Comments and forex-analytics from FBS

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Concerns about euro zone’s future strengthen

The single currency hit 7-week minimum versus US dollar sliding to the levels in the $1.3250 area. The risk environment seems to be quite unfavorable.

Yesterday German Chancellor Angela Merkel spoke against the idea of joint euro bonds and the bigger role for the European Central Bank in solving the crisis.

Alarm signal came on Wednesday when German government was able to sell only 3.644 billion euro ($4.92 billion) in 10-year bunds of the planned amount of 6 billion euro for an average yield of 1.98%. After auction the yield rose to 2.09%.

Analysts at Commerzbank warn that if German bunds lose their safe haven status, this will be a very hard blow for euro. The specialists underline that even during the severe times of 2008 and 2009 these securities were trading stable enough.

The fears about the region’s future are mounting. Italy’s 2-year yield climbed to the record high testing the levels above 7.5%.

The majority of specialists are bearish on EUR/USD. Support for the pair now lies at $1.3145 (October 4 minimum) and $1.3045 (61.8% retracement of euro's advance in 2010-2011).

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UBS, Deutsche Bank, Nomura on potential collapse of euro

Many experts from the major banks and ratings agencies agree that the euro area may break up unless the region’s policymakers find solution to the euro zone’s debt crisis.

Analysts at UBS underline that the currency market’s beginning to price in the collapse of the currency union. Strategists at Deutsche Bank and Nomura agree that the European debt turmoil has entered a very dangerous phase as investors started worrying about the euro zone’s core economies such as Germany.

Agency Moody’s Investors Service said today the “rapid escalation” of the crisis threatens all of the region’s sovereign ratings and that the risks will keep rising if no steps are taken to stabilize the situation.

Last week was full of negative events: Germen government failed to draw bids for 35% of 10-year bunds, while Spain decided not to sell 3-year bonds and Italian 2-year yields surged above the 10-year ones. In addition, Standard & Poor’s cut Belgium’s credit rating and Fitch Ratings lowered Portugal’s one to the junk grade. The IMF rejected the talks provoked by La Stampa that it’s preparing to lend Italy 600 billion euro.

Among the coming political news there are Ecofin meetings on Tuesday and Wednesday and EU leaders’ summit on December 9. I(t seems that the measures previously rejected by the region’s authorities such as the increase of the ECB bond buying and governments issuing common securities in a deeper fiscal union are now the only possible steps to save the monetary union.

Strategists at Morgan Stanley note that it’s possible that the European policymakers won’t be able to present credible solution at the summit. Analysts at UBS note that the surging bind yields will hit Germen and other euro zone’s banks which may require additional capital. According to Bank of America Merrill Lynch, if Germany left the bloc, the fair value of EUR/USD would drop by 2%, while if Italy quits it would increase by 3%.

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Commerzbank: comments on AUD/USD

Technical analysts at Commerzbank note that Australian dollar managed to find support versus its US counterpart in the $0.9660/70 (78.6% Fibonacci retracement) and open on Monday with a positive gap rising to the levels above $0.9900.

However, the specialists think that the current rebound is only a correction and that the outlook for AUD/USD will remain negative as long as it’s trading below resistance line at $0.9985.

According to the bank, if the pair gets below the previously mentioned support it will fall to October minimum at $0.9388. In the longer term Commerzbank expects Aussie to slide to $0.8545.

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Citigroup: recommends selling EUR/CAD

The single currency managed to recover versus the greenback from more than 1-month minimum at $1.3211 to the levels above $1.3300 on the speculation about the new plan which implies stronger integration of the core economies.

Never the less, analysts at Citigroup are bearish on euro and recommend selling it on the rallies. In their view, such plan would be difficult to realize as it will likely meet opposition of different European nations. As a result, the hopes that the ECB will increase bond buying may be unjustified.

The specialists advise investors to open shorts on EUR/CAD. In their view, the outlook for Canadian dollar as more bullish as Canada has rather credible fundamentals, is closely connected with the United States which seem to be resilient enough despite the negative effects coming from Europe, and, finally, because loonie is able to gain from advance in commodity prices.

