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We are seeing a mixed picture developing between FX sentiments and positioning with a backdrop of larger macro-elements also changing. With China, Taiwan, HK and Korea on holiday today, FX markets were range bound during the Asian session and should stay subdued as the economic calendar today is light.
As we creep closer to the imminent bailout, FX traders have increased their long risk-correlated positions. IMM data this week showed that USD shorts had increased while EUR, AUD and CAD longs also increased. EURUSD was able to close comfortably above 1.4600 on Friday on the news that the troika of EU / IMF / ECB had reached at least a staff level agreement with Greek policymakers. Fears over EU contagion have now subsided as participants realized that this phase of the EUR sovereign crisis has a temporary solution. Even Eurogroup Chairman Juncker, whom has had some of the most colorful statements on Greece's future, sounded confident that the Eurogroup had found a solution.
USDCHF pushed through any and all supports to new all time lows at 0.8331. Commodity currencies lagged slightly as the risk on environment as tempered by the broader macro story of decline global growth prospects. US data seems to have run smack into a soft patch highlighted by weaker than expected payroll data and punctuated by unemployment that climbed to 9.1%. If traders had not been convinced of the futileness of two massive rounds of QE, the continued weakness in the US labor markets was hammered home Friday.
Clearly, US GDP forecasts now have to be revised down and the prospect of the FOMC even thinking about tightening is far, far away (Q2 2012) as the calls for QE3 are getting louder. Equity markets reacted by selling off with the S&P falling -1.0% and US 10yr yield pushed down below 3.00% again. The decline in US / JAP yields spreads have hurt the rate sensitive JPY and will keep the price appreciation side of our JPY-fueled carry trades contained.
As Europe walked in this morning, the result of Sunday's Portuguese elections hit the wires. The results stated that the Opposition Social Democrats have pushed out the ruling Socialists with 37-42% majority of votes. The Democrats will now look to form a new coalition government with the smaller conservative Popular party. With the political environment in flux, pundits are concerned that the 3.5% spending cuts demanded by the EU/IMF bailout program will be compromised. It's still way too early to predict any renegotiations as to the austerity cuts which must be outlined by end of July but we suspect that given the lack of options, Portugal will maintain its current commitments.
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The highlight of the week will be the ECB rate decisions on Thursday. While the Forex market has been primary focused on the Greek situation, the inflation story has taken a back seat. However, the elevated current rate and expectations have continued to give Trichet restless nights. The ECB's Smaghi recently stated that "current very low level of interest rates does not seem justified" while Draghi comment that that higher interest rate expectation could become "entrenched" and the central banks need to take action. With fears of a peripheral collapse subsiding and EU growth remaining buoyant, we suspect that Trichet will signal a July rate hike. We continued to see conditions of further EUR appreciations and are looking to the EURCHF as perhaps the most promising trade given the impending Greece stop-gap and potentially higher interest rates in Europe.
