FX Update: Euro losing its grip

The Euro continues to plunge as policy makers seem to be falling farther and farther behind the curve and the situation in Greece spins out of control. What's next for the single currency?

Greece situation spinning out of control
The situation for Greece is spinning out of control from within and from without. Today, Greek PM is scrambling to reshuffle his cabinet in an effort to win a parliamentary confidence vote that will determine whether he can continue to govern and get the votes for the latest austerity package aimed at satisfying international creditors. (The situation is very fluid – this was the expectation leading into today, but we are seeing news now that the whole exercise is in doubt as some of his deputies have reportedly quit.) The opposition leader Samaras accused Papandreou of backing out on an offer to form a national unity government.

Outside Greece, Germany showed some signs of softening its stance on the requirement of forcing restructuring on private Greek bondholders as the relaxed their timeframe as the IMF said that it was ready to pay the next installment (EUR 12 billion) of the original rescue package funds that had been in doubt of late due to the concern on whether Greece would commit to its austerity/budget plans. So it appears that the IMF has abandoned its principles here a bit as it probably doesn’t want to be seen as the instigator of a new crisis. Also, the ECB’s Wellink was out saying that the emergency bailout fund for Europe should be doubled to EUR 1.5 trillion if losses are going to be forced onto private bondholders.

The market’s reactions to the spreading nervousness in Europe are rather obvious in the FX market and EUR crosses, and sovereign spreads have headed wider as well today, while sovereign CDS’ on sovereign peripheral debt were pushing close to their highest for the year in many cases as well yesterday. On the ECB front, the market has given up on the ludicrous exercise of predicting ECB rate hikes in the pipeline during all of this turmoil and expectations have dipped more than 10 bps today to 40 bps for the coming 12 months – down from 70 bps just two days ago and 100 bps in mid May.

There is significant risk of paralysis in the European banking system if banking counterparties decide they can’t trust each other on concern about exposure to the sovereign debt situation and whether credit is good. The ECB/EU is going to have to step in with a massive response and soon as liquidity could seize up if it doesn’t.

In other news…
As if there is an elsewhere at the moment while the European situation burns bright, but there were a couple of other news items worth note.

Australia’s quarterly ACCI survey of industrial trends showed a massive deceleration to a sub-50 reading. The Aussie was sharply weaker on the generally risk off environment and as rate expectations have plummeted today far more than they rose yesterday on the RBA’s Steven’s rhetoric. AUDUSD is down looking at its lowest levels since 25 May below 1.05. It hasn’t closed below that level since April and a break here could open up for a test of the next major support in the 1.0200/50 area.

UK’s Retail Sales suffered a very large drop in May that was far larger than the rise triggered by the royal wedding and underlines the risks to growth in Austerity Britain. Year-on-year, Retail Sales came in at 0.0%. The BoE’s King was also out talking up the need to keep interest rates low as wages and money growth is so anemic that the latest bout of higher inflation was likely to be temporary.

Chart: GBPUSD
Not particularly in focus with the Euro situation continuing to rage, but GBPUSD has dropped precipitously over the last couple of days as well and one can argue that we have seen a break in a long standing head and shoulders type neckline. The next key support level is the 200-day moving average down around 1.6000. In support of the move lower, the UK/US rate spreads at the front end of the curve are the tightest they have been all year today.

The SNB had nothing to add to the mix that could counter the overwhelming Euro downside on the latest round of Euro turmoil. The SNB kept its rate target unchanged and warned that the franc is “dangerously” strong against the US dollar and the Euro (EURCHF plunging below 1.20 for the first time today). The franc’s ascent is becoming parabolic and this is destabilizing, so whenever it does reverse, the two-way volatility is likely to be extreme. In other Swiss news, Q1 Industrial production dipped a remarkable -9.2% for the quarter-on-quarter comparison.

Looking ahead
The Philly Fed is the next item on the economic calendar of interest after the horrific Empire data point yesterday and now after a couple of  more positive US data points this morning in the form of a smaller initial jobless claims print and upside surprise in housing starts and building permits. The Philly Fed already saw a massive drop last month, so perhaps there is less room for a downside surprise relative to the Empire figure?

In this environment, fear is white hot and headlines can drive the market both ways. Upside volatility potential in EURUSD, for example, might be greater in the shortest term on some Euro positive headline as it is likely that the market has really piled on to the Euro here short term. With this in mind, stay particularly careful out there.

Economic Data Highlights

• New Zealand Q2 Westpac Consumer Confidence rose to 112 vs. 97.9 in Q1
• New Zealand May Business NZ PMI out at 54.7 vs. 52.0 in Apr.
• Australia Q2 ACCI Survey Composite out at 48.9 vs. 53.3 expected and 59.1 in Q1
• Australia May New Motor Vehicles Sales out at -7.6% MoM and -14.5% YoY vs. -9.1% YoY in Apr.
• Switzerland Q1 Industrial Production fell -9.2% QoQ and +5.0%  YoY vs. -7.8%/+5.6% expected, respectively and vs. +6.4% YoY in Q4
• Switzerland SNB keeps target rate at 0.25% as expected
• Sweden May Average House Prices fell to 1.986M vs. 2.058M in Apr.
• UK May Retail Sales ex Auto Fuel out at -1.6% MoM and 0.0% YoY vs. -0.6%/+1.7% expected, respectively and vs. +2.3% YoY in Apr.
• EuroZone May Core CPI out at +1.5% YoY vs. +1.6% expected and vs. +1.6% in Apr.
• US Q1 Current Account Balance out at -$119.3B vs. -$130B expected and vs. -$112.2B in Q4US Weekly Initial Jobless
• laims out at 414k vs. 420k expected and 430k last week
• US Weekly Continuing Claims out at 3675k vs. 3670k expected and 3696k last week
• US May Housing Starts out at 560k vs. 545k expected and 541k in Apr.
• US May Building Permits out at 612k vs. 557k expected and 563k in Apr.

Upcoming Economic Calendar Highlights (all times GMT)

• US Weekly Bloomberg Consumer Comfort survey (1345)
• US Fed’s Tarullo to Testify on Regulatory Reform (1400)
• US Jun. Philadelphia Fed survey (1400)
• Japan BoJ to Publish Minutes of last meeting (2350)
• Japan May Nationwide Department Store Sales (0530)