Best Thread FXCM/DailyFX Signals and Strategies

[Jason Rogers]

Oil to Follow Stocks Correction Higher

Written by Ilya Spivak of DailyFX.com

Crude is pushing sharply lower, with prices poised to take out support at the midline of a rising channel that has guided them higher since February 2009. Initial support lines up at $92.98, followed by the channel bottom now at $88.12. Taken together, this is a formidable barrier and a bounce higher seems likely before it is taken out in earnest. Initial resistance lines up at the $100/barrel figure.

Risk sentiment remains in focus, with the WTI contract moving in tandem with the MSCI World Stock Index. This puts the onus on April’s US employment figures. Expectations call for the world’s top economy to add 185,000 jobs in April – marking the smallest increase in three months – while the Unemployment Rate holds steady at 8.8 percent.

Traders have been selling risky assets and buying the US Dollar this week, apparently look ahead to rising US yields after the Federal Reserve firmly pledged to end QE2 in June at last week’s FOMC meeting. It seems reasonable that a soft employment figure may be just the catalyst to engineer some profit-taking on risk-averse positions, with shares as well as risk-correlated assets including crude recovering while the greenback retraces some of its advance.

 

[Jason Rogers]

U.S. Dollar Index Continues To Gain Ground As Investor Sentiment Remains Weak

Written by David Song of DailyFX.com

The rebound in the U.S. dollar index gathered pace on Monday, with the gauge advancing to a high of 9588.94, and the greenback may continue to recoup the losses from earlier this year as fears surrounding the European debt crisis bears down on trader sentiment. The DJ-FXCM index is 0.28% higher from the open after moving 106% of its average true range, but we may see a small correction over the next 24-hours of trading as the six-day rally remains overbought. However, the V-shaped rebound in the dollar index may gather pace going forward as European policy makers struggle to restore investor confidence, and the greenback may continue to gain ground against its major counterparts as the reserve-currency benefits from safe-haven flows.

Indeed, the British Pound is threatening the upward trend from earlier this year as the exchange rate tumbles to a fresh monthly low of 1.6270, and the sterling may face additional headwinds later this week as we are likely to see the Bank of England maintain a dovish outlook in its quarterly inflation report, which is due out on May 11. As the recovery in the U.K. cools, BoE Governor Mervyn King may show an increased willingness to support the real economy for most of 2011, and the near-term reversal in the GBP/USD may gather pace going into the second-half of the year as interest rate expectations deteriorate. Moreover, the sharp pullback in the euro looks as though it will accelerate in the days ahead as the EU struggles to stem the risk for contagion, and the Governing Council may continue to soften their hawkish outlook for future policy as the European periphery face record-high financing costs. In turn, any small correction in the DJ-FXCM index could be short-lived, and demands for the greenback may gather pace over the near-term as risk sentiment remains dampened by the uncertainties surrounding the global economy.

 

[Depth Trade]

Re: Jamie's Market Thoughts: 05/05/11

Written by Jamie Saettele of DailyFX.com

• Limit order to short AUDJPY at 8560 and 8600, stop 8685, targets 8200 and 8050
• Limit order to short NZDJPY at 6340 and 6400, stop 6450, targets 6100 and 6000
• Limit order to short AUDUSD at 10640 and 10690, stop 10775, target 10200
• Limit order to short NZDUSD at 7965, stop 8060, target 7550

Dude, can you guys update us on these positions instead of pretending you never called them?
So far I have you Stopped out on all four of your Aud/jpy, Aud/usd positions (4).

I'm going to be blown away if you guys can't even trade your own recommendations. If you guys can't trade, you really shouldn't be in the market of giving analysis.
Seriously, let's get real.

Have a great day.

 

[Jason Rogers]

Re: Jamie's Market Thoughts: 05/05/11

Dude, can you guys update us on these positions instead of pretending you never called them?

A new article is updated to the thread each day for any one of the analyst. If you would like to follow one analyst every day, please visit www.dailyfx.com. Thanks for reading!

 

[Jason Rogers]

EURUSD: Bearish Trend Change on Tap?

