FX: Dangerous Mix of Policy and Data Alignment
We know that EUR/USD and U.S. stocks traded lower today on concern that Europe's leaders will disappoint at this week's EU Summit. Yet the lack of support for sharing sovereign credit risk from the Germans is not the only threat to the euro. By prolonging the debt crisis at a time when economic data around the world is weakening, European leaders are creating a dangerous mix for risky assets around the world including the EUR/USD. According to the latest CFTC IMM data on speculative positions, traders have cut their short EUR/USD exposure in anticipation of progress on the policy front. This means that should policymakers fail to convince the market that a fiscal union is in the works, those who have cut their shorts could return the market and sell euros again.
The only thing preventing the EUR/USD from revisiting its year to date low at 1.2288 is blind faith in politicians. Without that, we are left with weaker investor and business confidence, slower manufacturing and service sector activity in Germany as well as recessionary conditions in many Eurozone nations. Growth in the U.S. and China is also slowing, posing a triple threat to the global economy. If European leaders fail to support the markets with policies that will end the debt crisis, the EUR/USD could make fresh year to date lows.
Everything lies in the hands of German Chancellor Merkel and unfortunately, based on her comments this morning, she continues to oppose the very measures that are needed to turn Europe around. In her speech, she blamed the euro debt crisis on Europeans living beyond their means and crushed everyone's hope for a ground breaking announcement on Friday by saying that it is counterproductive to share the euro-debt burden. Merkel left no room for ambiguity when she rejected joint euro bonds and bills, and joint deposit insurance if it means joint liability. She also expressed concern that investors were fixating too much on sharing debt, which confirms that the Germans are not relenting.
Unless Merkel softens her stance on burden sharing, this week's EU Summit will most likely end up being a major disappointment for the EUR/USD. While Angela Merkel will be heavily outnumbered at the EU Summit, she controls the purse strings and without her nod of approval, Europe will not be able to get the clear roadmap that it needs to reverse the vicious cycle that pushed so many nations into begging for a bailout. Along these lines, Spain formally requested aid to recapitalize its banks this morning, sending Spanish 10 year bond yields higher.
Cyprus also requested financial aid from the emergency bailout fund, making it the fifth nation in the Eurozone to beg for a lifeline. While we don't know yet whether they will need a bank bailout only or a broader sovereign bailout, it is terrible news for the euro either way. The currency pair took the news in stride but this news will add pressure to the euro, which we expect to remain weak going into the EU Summit unless of course Germany suddenly makes a U-turn and decides to come to the rescue of her distressed neighbors by sharing their debt burden - which is unlikely.
USD: Stronger New Home Sales Fail to Lend Support to Risk
Concerns about Europe drove investors back into the arms of safe haven currencies. Both the U.S. dollar and the Japanese Yen performed extremely well today, with the latter appreciating against all other majors. The weakness of USD/JPY confirms that risk aversion dominated trading as investors shrugged off the upside surprise in U.S. data. Sales of new home sales in the U.S. was the only piece of important economic data on the calendar today. According to the latest report, new home sales rose 7.6 percent to 369k in the month of May. This was the highest amount of homes sold since Nov 2009. The supply of new homes also dropped to its lowest level since October 2005.
While this data is very encouraging, it is important to realize that inventory is only moving because prices are dropping. The recovery in the housing market is expected to continue to lag the recovery in the broader economy and for this reason the improvement in new home sales will not soften the case for QE3.
Consumer confidence and the Richmond Fed manufacturing index are due for release tomorrow. Given the sharp decline in sentiment reported in similar surveys conducted by Investors Business Daily and the University of Michigan, there is a good chance that tomorrow's report will confirm that consumers grew less pessimistic in the month of June. As for the manufacturing sector, weakness in the Empire State and Philadelphia regions signals a broad based slowdown in the sector that will most likely hit the Richmond area as well. Overall, like new home sales, none of these reports are expected to diminish the chance of another round of asset purchases from the Federal Reserve.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
