Euro to face headwinds from deepening recession, debt crisis

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Despite some signs of stabilization in Europe, the outlook for the near to medium term is not positive, says David Song of DailyFX. Germany’s slowdown and the unsolved problems in the debt crisis will continue weighing on the value of the euro.

In the interview below, Song also discusses risk from the new debt ceiling talks, the options that the SNB has with the higher EUR/CHF and more topics.

David Song studied macroeconomic policies under a visiting scholar at the Federal Reserve Bank of St. Louis while attending the Zicklin School of Business at Baruch College, and graduated with a Bachelor of Business Administration degree majoring in finance. During his undergraduate program, David acquired a strong understanding of technical analysis from a former-president of the Market Technicians Association, and incorporates both fundamentals and technicals in his analysis. After starting at DailyFX, David authors the daily briefings for the U.S. Open as well as the Trading the News report. David Song

1. With European financial markets stabilizing, can we expect to see “positive contagion” to the real economy? Or could it be the other way around, with Germany slowing down?

Despite signs of stabilization in Europe, the deepening recession will be a major theme this year as market participants see the European Central Bank taking additional steps to stem the downside risks surrounding the region. Although the ECB expects the euro-area to return to growth later this year, Germany’s Economy Ministry lowered its 2013 growth forecast for Europe’s largest economy, and the central bank may show a greater willingness to cut the benchmark interest rate further as the deepening recession threatens price stability. As Germany is expected to expand at a slower pace this year, the downward trajectory in the growth outlook will dampen the appeal of the euro. The single currency remains poised to face additional headwinds over the near to medium-term as the debt crisis continues to drag on the real economy.

2. Another debt ceiling crisis is awaiting us. As the deadline gets closer, can we expect a “risk on / risk off” reaction to any piece of news from Washington?

As the deadline approaches, the stalemate in Congress may weigh on risk sentiment, but fears surrounding the debt ceiling are likely to be short-lived as U.S. policy makers want to avoid jeopardizing the economic recovery. Indeed, negative headlines surrounding the debt ceiling may sap demands for risky assets as it raises the threat of a credit-rating downgrade. We may see Congress find a near-term resolution as the government aims to encourage a sustainable recovery.

3. EUR/CHF has moved up lately. Could the SNB use the opportunity to diversify away from euros in a larger extent, or perhaps raise the floor under the cross?

The recent rally in the EUR/CHF should give the Swiss National Bank an opportunity to diversify its holding of foreign currencies, but the central bank remains poised to keep the floor at 1.2000 as the recent advance in the exchange rate may be short-lived. Moreover, raising the floor would require the SNB to play an even greater role in the foreign exchange market, and the central bank may retain its current policy throughout 2013 as fears surrounding the sovereign debt crisis start to ease. However, the deepening recession in the euro-area may fuel further demands for the Swiss franc. We should see the SNB retail a highly accommodative policy stance over the near to medium-term in an effort to shield the economy from external shocks.

4. Doubts have been expressed by various analysts regarding the recent GDP data. Is there reason to doubt China’s stabilization? Can the Aussie be impacted?

Beyond the GDP data, the shift in public policy continues to raise the risk of seeing a ‘hard landing’ in China as the government appears to be moving away from its export-driven market to a more consumer-based economy. The shift in policy along with the persistent threat of an asset bubble dampens the longer-term outlook for the world’s second-largest economy. The risks surrounding the region may reduce the appeal of the Aussie as China remains Australia’s largest trading partner. As China moves towards a self-sustaining economy, the new initiative will bear down on the resource boom in the $1T economy, and the slowing recovery in the Asia-Pacific may prompt the Reserve Bank of Australia to lower the benchmark interest rate further as it aims to balance the downside risks surrounding the region.

5. The British economy received a nice report from the OECD, yet there is still fear of a triple dip recession and the pound is on the back foot. Where is the British economy going?

Although the U.K. remains at risk of seeing another economic contraction, the Bank of England looks poised to shift gears in 2013 as the central bank sees a growing threat for inflation. As price growth is expected to hold above the 2% target over the policy horizon, the BoE has dropped its dovish tone for monetary policy, and we may see the Monetary Policy Committee scale back its willingness to expand the balance sheet further in an effort to preserve price stability. In turn, we may see a growing number of central bank officials start to adopt a more hawkish outlook for monetary policy, and the BoE may start to discuss a tentative exit strategy over the coming months as the headline reading for inflation has held above target since 2009.

Further reading: Merkel not likely to accept a Greek haircut before the elections

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Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned a significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.