Written by Ilya Spivak of DailyFX.com

Strategy: Pending Short

The EURUSD weekly chart reveals a well-defined Bearish Engulfing candlestick below the 1.50 figure. Furthermore, prices have taken out rising trend line support set from the swing low in mid-January. Prices are now re-testing resistance-turned-support at a rising trend line set from the record high above 1.60 in July 2008, a barrier bolstered by the October 2010 swing high at 1.4281, with a break below this barrier serving as confirmation of a major bearish reversal over the weeks ahead. We will remain on the sidelines for the time being and monitor how the pair behaves at this critical juncture before committing to position.

 

[Jason Rogers]

Euro May Plunge Below 14000 by Next Week

Written by Jamie Saettele of DailyFX.com

I wrote yesterday about “the inability of the EURUSD to bounce in the face of a snapback in the metals, crude, and stocks suggests that this market is weak. Additional weakness targets 14150.” The rally into 14423 is the largest since the decline from above 14900 – weakness since has been sharp and gives scope to the next leg down. 14150, the 4/18 low and 38.2% retracement of the rally from 12874, is potential support but there would be 2 equal legs down from above 14900 at 13736 which intersects with corrective channel support on May 16th(keep this date in mind). The drop to this level would constitute wave B within an A-B-C advance from 12874. Additional levels that may offer support are 14000 and 13861. Trading above 14423 would delay the bearish outcome and shift focus to resistance between 14510 and 14600.

240 Minute Bars

 

[Jason Rogers]

Haven Flows See Dollar Strength Accelerating

Written by Michael Boutros of DailyFX.com

The dollar was stronger across the board at the close of North American trade today on the back of a broad risk sell-off across asset classes. Traders piled into the safety of the greenback and US Treasuries as ongoing concerns over the crisis in Europe had investors shunning risk. The Dow Jones FXCM dollar index climbed to its highest level in three weeks after testing the lower bound trend line of the ascending channel that has held the index since April 28th. The channel formation remains intact noting interim targets at 50-day moving average, currently at 9693, and the 38.2% Fibonacci retracement taken from the November 30th decline at 9730.

A daily chart (see below), shows the dollar breaking above the 20 day moving average before encountering resistance at the 23.6% Fib retracement just shy of 9600. Expect the dollar’s strength to continue in the interim as the euro suffers over debt concerns, and commodities soften. Tenchnical indicators also leave room for topside moves, with RSI climbing above the 52 level, and the MACD spread widening. Note that a break below 9520 sees stronger support resting at 9460.

 

[Jason Rogers]

Euro on the Verge of Financial Panic but Risk Appetite Still Holding

Written by John Kicklighter of DailyFX.com

If ever there were a good example of the equilibrium of risk / reward in the markets, it would be the euro. Even though the shared currency does not maintain the highest yield amongst its peers (the Australian and New Zealand dollars are still offering a better return); it nevertheless holds itself out to be as resilient as its more valuable counterparts. What makes this performance particularly remarkable though is that this inherent optimism is maintained despite the euro’s facing some of the worst fundamental risks of any of the majors markets. The financial troubles facing Greece and Portugal specifically present problems that run to the very core of euro and the European Monetary Union it represents. In the balance between the fear and greed that defines this (and every) market, there is clearly a dislocation – and it is primarily centered on the under-appreciation of present and growing risks. If we want to gauge when the euro will finally capitulate, our focus should be expectations for instability.

My general outlook for the euro has been a bearish one for some time; but that does not necessarily mean we should immediately trade that bias. There have been historically many periods when the investing masses have tolerated excessive risk or disregarded exceptional return to maintain a comfortable trend. This seems to defy fundamental reason; but more accurately, it reflects the markets’ prejudices – and the market defines price. As for the financial troubles facing the Euro-region, the problems are well-known which may lead many to believe that they are fully priced in. Yet, the full potential fallout from a debt/currency crisis is unknown and the ECB’s effort to keep inflation under wraps has given short-term speculators a convenient distraction. Should we see the meeting of Eurogroup Finance Ministers over the first two days of the week come up short on a solution for Greece, Portugal and Ireland; it could further bring the region’s troubles into relief.

