Talking Points

  • Euro: France To Maintain AAA Rating, Italy At Risk According To Fitch
  • British Pound: Carves Out Short-Term Bottom Ahead Of BoE
  • U.S. Dollar: Risk Appetite Gathers Pace, Fed To Soften Dovish Rhetoric

Euro: France To Maintain AAA Rating, Italy At Risk According To Fitch

The Euro climbed to an overnight high of 1.2808 following the rise in risk-taking behavior, but the weakening outlook for the region is likely to weigh on the exchange rate as the economy faces a growing risk of a major economic downturn in 2012. The Bank of Portugal warned of a deeper contraction this year as policy makers see GDP declining another 3.1% over the next 12-months, and went onto say that the risks for the region are 'clearly on the downside' as the tough austerity measures undermines private sector activity.

At the same time, Fitch Ratings fired warning shots against Italy, saying that the region faces a 'significant chance' of getting down downgraded further, but noted that France will be able to maintain its AAA credit rating 'unless there is a serious intensification of the euro zone crisis.' As the fundamental outlook for the euro-area deteriorates, we should see the European Central Bank maintain a dovish tone for monetary policy, and central bank President Mario Draghi may lay the ground works for a zero interest rate policy as growth and inflation falter. As the EUR/USD finds near-term support around the 23.6% Fibonacci retracement from the 2009 to the 2010 low around 1.2630-50, we may see the exchange rate consolidate ahead of the policy meeting, but the statement accompanying the decision could spark a bearish breakdown in the single currency should the ECB talk up speculation for additional monetary support.

British Pound: Carves Out Short-Term Bottom Ahead Of BoE

The British Pound continued to recoup the losses from the previous week as market participants increased their appetite for risk, and the sterling looks poised to trend sideways in the days ahead as investors weigh the outlook for the U.K. Although we have the Bank of England interest rate decision on tap for later this week, market participants may turn a blind eye to the event as the central bank is widely expected to maintain its current policy in January. In turn, risk trends may heavily influence the GBP/USD over the remainder of the week, but we may see the sterling struggle to hold its ground as the economic docket is anticipated to show a slowing recovery in Britain. As the GBP/USD appears to be building a floor around 1.5400, the near-term correction may push the exchange rate back towards the 38.2% Fib from the 2009 low to high around 1.5680-1.5700, but the sterling remains poised to face additional headwinds in 2012 as the BoE shows an increased willingness to expand its asset purchase program beyond the GBP 275B target.

U.S. Dollar: Risk Appetite Gathers Pace, Fed To Soften Dovish Rhetoric

The greenback continued to lose ground against its major counterparts, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) falling to an overnight low of 9,947, and the reserve currency may weaken further over the next 24-hours of trading as the rise in risk-taking behavior carries into the North American session. As the economic docket remains fairly light for the remainder of the day, risk trends are likely to heavily influence the USD, but comments from Fed officials may prop up the greenback should the central bank talk down speculation for additional monetary support. In light of the recent developments coming out of the world's largest economy, the more robust recovery certainly limits the FOMC's scope to expand monetary policy further, and we may see central bank officials soften their dovish tone for monetary policy as the economic activity gradually gathers pace.

--- Written by David Song, Currency Analyst