With the euro bears still fixated on sovereign debt problems, Monday’s 200 point rally in euro-dollar caught many currency traders by surprise and created a massive short squeeze. As Ireland appeared to be on its way towards finalising the EU bailout, risk aversion flows abated and credit spreads stabilised, leaving late shorts wrong footed.
Meanwhile, China’s refusal to raise its benchmark rates despite strong inflationary signals was seen as positive for risk FX. Although the Chinese economy is experiencing pricing pressures and a rise in food costs – a gallon of milk is now more expensive in Shanghai than it is in Seattle – Chinese monetary authorities are reluctant to use interest rate hikes to fight the problem. Instead, the People’s Bank of China (PBoC) opted to raise the bank reserve requirements for the sixth time this year to try to control the developing asset bubble without hampering growth in the real economy.
The PBoC’s pro-growth stance was viewed as positive for Germany, whose economy benefits greatly from Chinese demand for capital goods. In fact, as long as Germany’s economy continues to expand at a robust pace, the risk of sovereign debt default in the Eurozone remains contained. The currency market views Germany as the financial backstop for the whole region. So the current consensus view is: as goes Germany, so goes the rest of the Eurozone.
That’s why the latest data could determine whether this move in euro-dollar can extend beyond the $1.3500 figure or stall and retrace towards the low $1.30s. Tomorrow, the market will get a look at the flash purchasing managers’ index (PMI) readings in both the manufacturing and service sectors, which provide the most accurate reading of the latest economic conditions in the region. If they surprise positively, showing even a modicum of improvement in demand, the euro could have further to run. Just as last week when I noted that the Aussie’s fortunes were dependent on the Australian jobs report, this week it all comes down to data for euro-dollar.
Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail email@example.com