To understand the market impact from the event; we need to know what is at stake. At the forefront of the discussion, we have Greece which forced the region to the next leg of the financial devolution. Though officials will not to admit as much, it is not unlikely that the country indeed threatened its EU counterparts that it would withdrawal from the monetary restraints (which come along with the currency) unless further accommodation was made. Few other scenarios would encourage such a prompt and compliant vow to offer the member further aid (regardless of the European Commission’s updated forecast for Greece to post a wide-target missing, 9.5 percent debt to GDP ratio this year). However, accommodation for this already deeply indebted nation would certainly encourage Ireland and Portugal (who have recently seen political upheaval as citizens vote on anti-austerity beliefs) to demand the same. With more than 250 billion euros in aid already extended, further rounds of accommodation will only push us closer to the breaking point.

Will this particular meeting provide the shock that changes the balance in the market? The probability is not high. As we have seen with previous meetings with similar stakes, policy officials are adept at playing to funding and currency markets that preoccupied with passive returns with flimsy promises. With Germany refusing further amendment without equivalent guarantees of progress, it is even more unlikely that we will see purposeful improvement. That said, a rebound for the euro is a more likely scenario; but it will die out quickly as few are expecting a roaring recovery from the region’s troubles. The deciding factor may actually lie outside of the euro’s own fundamental influence. Should we see global risk appetite falter, traders will abandon the most overvalued and troubled assets – the euro among them. - JK

 

[Jason Rogers]

Written by David Rodriguez of DailyFX.com

The Australian Dollar remains a speculator’s favorite, serving as a highly-correlated and high-yielding proxy to the US S&P 500, Gold, and Crude Oil futures prices.

The Australian Dollar has pulled back from record highs against its US namesake as broader financial markets correct. Yet the antipodean currency remains an attractive investment as its short-term yields are the highest among G10 currency and the US Dollar currently ‘boasts’ record-low interest rates.

As long as US Dollar yields remain near record-lows, we may continue to see cross-market correlations trade near historical strength across a broad range of raw materials prices. This seems particularly true for high-flying Gold and Crude Oil prices as well as the Australian Dollar.

Forex Correlations Summary
Forex correlations against Oil, Gold, and the Dow Jones Industrial Average for the past 30 calendar days:

 

[Jason Rogers]

U.S. Dollar Outlook Hinges On FOMC Minutes As QE2 Comes To An End

Written by David Song of DailyFX.com

Talking Points

• British Pound: Eyes 1.6000 As BoE Maintains Balanced Outlook
  
• Euro: ECB Holds Hawkish Tone Despite Heightening Risk For Contagion
  
• U.S. Dollar: FOMC Meeting Minutes On Tap

U.S. dollar price action was largely mixed during the overnight trade, and the short-term outlook for the greenback certainly hinges on the FOMC meeting minutes due out later today as currency traders weigh the prospects for future policy. As the FOMC plans to conclude the additional $600B in quantitative easing, market participants will keep a close eye on what the central bank intends to do in the second-half of the year. The committee may start to layout the foundations for its exit strategy, but the central bank is likely to endorse a wait-and-see approach for the third-quarter as it aims to encourage a sustainable recovery. At the same time, the Fed may also highlight an increased risk for inflation as economic activity gradually gathers pace, and hawkish commentary from the central bank could generate a bullish reaction in the USD as investors expect the committee to gradually normalize monetary policy going forward. However, currency traders may show a bearish U.S. dollar reaction should the Fed deliver a balanced statement, and the greenback may struggle to hold its ground as interest rate expectations falter. The British Pound slipped to a fresh monthly low of 1.6125 following a slew of disappointing developments out of the U.K. Unemployment claims in Britain increased for the second consecutive month in April, while the Bank of England maintained a cautious outlook for the region. The policy meeting minutes showed the Monetary Policy Committee voted 6-3 to keep the benchmark interest rate at 0.50% in May, with the majority arguing that higher borrowing costs could “adversely affect consumer confidence,” which would lead to an “exaggerated impact” on private sector consumption.

Moreover, the MPC said that a case could be made to ease monetary policy should “the downside risks to household spending to materialize,” but went onto say inflation expectations could “drift upwards” given the stickiness in price growth. Indeed, the balanced tone held by the BoE will continue to dampen the prospects for a rate hike in 2011, and the GBP/USD looks poised to work its way back towards former resistance around 1.6000 as it searches for support. Nevertheless, market participants still see borrowing costs in the U.K. increasing by nearly 50bp over the next 12-months according to Credit Suisse overnight index swaps, and the British Pound could face range-bound price action over the near-term as investors weigh the risks for the U.K.