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BBH: European policymakers meet this week

European finance ministers meet twice this week: today at the Eurogroup meeting and tomorrow at the Ecofin one.

Analysts at Brown Brothers Harriman believe that if the policymakers don’t come up with specific proposals of how to deal with the crisis, investors will resume selling euro and stocks.

As for the talk that the region’s leaders may be negotiating a new pact, the specialists note that earlier there were many times when the markets were lightened with hope but got disappointed as nothing happened.

According to the BBH, it’s also necessary to take into account surging bond yields in Europe and the warnings from the OECD and Moody's Investors Service that the way out of the escalation debt turmoil should be found urgently.

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Societe Generale: forecast for QE3

Currency strategists at Societe Generale believe that the Federal Reserve will decide to conduct the third round of quantitative easing by March 2012.

As the reasons for such forecast the specialists cite the projected US weak economic growth in the first quarter of the next year and the slowing inflation in the country.

The specialists claim the Fed will buy mainly mortgage-backed securities and QE will be worth about $600 billion over 6-8 months. As a result, the central bank’s securities portfolio will increase by the end of 2012 from $2.65 to $3.25 trillion.

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Commerzbank: comments on EUR/USD

The single currency managed to recover versus the greenback from more than 1-month minimum at $1.3211 to the levels above $1.3300.

Technical analysts at Commerzbank claim that EUR/USD is facing strong resistance at $1.3418 (resistance line) and $1.3457 (23.6% Fibonacci retracement of the recent decline). In their view, the pair won’t be able to get above $1.3615 (November 18 maximum) in the near future remaining in the $1.3457/3615 area.

According to the bank, if euro breaks below $1.3145 (October 4 minimum), it will be poised down to $1.2860 (2011 minimum). On the downside the longer term target lies at $1.20.

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Euro area, China: economic outlook deteriorated

Analysts at UBS reduced China’s 2012 GDP forecast from 8.3% to 8%. The specialists expect exports growth to slow as the demand for Chinese products weakens due to the euro zone’s debt crisis. In their view, the nation’s exports will stagnate the next year, while earlier they expected 5.5% growth.

The outlook for European GDP growth was earlier cut from 0.7% to 0.2%. According to the bank, the currency union has chance to avoid collapse of euro and banking crisis. However, UBS points out that the region’s economy will nevertheless be in recession in 2012.

Strategists at Deutsche Bank cut projections for euro area’s economic growth from +0.4% to -0.5%. The specialists underline that as Europe’s economic prospects deteriorate, the European authorities will be more motivated to act.

The OECD also lowered 2012 forecast for euro zone’s economic growth from 2.0% to 0.2%.

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Fitch Ratings: negative outlook for US rating

Fitch Ratings changed the outlook for US top credit rating to negative. The agency doubts that American authorities are able to act in time in order to put the nation’s public finances in order. According to Fitch, the probability of a downgrade now exceeds 50%.

Last week the Congressional Supercommittee didn’t manage to reach agreement on the deficit cuts and the country now faces $1.2 trillion in automatic spending cuts. The failure of the committee will delay any major deficit- reduction agreement until after the next presidential election that will threaten US economy.

“The scale of any subsequent budget cuts are probably going to have to be larger than they otherwise would have been and certainly implemented in faster manner,” said Fitch. The economists underline that US needs more the reforms of entitlements and taxation than simply discretionary cuts.

The agency expects that American federal debt held by the public will get over 90% of GDP by the end of the decade, while interest on the debt will require more than 20% of the tax revenue.

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EUR/USD: comments on trading day

The single currency has managed today to test the levels above $1.3400. The market’s sentiment improved as Italy was able to sell 7.5 billion euro in bonds meeting its target, even though the nation’s borrowing costs keep rising: the country paid almost 8% to sell 3-year bonds (critical level) and 7.56% for 10-year bonds (record maximum), but thankfully lower than the actual average yield levels were all lower than market levels.

