Euro punching above its weight

We’ve highlighted before the euro’s vulnerability to pushing higher as short positions are squeezed out and this was partly in evidence yesterday as the single currency moved back above the 1.28 level on a combination of better risk appetite and decent results from the latest round of debt auctions in the eurozone.  

It was notable that the euro outperformed the Aussie, CAD and sterling in yesterday’s weaker dollar environment.   Furthermore, yesterday was also an opportunity for EUR/USD partially to catch up with the breakdown in the risk correlations seen since the start of the year, namely higher equities being met with dollar strength rather than the more established inverse relationship. Video:

Naturally, there is no guarantee that the old risk-on/risk-off relationship is going to return for EUR/USD, but for now it can be a hook for further rallies to be pinned on.

Guest post FxPro

Commentary

Further signs of softening in China.   The flash estimate for the February reading of the HSBC PMI data showed a third consecutive month of sub-50 readings, recording 48.8, vs. Jan’s 48.7 final release.   The softness is not a massive surprise given the recent trends in other data, but is indicative of a further decline in the pace of activity in the first quarter of this year.   The authorities have been busy both preparing expectations for such an event and also enacting several policy measures designed to cushion the blow, the latest of which was an increase in lending quotas for the major banks.   Note that the yuan weakened today, the reference rate set at the weakest for the year so far, but largely reflecting the softer dollar tone this week.

The Asian bounce. After a dreadful wobble in the final months of 2011, Asian currencies are enjoying a better time as fresh capital is attracted by the prospect of buying cheaper assets. A tentative improvement in risk appetite has stimulated demand for investment in the emerging world. The Indian rupee, which fell more than 20% vs. the dollar in the five months to end December, is up an impressive 5.1% already for the year-to-date. International investors have been especially keen to purchase Indian bonds in recent weeks. Indian equities are also in the ascendancy, up nearly 8% in local currency terms already in 2012. Separately, the Malaysian ringgit is up 3% this year and the Indonesian rupiah 2%. It remains to be seen how sustainable this recent optimism towards Asian assets and currencies is. The key is the single currency. If confidence that Europe can ultimately repair its strained balance sheets continues to grow, then this will clearly assist global risk appetite.

The hard sell for UK on IMF.   Although the Chancellor seems minded to raise the UK’s contribution to the IMF as part of a concerted global push to raise the latter’s firepower, it will likely be a very hard sell to members of his own coalition. In addition, should he choose to go ahead, it will not do the currency any favours. Back in the summer, MPs reluctantly signed off an extra GBP 10bln, but eurozone members are hoping that this will be raised to GBP 30bln. This week, the IMF announced that it was hoping to tap members for an additional USD 600bln. At a time of excruciating fiscal austerity, this issue has the capacity to hurt the political standing of the government and could trigger a re-examination by foreign investors of the government’s commitment to fiscal consolidation.

The euro’s grind higher.   Evident over the last few days has been some consistent buying interest in the single currency. After looking like death at the start of the week, down near 1.26 in response to the S&P sovereign downgrades and collapse of the Greek debt talks, the euro has gradually edged higher and this morning is not far from 1.30. Sovereign wealth funds have been on the bid recently, as have various traders who are becoming frustrated that their short positions are not delivering the goods. News from the IMF that it is likely to push for an additional USD 600bln of contributions and a suggestion from a German newspaper that the next Merkozy meeting will float the idea of a eurozone growth and competitiveness pact have both helped the tone. It is just possible that the worm is turning for the euro, at least in the near term.