The Euro fell back from a high of 1.4285 and the single-currency is likely to face additional headwinds over the near-term as European policy makers consider ‘reprofiling’ Greece’s government debt. European Central Bank board member Vitor Constancio said an adjustment path for Greece could be in store to avoid a default, but argued that restructuring the debt ought to be “the last resort” as it entails “enormous consequences.” Despite the heightening risk for contagion, Governing Council member Ewald Nowotny said interest rates in Europe will continue as growth and inflation accelerate, and went onto say that a restructuring/rescheduling of Greece’s debt is “definitely not an element of discussion” at the central bank. The mixed outlook held by the Governing Council could make it increasingly difficult for the ECB to raise the benchmark interest rate further in the first-half of the year, and the board is widely expected to maintain its wait-and-see approach in June as the economic outlook remains clouded with high uncertainty. In turn, the EUR/USD may consolidate further heading in the following month, and the exchange rate could make another run at 1.4000 as it struggles to retrace the decline from the previous week.

 

[Jason Rogers]

This thread will not be updated until May 30th. Until then, happy trading!

 

[Jason Rogers]

Canadian Economy Grows for Fifth Time in Six Months

Written by Christopher Vecchio of DailyFX.com

The Canadian economy grew for the fifth times in six months, data released today by Statistics Canada showed. The aggregate growth figure expanded at a 3.9 percent annualized rate in the first quarter, following a 3.1 percent expansion in the fourth quarter of 2010. According to a Bloomberg News survey, the median forecast called for 4.0 percent growth in the first quarter of 2011. The economy grew by 0.3 percent in March, up from a 0.1 percent contraction in February, on a month-over-month basis. Overall, GDP was up 2.8 percent on a year-over-year basis, slightly worse than the 3.0 percent figure from February.

While the data comes in softer than anticipated, it still remains stronger than growth figures released by Canada’s largest trading partner, the United States, which grew by a meager 1.8 percent in the first quarter. The differential in growth rates and growth prospects has helped the Loonie against its American counterpart, as the USD/CAD pair fell by 2.82 percent in the first quarter of 2011.

Canadian GDP (YoY): May 2007 to Present

Courtesy: Bloomberg​

The stronger Loonie could have adverse effects on the overall growth figure in the following quarters, however, as evidenced by the current account figure from the first quarter that was also released today. While the current account balance improved significantly from its last reading, improving to -$8.9 billion from -$10.3 billion, the figure missed the forecast of -$7.2 billion due to the strong domestic currency, which suppressed net exports.

Should growth cool after the strong first quarter reading, pressure will likely be alleviated on the Bank of Canada to raise rates, which have been maintained at 1.00 percent since September 2010. Indeed, the central bank’s forecast shows an expectation of growth to drop to 2.0 percent this quarter.

Following the release of the news, the Loonie lost ground against its American counterpart, with the USD/CAD pair’s exchange rate rising from as low as 0.9754 to as high as 0.9782 in the minutes after the report was released. The impact was muted due to the fact of the closure of the U.K. and U.S. equity markets for national holidays. Similarly, the Dollar Index gained from 9561.06 to as high as 9567.03 following the data release.

 

[Jason Rogers]

Dollar Index Closely Linked to Dow Jones, Crude Oil, Gold Prices

Written by David Rodriguez of DailyFX.com

The US Dollar remains strongly correlated to equities and commodity prices, as the Dow Jones FXCM Dollar Index sees record correlations to the Dow Jones Industrial Average, NYMEX WTI Crude Oil contract prices, and spot gold exchange rates.

As the second-lowest yielding major world currency, the US Dollar is a speculator’s favorite as a cheap funding source for investments in higher-yielding and higher-return asset classes. Said dynamic explains the strong link between the USD and the Dow Jones Industrial Average, while the fact that the US is a large net-importer of Crude Oil largely explains its link to futures prices.