However, the relief didn’t last long – the European currency erased its today’s advance easing down to $1.3300 as the ECB failed to attract enough deposits from banks required to offset its purchases of bonds from the indebted euro zone’s economies. The central bank attracted 194 billion euro in 7-day bank deposits versus 203 billion needed. This way it may be regarded as a form of quantitative easing as the supply of euro went up, though analysts at Credit Agricole that QE will occur in case the shortfall repeats and grows.

Analysts at Deutsche Bank remain bearish on euro claiming that the situation is still very serious. Strategists at Lloyds Bank expect EUR/USD to test this week the levels below $1.3150.

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UBS: demand for Japanese debt will remain high

Japanese 10-year bond yield rose yesterday 3-month maximum at 1.055% from the record minimum of 0.94% hit last week. As a result, the pair USD/JPY tested levels above 78 yen.

Analysts at UBS think that the greenback will remain trading 75.00 and 80.00 yen unable to get higher as the demand for yen and Japan’s debt will remain high amid concerns about the euro area. The specialists point out that 95% of Japanese government bonds are held by domestic investors which prefer the home currency distrusting other major countries' sovereign debts.

Strategists at Societe Generale see only 2 risks to Japan’s safe haven status: either household and corporations will start to save less than what the government needs to borrow or the country would have to suffer a capital flight. In their view, for now both these outcomes aren’t likely.

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Danske Bank: outlook for 2012

Analysts at Danske Bank shared their expectations about global economic development in 2012. The specialists advance several assumptions:

- Concerns about recession are exaggerated – an overly negative economic and financial outlook is priced into financial assets;

- The world’s central banks will keep easing monetary policy;

- Euro zone crisis will continue, though the currency union won’t break up;

- Volatility will remain high;

- US dollar will experience structural weakness;

- Currency interventions will continue.

Danske give several arguments against euro zone’s break-up:

- It’s consequences would be worse than those of Lehman Brothers’ collapse;

- The costs of the break-up would be enormous both peripheral and core economies4

- The single currency is secured by political support as most of the member nations seem ready to give up more sovereignty.

The strategists, however, don’t rule out the possibility that the euro area may split, the exit would be very risky and potentially very costly for any country.

As for US dollar’s structural weakness, the analysts note that the greenback has been steadily depreciating during the last decade (with only a few interruptions like due to the introduction of the homeland investment act in 2005 and the global financial crisis in 2008). Among the reasons of such USD dynamics the specialists cite:

- Euro’s initial strong undervaluation versus the greenback;

- America’s persistent current account deficit;

- Rising commodity prices;

- On average easier monetary conditions.

In the absence of a global recession the dollar will lose to stronger currencies, such as Australian, New Zealand’s and Canadian dollars. The Dollar Index may decline in such case by about 4%, though not more as Danske isn’t bullish on riskier assets, but expects weak US fundamentals to drive a dollar depreciation trend in a “normal” risk environment.

As for EUR/USD, the analysts see the pair below $1.30 during the next few months until the market prices in new ECB monetary policy regime and then rebound end 2012 higher.

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December 20: news and data to watch

News:

RBA meeting minutes (full text here):

-comments are less dovish than expected;

-Australian economy will keep expanding even though euro zone’s debt crisis has a negative impact on the global economic growth.

So, RBA rate cuts in the near future are unlikely. Australian dollar has managed to gain a bit on the news rising from $0.9890 to $0.9950.

UK consumer confidence improved in November (40 vs. 36 in October).

Watch today:

Germany: Ifo Business Climate (decline is expected);

Spain: 3- and 6-month bills auction;

The ECB begins longer-term refinancing operation (LTRO) in which banks can borrow unlimited funds in return for eligible collateral, including euro-region government bonds. The banks will be able to decide what to do with the funds on their own.

The single currency may find some support in the short term as the LTRO may provide a new source of demand by banks for euro-zone sovereign debt.

