Talking Points

  • Euro: Italy Bond Auction Fails To Impress, Merkel and Sarkozy To Meet
  • British Pound: Searches For Support, Eyes October Low
  • U.S. Dollar: Index Hits Fresh Weekly High, Pending Home Sales On Tap

Euro: Italy Bond Auction Fails To Impress, Merkel and Sarkozy To Meet

The Euro tumbled to a fresh year low of 1.2857 as Italy's bond action fell short of market expectations and the EUR/USD may track lower over the remainder of the week as it maintains the downward trend from the end of October. Italy missed its EUR 8.5B target as the Treasury raised EUR 7.02B at its bond auction earlier today, while the government offered 6.98% on its 2022 bond, which compares to the 7.56% yield from back in November. As heightening finance costs dampen the outlook for the euro-area, German Chancellor Angela Merkel and French President Nicolas Sarkozy are scheduled to meet on January 9 to further discuss the debt crisis, but the two may fail to restore investor confidence as the governments operating under the monetary union becoming increasingly reliant on monetary support.

In turn, the European Central Bank is widely expected to ease policy further in 2012, but we may see the Governing Council take aggressive steps to shore up the ailing economy as the slowing recovery heightens the risk of undershooting the 2% target for inflation. ECB board member Ewald Nowotny said price stability will be the 'main concern' for the central bank as he expects price growth to recede over the next two-years, and we expect the Governing Council to push the benchmark interest rate below 1.00% as President Mario Draghi moves away from the nonstandard measures. However, the ECB may have little choice but to expand its balance sheet further as the ongoing turmoil in the world financial system drags on the banking sector, and the weakening outlook for the euro-area should push the exchange rate lower as market participants scale back their appetite for risk. As a result, it seems as though it will only be a matter of time before we see the EUR/USD threaten the rebound from last August (1.2586), and the bearish sentiment underlining the single currency may gather pace in the following year as European policy makers struggle to address the debt crisis.

British Pound: Searches For Support, Eyes October Low

The British Pound slipped to a fresh monthly low of 1.5360 as currency traders scaled back their appetite for risk, and the GBP/USD may make another run at the 50.0% Fibonacci retracement from the 2009 low to high around 1.5270-1.5300 as it searches for support. As the pound-dollar breaks out of the broad range carried over from the previous month, we may see the pair give back the rebound from back in October (1.5270), and the sterling is likely to face additional headwinds over the near-term as Britain faces an increased threat of a double-dip recession. However, as the U.K. government takes extraordinary steps to balance its public finances, market participants may treat the British Pound as a safe-haven in the following year, and we may see the sterling decouple from its major counterparts as the Bank of England keeps the benchmark interest rate at the record-low.

U.S. Dollar: Index Hits Fresh Weekly High, Pending Home Sales On Tap

The greenback continued to gain ground on Thursday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) advancing to a fresh weekly high of 10,062, and the reserve currency may appreciate further ahead of the New Year as the flight to safety gathers pace. However, as U.S. Pending Home Sales are expected to increase another 1.5% in November, the ongoing improvements in the world's largest economy could prop up market sentiment, and we may see the USD consolidate over the next 24-hours of trading as market participation thins going into the end of 2011. Nevertheless, the bullish sentiment underlining the greenback should gather pace next year as the more robust recovery limits the scope of seeing another large-scale asset purchase program, and we may see the Federal Reserve continue to soften its dovish tone for monetary policy as the fundamental outlook for the U.S. improves.

--- Written by David Song, Currency Analyst