The US Dollar remains weak as traders expect the US Federal Reserve will keep interest rates at record-lows and monetary policy loose through the foreseeable future. As long as the Fed maintains its current bias, expect the Dollar Index to remain a strong proxy for moves in the Dow Jones Industrial Average, Crude Oil, and Gold prices.

Forex Correlations Summary

Forex correlations against Oil, Gold, and the Dow Jones Industrial Average for the past 30 calendar days:

Dow Jones FXCM Dollar Index vs Dow Jones Industrial Average

The US Dollar’s link to the Dow Jones Industrial Average has almost literally never been stronger, underlining that the USD is likely to decline if we see further strength in equity prices and broader ‘risk’. As the second-lowest yielding major world currency, speculators have been quick to borrow US Dollars as a cheap funding source for higher returns elsewhere.

As a result we see the US Dollar decline when relatively risky assets such as the Dow Jones Industrial Average become more attractive. In times of DJIA declines, the US Dollar often rallies as speculators become more risk averse and close their leveraged high-yielding bets. We are likely to continue to see the US Dollar act as a strong proxy for the Dow Jones Industrial Average and other key ‘risk’ barometers.

 

[Jason Rogers]

Swissie Surges to Fresh All-Time Highs

Written by Michael Boutros of DailyFX.com

The Swiss franc topped the performance charts against the dollar overnight, advancing to fresh all-time highs versus the greenback. As sovereign debt concerns continue to take root in Europe, the swissie remains well supported on haven flows as domestic investors seek to hedge against the possibility of a debt restructuring from Greece. The pair broke through the 100% Fibonacci extension taken from the April 19th and May 13th crests at 0.8494 in pre-market trade. Interim downside targets are set at the 0.84-handle and at the long-term 76.4% Fibonacci extension taken from the April 4th and May 13th crests at 0.8340. Topside resistance is held at 0.8490 backed by 0.8540 and 0.8580.

 

[Jason Rogers]

Rate Decisions Ahead Could Shift Risk Sentiment After Troubling Week

Written by Christopher Vecchio of DailyFX.com

After a week of troubling data out of the United States that cast a shadow of doubt about the resiliency of the recovery in the world’s largest economy, with no critical events on the calendar for the United States, the market will turn its collective eye overseas as there are four rate decisions on the calendar for the first full week of June. Growth and inflation are two of the top priorities for central banks around the world, and yet, even in a globalized economy, prices pressures are affecting the four countries that have interest rate decisions very differently. Although the current attitude in the market has shifted toward risk-aversion, commentary following each of the rate decisions could spark hope among traders, sending the various domestic currencies affected by their respective rate decisions higher still against the U.S. Dollar.

Reserve Bank of Australia Rate Decision (MAY): June 7 – 04:30 GMT
Price pressures, though contained, are beginning to rise for Australia, which saw first quarter CPI jump 1.6 percent on a quarterly basis, and 3.3 percent on a year-over-year basis. Although the antipodean nation’s gross domestic product fell by 1.2 percent in the first quarter, the Reserve Bank of Australia blamed massive flooding which suppressed coal exports, and thus the decline is only viewed as temporary.

The markets are discounting the possibility of a rate hike, with only a 13.0 percent chance of a 25-basis point rate hike at the meeting next week. Similarly, only 24.0-basis points are priced in the Australian Dollar for the next 12-months. Rhetoric following the meeting will be key, as if inflationary pressures continue to build, there might need to be the need to raise the key rate in the coming months. As such, should commentary following the meeting be hawkish, the Australian Dollar could continue to see an appreciation against the U.S. Dollar.

Euro-zone Gross Domestic Product s.a. (YoY) (1Q P): June 8 – 09:00 GMT
Euro-zone gross domestic product data for the first quarter could disappoint expectations, as continued sovereign debt woes has weighed on many of the smaller Euro-zone nations. Similarly, while there was a rate hike in April, the rates were still lower in the first quarter. The Euro-zone economy was continuing to expand in first quarter, though, with retail sales, industrial production, and manufacturing data all moving to the upside in the first three months of the year. Nonetheless, the components of growth are well-documented before the release of the aggregate number, the price action sparked onto Euro-crosses could be limited.

