Euro rally continues buoyed by higher European rates
15/Jun/2015 • Currency Updates•
Last week we saw fairly unusual developments in currency markets. Whilst the Dollar continued to rally against most non European currencies, supported by strong economic data and the imminent prospects for a first Federal Reserve hike, the Euro and Sterling both managed to outperform the greenback and hence nearly every other major currency.
The reason for the Euro outperformance must doubtlessly be found on the sharp selloff we are witnessing in European bonds, where negative rates are becoming a distant memory. Higher bond rates tend to be supportive of a currency as they attract investment flows. In the case of Sterling, a spate of positive macroeconomic news confirmed our view that growth is likely to rebound above 3% in the second quarter, bringing forward in time the prospect for Bank of England hikes and helping the Pound outperform both he Euro and the Dollar.
Perhaps the most important economic news out of the UK last week were those that suggested a fresh surge in the housing market. Buyer inquiries rose strongly, as did expected increases of house prices.
The Bank of England cannot be happy about the signs that another wave of speculation is about to hit the UK housing market, particularly in London, and that extraordinarily low rates are playing a major role in bringing it about. Therefore, we continue to expect a first hike as soon as the first quarter of 2016. As markets increasingly come to agree with this view, higher rates are providing strong support for Sterling.
Eurozone economic growth in the first quarter was confirmed at a rather modest 1.5% annualized rate. However, the more important story for the common currency as the continued rise in interest rates. Most Eurozone sovereign bonds have backed up on the order of 1% from their April lows. In the short term, these moves are providing good support for the Euro, as they attract short term financial flows from worldwide investors that have long been starved for yield. However, in the medium term these higher rates provide a headwind for the still fledging Eurozone recovery.
It is notable that Chancellor Merkel took the unusual step of publicly complaining about the strength of the Euro, although this had no more than a temporary effect in FX markets and the common currency still ended the week comfortably higher against the dollar.
While there was negative news from the Greek negotiations, as IMF staff left the talks and returned to Washington, last minute efforts to reach agreement continue and the market is obviously taking a fairly relaxed attitude towards the possibility of a Greek default, choosing to focus instead on higher yields available from Eurozone bonds.
We received strong further confirmation last week that the US economy is rebounding for its weather-induced first quarter slowdown. Retail sales in May were very strong, the headline number rose 1.2% on the month on the back of strong, driven by volatile auto sales and higher gas prices. However, the ex-auto and gas number came out at 0.7% higher on the month and is much more reflective of the underlying strength of consumer spending.
Core retail spending rising at over 7% annualized levels over the past three months, consistent with a notable acceleration of domestic demand in the coming months. All eyes now shift to the FOMC meeting next week and the Fed´s reaction to the undeniable acceleration of economic growth in the US, as well as hints regarding the exact timing of a Fed hike this year.