Dollar safe haven status underpinned as Fitch Ratings threatens further downgrades and UK trade balance data disappoint

Tom Tong12/Jan/2012Currency Updates

EUR

The euro yesterday hit a new 16-month low against the dollar as renewed eurozone debt concerns overshadowed recent global economic optimism. Despite strong demand for German debt at an auction yesterday, the euro fell by 0.8% to new lows of $1.2661. These falls were driven by reports of an official from Fitch Ratings telling investors that if the ECB did not take a more active role in buying sovereign bonds, the euro could collapse. Rumours were also abound of further rating agency downgrades of eurozone nations; particularly that a downgrade of France’s triple A status could be imminent.

These rumours overshadowed positive signs for eurozone bonds, where the 10-year Bund yield fell 4bp to 1.82%; triggered by strong demand for German five-year debt at an auction yesterday, underpinning its safe haven appeal against continued uncertainty over Greece’s negotiations over a debt restructuring plan. This safe haven appeal was backed up by strong preliminary data from Germany, showing its economy expanded at a strong pace of 3% in 2011.

Today we see key sovereign debt auctions in Spain and Italy, where analysts suggest that cloudy market valuations for the Spanish three-year debt to be offered today pointed at an attractive discount, and could lead to strong demand. We will also see the ECB’s policy meeting today. The recent combination of looser monetary conditions in the eurozone and improving prospects for global growth has led analysts to believe that a third successive interest rate cut would not be necessary, and are not expecting it to be cut further until March. However, Mario Draghi is expected to pave the way for further easing in the months to come.

Today, as the market is so strongly positioned short euros, there is the possibility of a squeeze higher (as seen on Monday and Tuesday).

GBP

Data showed yesterday that the UK trade balance widened more than expected in November in addition to British shops growing at their slowest pace in 16 months in December due to slashed prices in the run up to Christmas. Despite the fragility of the economy, with the credible fiscal plan and gilts’ safe haven status, the outlook is skewed in Sterlings favour against its European counterpart but neared a three-month low yesterday against the USD on waning risk appetite. The Bank of England meets today but no changes in interest rates is expected and they are unlikely to announce another round of QE before the already approved bond purchase program expires next month.

USD

Wall Street recovered from early losses on Wednesday brought on by a warning from Fitch Ratings of severe repercussions, including a possible collapse of the euro, without more supportive action by the European Central Bank.
The Fitch news sent the euro to its lowest level in 16 months against the U.S. dollar, which would normally have spelled steeper losses for stocks. The U.S. is being looked at clearly as the safe-haven trade, not only on the fixed income side but now even from equity investors.

Stocks held firm near recent five-month highs on Wednesday as investors awaited key bond market tests for Europe in the next two days that could determine the direction of the euro zone crisis.U.S. equities have been performing better in the face of turmoil from Europe’s sovereign debt problems. This is a major change from four months ago and comes as investors have taken improving U.S. economic data to heart and an optimistic view about corporate earnings.

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Written by Tom Tong

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