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BofA: sell EUR/USD on the rallies

Technical analysts at Bank of America believe that the single currency may fall to 1-year minimum versus the greenback at $1.2510 (last visited in July 2010).

The specialists make such forecast as on December 14EUR/USD went below October minimum at $1.3145 sliding to $1.2945. In their view, support in the $1.2901/2859 area will be the last obstacle ahead of $1.2533.

In their view, the pair is with no doubts trading within the downtrend. The analysts note that as the market's sentiment about euro is extremely bearish, short squeezes are possible and the pair has chances to rise to $1.3250. At that point Bank of America recommends opening short positions.

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NAB: forecast for AUD/USD in 2012

Analysts at National Australia Bank believe that Australian dollar will be fluctuating in 2012 between $0.9000 and $1.0500 versus its US counterpart.

The specialists note that the pair AUD/USD, which has set this year’s maximum at $1.10 on July 27, will be capped by this level during the next year.

According to the bank, in the first quarter of 2012 Aussie will drop to the $0.9600 zone as the global growth prospects deteriorate and then stay around parity in the second half of the next year. In the worst case, if some European nation defaults and the euro zone falls into recession making the global economy contract as well, AUS/USD will drop to $0.8500.

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BBH: euro will decline to $1.24

Analysts at Brown Brothers Harriman expect the single currency to decline versus the greenback in the coming months to end the first 3 months of the next year at $1.24.

The specialists note that euro is still overvalued as its fair value is in the $1.20 zone. The fact that EUR/USD was trading rather high may be explained by the repatriation and the ongoing diversification of reserve inflows which supported the European currency. At the same time, BBH says that these processes may slow down euro’s slump, but won’t stop it.

According to the bank, the pair will find itself under pressure due to the euro area’s economic weakness amid tough austerity measures and the tensions at the peripheral band markets. Such outlook increases euro risk premium and the possibility of further rates cuts by the ECB.

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GBP/USD: MPC minutes and technical comments

Bank of England Monetary Policy Committee members voted unanimously at their December meeting to keep policy unchanged as uncertainty over the economic outlook remained high.

All nine members of the MPC voted to continue with the current 275 billion pounds of asset purchases and to leave the benchmark interest at 0.5%. Divisions on the MPC remained over the outlook, with some members saying the November Inflation Report projections meant more quantitative easing was likely to be needed.

UK Borrowing turned out to be lower than expected in November: 18.1 billion pounds versus the forecast of 19.6 billion.

Although UK central bank left door open for more easing in February, pound strengthened versus the greenback. GBP/USD tested the levels in the $1.5773 zone. Support for British currency is situated at $1.5650. Watch the bullish “double bottom” pattern: it will be confirmed if sterling overcomes resistance in the $1.5768/77 area.

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ECB conducted first 3-year LTRO, analysts’ comments

The ECB has reported a strong demand for its 3-year longer term refinancing operation allotment. The central bank lend more than 489 billion euro to 523 financial institutions at the fixed rate of 1% and to be paid January 2015. The analysts were expecting the amount of about 300 billion euro.

It was the first of the two 3-year loan auctions announced ECB president Mario Draghi at the central bank’s last meeting on December 8. The next one will be allotted on 29 February 2012.

Reuters sited the following analysts’ comments:

Societe Generale: “This is good. It's a positive number, at the top end of expectations. You have to regard it as a positive result. This is at least a solid 240 billion euro (net) increase for banks. But it is still short of covering all of the banks' financing for next year. So, it could ease fears of a credit crunch somewhat.”

ING: “…the lower number of participating banks (523 versus 1121 previously) suggests that the take-up is currently less widespread — and probably more concentrated in banking systems in peripheral euro zone countries. We will be keeping a close eye on national central bank data over the next few weeks for further clues on which countries' banking systems tapped the three-year facility.”

Analysts at UBS claim that though the LTRO will provide breathing space for banks it won't improve the long-term outlook for the European financial sector.

