Several positive developments out of Europe today, including a much stronger than expected reading out of the ZEW Economic Sentiment index, a drop in the final reading of inflation (opening up leeway for ECB to consider lowering interest rates further), and a fall in borrowing costs at auction for Spanish bills.
The euro was generally higher against all of its counterparts - the dollar, yen, pound, and Canadian Dollar - though it was a bit weaker against the Aussie which rallied on the back of better than expected data from China.
1. German ZEW Jumps in January, Giving EUR a Boost
First up we saw a big jump in the ZEW sentiment indicator for Germany, a positive surprise that may help to give some confidence around the near-term prospect for the main economy in the Euro-zone.
From Reuters: The ZEW's monthly poll of economic sentiment rose to -21.6 from -53.8 in December, the largest single monthly increase since the survey started in 1991, driving the euro to a session high versus the dollar after the data, as Bund futures fell to a new session low.
ZEW economist Michael Schroeder said the rise was driven by upbeat economic data as well as the European Central Bank's massive injection of cash on the markets last month, which has left banks awash with money.
We have better figures from the United States, that is one reason, he said. The second reason is that it seems that the worst of the euro zone crisis might be over due to the reaction of the central bank and the rescue mechanism.
2. Euro-zone Inflation Eases to 2.7%
In a second release, inflation eased to 2.7% in the final reading for December. While still running above the ECB's target of just below 2%, it shows some disinflation, which can help bolster the case for the ECB to cut rates further if needed. That has cross currents for the Euro, as lower rates is a negative fundamental development for interest rate differentials, but it is a positive because lower interest rates are good for economic growth and the prospect of looser monetary policy helps risk sentiment which boosts the EUR in the short term.
From Reuters: Inflation in the 17 countries sharing the euro was 2.7 percent in December on an annual basis, revised down from an earlier estimate of 2.8 percent for the month, the European Union's statistics office Eurostat said.
The pressure is abating although the risks from energy are still there, said Fabio Fois, an economist at Barclay's Capital. We think the ECB could bring rates as low as 0.5 percent in March, he said.
Stripping out volatile energy prices, the main driver behind a 3 percent peak in the headline number in September, October and November, inflation was 1.9 percent. Without energy and food, it was 1.6 percent.
3. Yields in Spain Decline, Helping EUR
In a 3rd development, we have another successful short term debt auction by a Euro-zone periphery member, showing that European banks and investors are pretty comfortable buying shorter maturity bills with the money they do have on hand thanks the the ECB's ample liquidity via the LTRO.
From Bloomberg: Spain sold 4.88 billion euros ($6.23 billion) of 12-month and 18-month bills, just below the maximum target, and its borrowing costs fell in its first auction since its credit rating was cut by Standard & Poor's.
Spain sold 12-month debt at an average yield of 2.049 percent, compared with 4.05 percent at an auction on Dec. 13. It sold 18-month paper at 2.399 percent, down from 4.226 percent last month.
Demand for the 12-month bills was 3.54 times the amount sold, the Bank of Spain said, compared with 3.14 times the last time the securities were sold on Dec. 13. The bid-to-cover ratio for the 18-month notes was 3.23, compared with 4.97 in December. The Treasury had said it would sell a maximum of 5 billion euros.
Spain aims to sell as much as 4.5 billion euros of bonds maturing in 2016, 2019 and 2022 on Jan. 19.
In the chart below we can see the nice rally in the EUR/USD pair as a result of the positive developments, though part of this was driven from overnight risk-appetite on the back of better than expected growth out of China.
We see not only a nice clean break of the resistance level from yesterday at 1.2680, but also a move above the 200-ema, and a 61.8% retracement of the downswing we saw on Friday as a result of the S&P downgrades. The question is if the euro can sustain these gains or will this rally be faded as we move through the NY trading session.