Euro in modest rebound in spite of Greece concerns

Enrique Díaz-Álvarez02/Feb/2015Currency Updates

The widely expected victory of the leftist Syriza coalition in the Greek elections and the looming negotiations with the Eurozone was the main focus in financial markets last week. In spite of some initial bluster on both sides, some signs emerged over the weekend that a face-saving solution for both sides is at least possible. It is notable that the Euro stabilised and even managed a modest rebound against the US Dollar. Meanwhile, the easing tide among G10 central banks continued unabated, as the Bank of Canada also surprised markets with an unexpected cut in its base rate. We are now moving our call for a first Fed interest rate hike from April to June, but note that the Fed statement last week carried a mention of the strengthening US Dollar. This calm outlook on the part of the Fed leads us to maintain our expectations for an initially steady pace of hikes in the US until the level of 1% is reached.

GBP

Fourth-quarter GDP growth in the UK slowed to 2.0% SAAR, a modest but noticeable slowdown form the third-quarter pace of 2.8%. The slowdown was most pronounced in the manufacturing sector. This is not surprising, given Sterling strength against the Euro. However, service output, driven by domestic demand, stayed strong. Given the tail winds of stronger real incomes (due to falling energy prices) and a strengthening labour market, the UK economy is unlikely to slow down much further, absent some financial accident in the Eurozone. In spite of the change of mind by the MPC hawks, we think that interest rate markets are under-pricing the likelihood of a first Bank of England hike sometime late in 2015, given the resilience of consumer demands and the improvement in employment and wages.

EUR

Financial markets last week were rightly focused on the sweeping leftist victory in the Greek elections and the looming confrontation between the new Greek Government and Eurozone officials over the terms of the current bailout, due to expire at the end of February. Early signals were distinctly mixed. On the one hand, new Finance Minister Varoufakis struck a defiant tone, stating that Greece would no longer deal with the Troika after a joint press conference with an unhappy-looking Dijsselbloem, the Dutch Finance Minister. More conciliatory statements were heard over the weekend from Prime Minister Tsipras, and the French Finance Minister, who accepted the possibility of a change in the maturity and interest profile of Greek debt. Overall, relative Euro stability seems to indicate that markets are not panicking. Of immediate concern is the fate of the Greek banking system, where there were persistent but uncorroborated rumours of steady deposit outflows as shares in Greek banks dropped by 40% for the week. For now, Greek banks have access to European Central Bank (ECB) funding, and some ECB officials have softened the rhetoric as to the possibility of cutting Greek banks off if a new agreement isn’t reached.

We are still fairly optimistic that both the Greek Government and the Eurozone will step back from the brink and reach a solution that allows both sides to save face and enables the Greek Government to focus on its domestic front, which is likely to yield better results at lower risks than confrontation with Eurozone authorities.

USD

News from the United States was a bit of a disappointment last week. GDP growth in the fourth quarter slowed to 2.6% SAAR. Strong domestic demand was offset by the external sector and a large inventory built. The latter is likely to be reversed in future quarters, and consumer demand is unlikely to slow, driven, as it is in the UK, by a strong labour market performance and increased real incomes from lower energy prices.

Key for the US Dollar will be the exact timing and pace of Federal Reserve interest rate hikes. Last week’s statement indicated that, while the US economy continues to strengthen, the Fed can afford to be “patient” in normalising monetary policy. This leads us to tweak our call for the first interest rate hike, delaying it from April until the June meeting. However, we still expect the Fed Funds rate to end the year at about 1%, at which the Fed is likely to pause and reassess the impact of the hikes.

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Written by Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.