Reserve Bank of New Zealand Rate Decision (MAR): June 8 – 21:00 GMT
Although food prices and producer prices continued to rise in April, according to their most recent data releases, muted concern by Reserve Bank of New Zealand policymakers with rising inflationary pressures in the Pacific Rim’s economy have weighed on the notion of a rate hike. Additionally, housing prices continue to fall, down 1.9 percent in April. Consumer spending has started to move higher again, as evidenced by increased card spending on retail goods in April.

With inflation currently contained within the Reserve Bank of New Zealand’s acceptable medium-term range, markets are doubtful on a 25-basis point hike, with a 0.0 percent chance of a move at their next meeting. Similarly, according to the Overnight Index Swaps, 57.0-basis points have been priced in over the next 12-months.

Bank of England Rate Decision, Asset Purchase Target (MAY): June 9 – 11:00 GMT
The Bank of England is widely expected to keep their key overnight interest rate on hold at 0.50 percent at their meeting on Thursday: according to the Credit Suisse Overnight Index Swaps, there is a near non-existent 1.0 percent chance that the Monetary Policy Committee votes to hike rates now. Also of note: inflation hawk Andrew Sentance ended his tenure this week, and was replaced with a much more moderate policymaker. The OIS shows that markets are pricing in a 31.8-basis pointsover the next 12-months, having fallen significantly over the past few months, despite rising inflationary pressures.

It appears that policymakers are more concerned with restarting the economy rather than tempering inflation – they are unwilling to let a stagflationary state kick in.The Bank of England will be forced to readjust their monetary policy stance towards a more dovish tone in the near-term, and after moderate growth, a more hawkish bias to contain price pressures. This commentary is unlikely at the next meeting on Wednesday.

European Central Bank Rate Decision (MAY): June 9 – 11:45 GMT
Growth is expected to have climbed slightly higher the first part of 2011, as noted early. Still, the main concern for the European Central Bank is to keep inflation tethered within its acceptable range, in spite of an interest rate hike at their meeting on April 7. April’s inflation rate was 2.8 percent, as indicated by the year-over-year consumer price index reading. Nonetheless, because it typically takes a few months for the effects of a rate hike to be felt by the broader market, inflation pressures are unlikely to have cooled since the last meeting.

Various European officials have hinted at the possibility of a rate hike at next week’s meeting, and with the news of a Greek bailout on the table, it is possible that President Jean-Claude Trichet moves to raise rates once more. Still, his rhetoric at the press conference following the meeting is the most important event on the day, as his commentary will clue traders into whether or not there is a rate hike in the future.

 

[neil]

Jason - thanks for the info. you post. Very useful stuff.

 

[Jason Rogers]

US Dollar Tests Former Channel Resistance as Support

Written by Jamie Saettele of DailyFX.com

The drop below 7496 could complete a flat correction. The buck has reached potential support from the topside of former channel resistance. Additional weakness would test support from former resistance at 73.32 (near term structure favors weakness into this level). Trading above 74.94 would indicate that the secondary low is most likely in place.

Dow Jones FXCM US Dollar Index (Daily Bars)

 

[Jason Rogers]

Crude Oil Positioned to Decline on Risk Aversion

Broadly speaking, crude oil positioning is little changed over the past two weeks, with prices carving out a triangle chart formation below $103.30. The setup is typically indicative of trend continuation, which argues for losses in this case considering the WTI contract entered consolidation following a sharp decline. Although crude remains closely correlated with the S&P 500, it managed to decouple from the stocks selloff in New York trade in the aftermath of unnerving remarks from Fed Chairman Ben Bernanke, as API reported that inventories dropped the most since December last week.

Looking ahead, there seems to be ample scope for a catch-up, with S&P 500 index futures pointing the way lower as markets continue to reel from Bernanke’s simultaneous worries about an “uneven” and “frustratingly slow” recovery and apparent dismissal of further stimulus, with emphasis placed on limiting inflation and an allusion to the “prospect of increasing fiscal drag” on the economy (implying the Fed is expecting US Treasury bond yields to rise as QE2 expires). Downward pressure may be compounded as the US central bank releases its Beige Book regional economic conditions survey, which is likely to reinforce signs of an acute slowdown heading into the end of the second quarter.