The pair EUR/USD climbed to the weekly maximum in the $1.3200 area on the ECB’s announcement before sliding back to $1.3090.

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Japan: monetary policy and efforts to stem yen

Bank of Japan: monetary policy unchanged

The Bank of Japan kept monetary settings unchanged at today’s meeting, but cut its economic assessment saying that the nation’s GDP growth will stagnate at least until spring next year. Japan's economy recovered from a recession triggered by the March earthquake but is expected to slow sharply in the fourth quarter as the initial rebound driven by companies restoring supply chains and production facilities dies out and the overseas demand decreases.

BOJ Governor Masaaki Shirakawa underlined that the euro zone’s debt crisis and economic weakness have negative impact on the global economy in general and on Japan in particular.

The central bank left the key interest rate below 0.1%. The BOJ didn’t increase asset purchases after 2 months of doing so, trying to save this option for future action.

Analysts at Nomura expect more easing in January-March referring to the risk of a credit rating downgrade for European sovereign debt and the possibility of more stimulus from the Fed and the ECB.

Japan’s government: intervention fund increased

Yesterday Japanese government decided to boost its currency market intervention fund by 30 trillion yen ($385 billion) from 165 to 195 trillion yen – that’s the second biggest* increase and the sign that Japan’s officials are keen to prevent sharp advances of the national currency. Finance Minister Jun Azumi announced that Japan is ready to act at any moment if necessary.

The increase was included in a fourth extra budget approved by the government Tuesday. The extra budget is aimed to revive Japanese economy and will be submitted to the regular parliamentary session starting January along with a main budget for the next fiscal year.

Japanese authorities had to lift up the intervention fund as they spent 9.092 trillion yen between October 28 and November 28 trying to stem yen’s appreciation and support exporters, so it was needed to replenish it.

Japanese government kept its economic assessment intact in its monthly report issued on Wednesday but cut its view on business sentiment, reflecting worsening confidence among big manufacturers in the BOJ's December Tankan survey.

*The biggest one was 40-trillion increase in 2004 fiscal year which was conducted after yen-selling intervention campaign of 2003-2004.

According to the estimates of Barclays Capital, the actual amount available to the central bank for selling yen may increase from about 40 to 70 trillion yen. The analysts say that taking into account the general strengthening of US dollar seen so far and better economic data, the intervention fund will be able to satisfy the need for selling yen during several months.

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Europe: event to watch today

- Italy's government will hold confidence vote on austerity in Senate around 2 p.m. GMT: the lawmakers are set to give final approval today to Prime Minister Mario Monti’s 30 billion-euro ($39 billion) emergency budget plan, including a pension overhaul and a levy on primary residences.

The draconian austerity measures will affect the nation’s weak economy. Data released yesterday showed that Italy’s GDP shrank contracted by 0.2% in the third quarter after 0.3% growth in the previous 3 months. The government forecasts contraction in the fourth quarter, 0.6% growth in 2011 and a 0.4% contraction in 2012.

- European Central Bank President Mario Draghi speaks today in Frankfurt after a meeting of the European Systemic Risk Board which begins at 4 p.m. GMT.

Yesterday the ECB made the region’s banking sector a Christmas present – the central bank lend a record sum of 489 billion euro ($638 billion) to 523 euro-area banks in 3-year loans. That was the first of ECB’s LTROs announced on December 8. The second one will be allotted on February 29, 2012. According to Goldman Sachs, the borrowings equal about 63% of the European bank debt maturing in 2012.

The majority of analysts argue that the ECB’s move won’t be efficient as the region’s banks can decide on their own where to invest the obtained funds and they aren’t very likely to invest in the peripheral debt.

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St. George: 2012 forecast for AUD/USD

Analysts at St. George believe that although Australian dollar will be affected in 2012 by the euro zone’s problems and potential slowdown in China, it will fall, but not much.

The specialists note that Aussie has shown greater resilience during bouts of risk aversion this year in comparison to previous episodes of risk aversion due to its strong underlying fundamentals.

