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Tuesday, February 10, 2015

Euro Shorts Will Live or Die by Greek Talks

How the euro trades against the U.S. dollar this week will be determined by one thing alone – the Greek debt negotiations. Last week, the Greek government accused the ECB and European Union of blackmail after the ECB refused to accept Greek debt as collateral but over the weekend, Greece has become the blackmailer with Finance Minister Varoufakis threatening Armageddon for the Eurozone if Greece is forced out of the monetary union. According to Varoufakis, “the euro is fragile….if you take out the Greek card, others will collapse.” Whether the Eurozone can survive without Greece is up for debate but Varoufakis is right in the sense that there is no benefit in allowing Greece to default on its debt, which is why we are optimistic that an agreement will be reached. The big question is how much pain Greece, the ECB and the European Union will put us through before that happens. Based on the latest CFTC report that shows euro short positions at their highest level since June 2012, traders are positioned for a Grexit. While growth and monetary policy divergence between the Eurozone and U.S. played a role in this positioning, euro shorts will live or die by the Greek debt negotiations. Euro area Finance Ministers are holding a special meeting on Wednesday to discuss Greece and this meeting will be followed by Tsipras’ first ever leaders summit. If either side starts to make concessions and there are signs of progress, traders will begin to take profits on their shorts, driving the euro higher. If an official announcement is made, expect EUR/USD to squeeze sharply higher with a likely move above 1.15. Based on the consolidation in EUR/USD today, investors are recognizing the upside risk for the EUR/USD. However if Greece and Europe continue to play their game of chicken waiting to see who blinks first, the threats from both sides will keep the euro under pressure. Yes, a Grexit could happen but the chance is slim and there will be repeated attempts at debt restructuring along the way because the costs to both sides are extremely high. Yet in the long run, we still expect EUR/USD to trade lower, especially once the Greek risk passes.

Buy Pullbacks in the Dollar

With no U.S. economic reports released today, the dollar traded lower or held steady against all of the major currencies. Considering the lack of negative news flow, today’s pullback represents nothing more than profit taking after strong gains on Friday. Treasury yields fell slightly but the decline was so modest that its impact on the dollar should be nominal especially since the greenback still needs to adjust for the recent uptick in U.S. rates. The latest non-farm payrolls report hardens the case for a rate hike in the third or fourth quarter and this prospect should keep the dollar bid. In other words, we view today’s decline as an opportunity to buy the dollar at lower levels. In fact, the dollar should attract bargain hunters all the way down. Retail sales is the only piece of U.S. data this week that is worth watching and while lower gas prices are expected to drive down the value of sales, excluding autos and gas, consumer spending is expected to rebound in the month of January. A positive report would make the dollar even more attractive. A handful of Fed Presidents are also scheduled to speak. We heard from Plosser this morning and he believes the Fed should raise rates in the near future. Unfortunately his comments did not have much impact on the dollar because he retires on March 1st. Instead, traders should keep an eye out for Lacker and Fisher, two voting members of the FOMC scheduled to speak later this week.

CAD Recoveries Losses on Oil

It took a day but the Canadian dollar finally rebounded against the U.S. dollar, acknowledging the recovery in oil and Friday’s better than expected Canadian labor market numbers. Oil prices rose approximately 2% today, solidifying the bottom established last month. Although economic reports are released with a lag and we still expect some more weakness in data, if oil continues to move higher, we will be looking for further gains in CAD. USD/CAD has been trading within a 1.2350 to 1.26 range in recent days and there’s a good chance that the bottom of this range will be broken this week as the lack of Canadian data leaves the market focused on the moves in oil. The Australian and New Zealand dollars also performed well after China’s stronger than anticipated trade numbers. The country’s trade surplus jumped 20% in the month of January but we can’t get too excited about the report because both imports and exports declined with the former falling 19.9%. China expressed concerns about the challenges for the global economy in 2015. Deputy Finance Minister Zhu Guangyao is worried about sluggish global, diverging monetary policies, decline in oil prices and the Russia/Ukraine crisis – these concerns explain the PBoC’s dovish monetary policy bias. The Australian dollar will be in play this week with Australia’s employment report scheduled for release along with speeches from Central Bank Governor Stevens and Assistant Governor Debelle.

Sterling Hampered By Concerns for BoE Deflation Forecast

The only currency that failed to benefit from the decline in the dollar was the British pound. There were no economic reports to explain the underperformance but Prime Minister Cameron expressed concerns about the potential market uncertainty that could be caused by Greece. Bank of England Governor Mark Carney on the other hand is focused on the positives – in his speech today, he talked about how the U.K. economy is just starting to see a turn in wages. Last week we saw significant improvements in U.K. data with manufacturing, service and construction sector activity accelerating. Unfortunately, the Bank of England’s Quarterly Inflation Report may focus less on growth and more on inflation. With CPI hovering at a record low of 0.5% in December, there is talk that the central bank could issue its first ever deflation forecast. Even if the central bank does not lower its inflation forecast to negative levels, they will cut it to 0% because BoE Governor Carney acknowledged that inflation could turn negative this year. The fear that low inflation will overshadow growth prospects prevented sterling from rallying today. In light of this, tomorrow’s industrial production report could surprise to the upside but the support it provides for sterling should be limited ahead of the Quarterly Report.

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