Beyond sentiment trends, sellers may find additional reasons push crude lower amid rumors that OPEC will raise its production quote at today’s meeting in Vienna. Official Department of Energy inventory figures are also on tap. A break through the triangle formation’s bottom exposes supports at $96.43

 

[Jason Rogers]

Gold Decline Still Corrective Thus Far

Written by Jamie Saettele of DailyFX.com

It remains possible that the rally in gold is corrective but price has exceeded the 61.8% retracement and extended from its 20 day average so respect potential for one more high to complete the 5 wave advance from the January low. A 5 wave decline from 1555 is required in order to suggest that the larger trend is down. Weakness to this point is corrective.

Daily Bars

 

[Jason Rogers]

Euro Tumbles as Greek Fears Swell on Possible Papandreou Step Down

Written by John Kicklighter of DailyFX.com

At points over the past few months, it has seemed that the currency and asset markets have resolved to default with confidence in the European Union’s efforts to stabilize Euro-area financial troubles. However, the ongoing deterioration of the country’s financial troubles coupled with a general decline in investor sentiment globally is exposing a situation that may have no palatable ending.

The most recent flare up in the financial troubles for the euro this afternoon comes from rumors that Greek Prime Minister George Papandreou has offered to step down from power so that a unity government could be formed. This may be reassuring to those Greek citizens who have protested severe austerity measures implemented by the government; but it is very worrisome to international investors and policymakers who are looking to avoid a financial crisis. FX and bond traders are particularly aware of the implications this brings with the euro dropping sharply and yields while two-year Greek bond yields surge.

Graph Generated with Data from Bloomberg Professional Terminal​

The possibility of Prime Minister Papandreou stepping down creates an incredible amount of uncertainty for the situation in Greece and strength of the euro specifically. Over the past month, the officials from the European Union have been locked in an intense debate over whether Greece should be given a second bailout and what the terms on that additional aid would be. Though there have been reassuring words on this front; no clear confirmation has been given about the timing and conditions of further support. In fact, at the conclusion of the EU Finance Ministers meeting yesterday, it was made clear that no consensus was met and an agreement may not be made until July.

However, debate amongst those authorities that would determine further financial support for Greece is a familiar sight and history has shown agreements are generally met when market conditions force an agreement. Yet through this entire process, Greek authorities have shown themselves to be exceptionally willing to adopt further austerity efforts to win assistance. That said, protests against painful austerity have been a constant presence in the country and precedence for political change has been spelled out in both Ireland’s and Portugal’s change of power around the adoption of their respective bailout packages.

Now the back and forth between EU officials seems only one facet of the problem as a shift in Greece’s government is likely to produce a less receptive bailout recipient. Considering the pressure on Papandreou comes in the form of lawmakers decrying the pain impressed upon the country through austerity measures that the EU/IMF/ECB have deemed necessary to tap rescue funds. This means a Unity Cabinet is likely to demand better conditions for Greece in the second round rescue deal – which makes the situation seem almost untenable given the lack of agreement when the country was unfailingly comlpiant.

The fallout from this development doesn’t just stop with Greece. Certainly, an impasse on additional assistance will virtually guarantee that the nation will be unable to cover its obligations heading into 2012; and – unable to access the capital markets – the nation will be forced to restructure or default. With a member of the EU (a body that is supposed to ensure such financial troubles never occur) defaulting, it will significantly undermine the perceived stability of the euro and the Union it represents.

Alternatively, should officials accommodate more lenient conditions for the country to draw additional aid, the fix will only be temporary. Ireland has demanded lower rates on its emergency stimulus for some time; and favorable terms for Greece will only intensify the demands. The same would almost certainly be true for Portugal. Furthermore, modestly better conditions for Greece for the immediate future does not guarantee that the country will be able to avoid a default later down the line.

The markets certainly recognize the short-term implications of this uncertainty as we have seen in the euro exchange rates, bond yields and implied volatility measures (shown below). Yet, it is the long-term view that could really lead to significant changes. The reality that a EU member could be forced into a technical default or could potentially withdraw in the future can dramatically alter the euro’s long-term gain as a currency that stands as a good reserve alternative to the US dollar. For a medium-term view, we should also note, that these troubles have also led to a significant drop in interest rate expectations – a key for the euro’s strength this year.

Graph Generated with Data from Bloomberg Professional Terminal​