The bank expects AUD/USD to trade around $1.0000 in March, in the $0.9900 area in June and near $1.0100 at the end of 2012.

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Japan: government revised economic forecasts

Japanese government reduced forecast for the nation’s real GDP growth in 2012 fiscal year which begins in April from 2.7%-2.9% to 2.2% (y/y). The estimate of this year’s growth were lowered from +0.5% to -0.1%.

As the reason of the revision the officials cited negative impact of the yen's appreciation and the ongoing sovereign debt crisis in the euro area. At the same time, the next fiscal year Japan’s economy is expected to “recover moderately” on the assumption that the global situation starts improving.

Consumer prices will add 0.1% in fiscal 2012 (y/y) after showing declines in the previous three years, says the government. In fiscal 2011 CPI will drop by 0.2% (previous forecast was the 0.2% rise).

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Citigroup: warning for USD bulls

Currency strategists at Citigroup say that US economic data has so far been surprising the markets in a positive way referring to the recent labor, housing and trade figures. As a result, the Economic Surprise Index designed by the bank has risen from the record minimum in June almost reaching the record maximum at present.

According to Citigroup’s experience, the upside moves of the index correspond to US dollar’s selling periods. It happens as the market becomes more optimistic and risk sentiment improves making the demand for US currency decline.

The analysts don’t think that dollar will weaken this year as many traders have already closed their books for the year and others may be reluctant to take on big new positions right before the end of a quarter. At the beginning of 2012, however, if the economic data remains favorable, investors may decide that they have overestimated the negative effects of the euro zone’s crisis on the global economy. “The surge in data flow itself may be insufficient to reverse recent risk aversion, but it does suggest that dollar’s weakness could reassert itself more quickly and forcefully than many anticipate once conditions settle down,” says the bank.

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Analysts expect Aussie to weaken early in 2012

Analysts at Commonwealth Bank have so far lowered forecast for AUD/USD to $0.9800 by March 2012 and to $0.9500 by June 2012.

Reasons:

— general strength of US dollar due to improved US economic data (opposite views to Citigroup);

- funding demand for the US dollar in response to Basel III capital requirement;

- central banks slow down their diversification efforts out of US dollar into euro as the European debt problems persist.

Strategists at TD Securities expect Aussie to slide to $0.9500 by the end of the first half of 2012.

Reasons:

- slowing growth in the global economy with the deep recession in the euro zone and the United States;

-China’s economic slowdown.

Westpac economists think that AUD/USD will rise to $1.0200 in the near term as it’s supported by foreign direct investment inflows. Never the less, Aussie has been trading above its fair value in the $0.91 area for a long time and the odds are that it will depreciate.

Analysts at National Australia Bank also claim that Australian currency will end December at $1.0200, then drop to $0.9600 by March before rising gradually to $0.9800 by June and then to parity by September.

Barclays thinks that AUD/USD will weaken to $0.9800 by the first quarter and then rise to $1.0100 by June. In the short term Aussie will stay under pressure as the euro zone governments failed to commit to faster fiscal consolidation and the ECB refused to extend bond purchases. In the medium term, however, the bank retains a constructive view due to many factors including limited impact on Australia's macro fundamentals from deteriorating euro zone’s growth, expectations of more easing from China, stability in local-currency commodity prices which are helped by weaker currencies.

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UniCredit: forecasts for EUR/USD and GBP/USD

EUR/USD: the single currency will keep weakening in the first quarter of 2012. The pair may slide to $1.25. If the tensions at the market ease, euro will be able to rebound, though sustainable rally seems unlikely.

GBP/USD: British pound may decline versus the greenback in the first half of the next year as US currency will keep enjoying strong demand, while the bank of England will continue asset purchases. In the second part of 2012 the outlook for pound is less negative, though UK economic growth will remain sluggish. As a result, the pair GBP/USD will be capped by the levels in the $1.60 area.

Chart. Daily EUR/USD

Chart. Daily GBP/USD