By Dean Popplewell
The EUR rallying to its highest level in four months reflects a market that is getting more bullish on the single currency, and not just less bearish. Apart from the hot money being poured into the market, there are some longer-term funds behind this stellar run up as investors buy new long positions rather that just investors covering their weaker shorts. Aiding the single unit this morning is the German court rejecting complaints against the ESM and fiscal compact.
In a long awaited ruling, the court turned down an injunction request that would have stopped the ESM finally being signed into German law (should have been done by July 1). It will now allow ratification, but not surprisingly, it has set conditions. This is what the markets had been expecting. The surprise would have been if the court had upheld the complaint. Now it’s all about the question of detail and how the actual programs are going to work. Understandably, market reaction thus far has been choppy, especially more so as we trade at the top of various asset classes ranges. Even in the debt markets, yields by bonds issued by fiscally frail eurozone countries have been steady after the verdict. The ruling certainly sends a clear signal about the likely outcome of the court's final decision on the legality of the ESM and fiscal pact due in December.
Besides Germany, the Dutch are also busy today with national elections. No outright majority is expected, however a prolonged period of coalition negotiations are possible following the vote. Analysts anticipate a decline in support for austerity measures being evident in the results. Event risk and renewed sovereign stress are not expected to be an issue because of the economic dynamics of the country itself. The Netherlands is situated in the strong dominant north of the eurozone and is only one of a handful of current account surplus economies currently funding itself at near-zero rates. Such dynamics do not present to many economic stresses, mostly political.
Data this morning confirms that the eurozone's industrial production rebounded in July, while higher energy prices have led to a pick up in the annual rate of inflation last month. This should pressurize the ECB to consider not easing interest rates any further. IP was +0.6% higher, m/m, but -2.3% lower, y/y. The rise was larger than expected, driven mostly by a spike in the manufacturing in capital goods (+2.3%-led by a +1.3% increase in German output). The rise was not even large enough to offset the previous month's decline. Perhaps this is not sustained growth in the making? The market had been expecting only a +0.1% increase. There is a "eureka" though that many have dismissed. Does this factory output rebound suggest that the eurozone economy may be more resilient than many have suspected?
Euro inflation has also picked up, driven mostly by higher oil prices (Germany +2.1%, Spain +2.7% and France +2.1% for July, y/y). It's certainly not good news for the economically frail region. It makes it less likely that Draghi and his cohorts will cut key interest rates in the coming months. The inflation scourge will only damage the already anemic growth prospects, weaken consumer spending even further already under pressure from rising unemployment. The final August inflation expectations are not expected to be revised higher (+2.6% expected).
The technicals like being long the single unit. The market yesterday broke the 200DMA, opening up the May 9 high of 1.3008. Helping the current bullish momentum is both the 10- and 30-day moving averages becoming more positively aligned. Much of the hot money got long once the 1.2850 option barriers were triggered. It seems stop losses are accumulating at the overnight session low (1.2815-strong psychological support first time around). So far, after the German court decision, there seems a marked rise in EUR volumes, but little bias to net flows. This heavy two-way trade reflects the markets widespread divergence of opinion. It will be interesting to see how much of this upward momentum North America has to offer ahead of the FOMC decision tomorrow. Techs remain supportive for further gains, especially with large stops deposited above 1.2910,25, 35 and 50. The retail sector remains short, but at a horrid average!