they expect a higher value for the USD, they could open a short position in the ETF.
For those who would not prefer to measure the USD only against the euro, the PowerShares DB USD Bullish ETF (UUP) and the PowerShares DB USD Bearish ETF (UDN) are available. Both funds are U.S. dollar denominated and track the value of the USD against six other major currencies - euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. The funds' expense ratio is 0.50%.
Investors could also hedge some of their U.S. dollar exposure by using alternatives whose prices often move inversely to the price of the U.S. dollar. A possible option here would be the SPDR Gold Trust (GLD). As of the end of November 2012, the monthly correlation for the last one year between GLD and UUP stands at -0.77. This is an increase since the September value of -0.75. The negative correlation suggests that those expecting the U.S. dollar to decline in a near- to long-term horizon could use a long position in the ETF, and vice versa. GLD tracks the spot price of gold and holds physical gold bullion. It has an expense ratio of .40%.
Because the correlation is a dynamic characteristic, it should be periodically evaluated to see what the current value is. Any lowering of the correlation would suggest a further assessment of the effectiveness of the hedge on behalf of the investors.
Monday, Dec. 3
EU Germany Markit Manufacturing PMI (Nov.)
EU Markit Manufacturing PMI (Nov.)
USA Markit Manufacturing PMI (Nov.)
USA ISM Prices Paid (Nov.)
USA ISM Manufacturing PMI (Nov.)
USA Construction Spending (m-o-m) (Oct.)
The week starts with Markit indexes for Germany and the European monetary union. According to the consensus estimates, they both will rise by about 1.7%. The expectations for the Markit manufacturing PMI in U.S. are for a lower increase (0.3%). Any positive surprises from the estimates would benefit the euro against the U.S. dollar because of increase in the risk sentiment. Negative surprises would do the contrary.
For all of the other U.S indicators presented above, the consensuses point to slight declines. This sentiment could however be influenced by the previous week's mismatch between the market consensus and the real data, where the estimates were above the real values in almost 70% of the cases. A positive surprise in ISM PMI or construction spending would support the notion that the U.S. economy is improving, despite the "fiscal cliff" danger. This would support the single currency.
Tuesday, Dec. 4
EU ECOFIN Meeting
EU Producer Price Index (Oct.)
USA Redbook Index
The Economic and Financial Affairs Council of the EU will meet on Tuesday. Its agenda includes an agreement on the general approach on the European Banking Supervision Mechanism. A press conference will be held after the meeting is over. The importance of the ECOFIN meeting is in the fact that the agreement the delegates have to arrange is a necessary step in the process of bringing the mechanism to life. A negative surprise here could significantly damage the market positive sentiment toward the euro.
The consensus on the Europe PPI points to a decline. Such an outcome would support the expectations that the EU CPI decrease we saw last week is not just a temporary event. Lower inflation expectations will lighten the pressure on the ECB to rise its interest rate on its meeting on Thursday.
Data on the U.S. Redbook index will show whether after the strong start given by the Black Friday (when the index grew from 1.8% to 4.5%), the Holiday shopping season continues in the same manner. A significantly lower value could weigh on the notion that the U.S. is experiencing a healthy recovery. This will support the USD as a safe haven currency.
Wednesday, Dec. 5
EU Germany Markit Services PMI (Nov.)
EU Retail Sales (Y-o-Y) (Oct.)
USA ADP Employment Change (Nov.)
USA Factory Orders (M-o-M) (Oct.)
USA ISM Non-Manufacturing PMI (Nov.)
Market consensuses for both Germany Markit services index and the EU retail sales are for slight or none changes. The value of the Markit index is not expected to go above 50, a level which is considered a threshold between an expanding and contracting economy. Positive surprises here would support the euro against the USD.
Concerning the ADP employment change, in the last 5 months the estimates tend to be steady below the real values. A value here above the consensus will benefit the euro as the risk-on currency in the EUR/USD pair.
Positive surprises on the other two indicators will also support the euro.
Thursday, Dec. 6
EU GDP (Y-o-Y) (Q3)
EU Germany Factory Orders (M-o-M) (Oct.)
EU ECB Interest Rate Decision
EU ECB Monetary Policy Statement and Press Conference
USA Initial Jobless Claims
Thursday presents significant data in Europe, starting with the EU GDP. The expected value of -0.6% will mark a third quarter of negative growth for the Eurozone. The monthly change consensus is for a slowdown of the decline but the expected value is still negative. This will put pressure on the euro but not as much as a positive surprise could make it to appreciate.
The positive expectation is for Germany's monthly factory orders. A positive value would indicate some strength in the German economy which would be able to give the single currency a certain support.
The event of the day, and possibly the week, is the ECB rate decision. Data from the previous week showed the inflation in Europe is down to 2.2% (from 2.5%). Thus, the only factor that seems to put pressure on the ECB to rise its interest rate, is the increase of the M3 money supply on annual basis (3.9%, from 2.7%). With the inflation moving lower however, it is like the increased money supply does not find its way to consumers. So there seems not to be a strong need for the ECB to raise rates.
A decrease of the rate is generally possible and such a surprise would support the USD because of the interest rate differential becoming more narrow. However, in the previous edition of this "EUR/USD: week ahead" review we cited Mr. Draghi, President of ECB, who said that "The ECB's attachment to the primary objective of price stability remains unquestioned." Having this in mind, we favor the outcome that the ECB will leave the rate unchanged.
Friday, Dec. 7
EU Germany Industrial Production (M-o-M)(Oct.)
USA Non-farm Payrolls (Nov.)
USA Unemployment Rate (Nov.)
USA Consumer Credit Change (Oct.)
Market consensus for Germany's industrial production is that it will slow down its deterioration but still show a negative value. Any positive surprise here would benefit the euro.
The most important data for the day come from the U.S.
Apart from the unemployment rate, where the consensus is that it will stay the same, the market expects the other two indicators to mark declines. Any positive surprises here, on each of the indicators, would increase the positive sentiment towards the American economy. Such an environment would generally support the euro against the U.S. dollar, as it would make investors more risk-seeking.
A higher, and unexpected, value of the unemployment rate would weigh significantly on the market sentiment and a search for currencies perceived as safe havens (USD, JPY, CHF) could occur.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.