Pain in Spain pushes down Euro, risk assets

Tom Tong01/Oct/2012Currency Updates

Investors worldwide continue to be focused on events in the European periphery, particularly in Spain. Images of police and demonstrators clashing near the Spanish Parliament, together with the Catalan nationalist push towards full independence, added to the sense that the social impact of austerity measures is increasingly difficult to control. In this context, equities lost some ground for the week, particularly in Europe, and the usual safe havens (core Government bonds, the dollar) continued their rebound from the previous week. We think that the Euro’s inability to rally in spite of dismal US data and increasing long Euro positioning among traders is significant, and forecast a downward trend for the Euro in the last quarter of 2012.

We have revised our EUR/USD and GBP/USD forecasts. We have pushed our short-term forecasts slightly higher (but still much lower then current levels) while retaining our bearish perspective over the long term.

GBP

GDP growth in the second quarter was revised slightly upwards last week, from -2.0% to -1.6%, both qoq saar.Since the rough estimate of the calendar effects of the Queen Jubilee holiday is roughly of that magnitude, we now think that the UK economy is flat lining, rather than contracting. This would be consistent with the less gloomy data we are seeing form the labour market. However, flat lining is better than the actual contraction we are seeing throughout the European Union. Therefore, we are comfortable maintaining our forecasts of a higher Sterling against the Euro, even though we expect a new increase in the Gilt purchase target as early as November.

EUR

Events out of Spain continue to be the main driver for risk assets in general, and FX markets in particular. Last week provided little additional information in either the macroeconomic or the policy making front, beyond a Spanish budget release for 2013 that is little more than an exercise in wishful thinking; every single official projection for growth in the periphery so far in the European crisis has proven too optimistic. However, clashes between police and protesters around Madrid’s parliament and the Catalan nationalist increasing drive for outright independence provide confirmation that Spanish society patience with endless austerity and pain for the sake of pain is quickly evaporating. Meanwhile, the Spanish Government appears bent on carrying forth the fine European tradition of denial and magical thinking, insisting that it does not yet need to ask for a bailout even as spreads head higher once again. Outside politics, news was once again gloomy, as German retail sales in August did not recover from their July fall. The Euro fell against both Sterling and the dollar, more or less in line with the retracement of risk assets over the week.

USD

Macroeconomic news in the US last week was not encouraging outside the housing sector. GDP growth for the second quarter was revised down to 1.3% from 1.7% saar. The durable goods report was extraordinarily weak. The headline was down over 10%. Even excluding the volatile transportation component, this number for capital good orders is down 24.3% saar over the past three months, a worrisome sign that business investment is dropping off sharply to near recessionary levels. We must admit that these numbers increase downside risks to our forecasts of 1.5-2.5% growth for 2012. We await the all important payrolls number next Friday, but a sharp downwards surprise there would lead us to revise our estimates. In FX markets, the dollar was generally buoyed by the sell off in risk assets and extended its rally from the previous week.

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Written by Tom Tong

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