Talking Points

  • Euro: Spain To Cut Spending, Outlook Remains Bearish
  • British Pound: BoE King Holds Improved Outlook, Broad Range Ahead
  • U.S. Dollar: Weakens Across The Board, New Home Sales On Tap

The EUR/USD advanced to an overnight high of 1.4499 and the rebound in the exchange rate may gather pace as the governments operating under the fixed-exchange rate system step up their efforts to contain the sovereign debt crisis. Indeed, Spain's parliament passed additional measures to cut the national deficit by EUR 3.1B this year, but the renewed efforts to stem the risk for contagion could be too little too late as the region faces a slowing recovery.

As growth and inflation falter, there seems to be an increased reliance on the European Central Bank to address the imbalances, and the ongoing turmoil within the banking system may lead the Governing Council to carry its nonstandard measures into the following year in an effort to preserve financial stability. Given the recent developments coming out of the Euro-Zone, market participants are pricing a 25bp rate cut for the next 12-months according to Credit Suisse overnight index swaps, and the near-term outlook for the single-currency remains fairly bearish as the fundamental outlook for Europe deteriorates. As the EUR/USD fails to test the monthly high at 1.4516, we may see the exchange rate struggle to hold above the 78.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.4440-60, and a close below this level should produce a near-term correction in the euro-dollar as the pair continues to trade within a bearish pattern.

The British Pound struggled to maintain the overnight advance to 1.6572 and the sterling may continue to consolidate in the days ahead as market participants weigh the outlook for future policy. During an interview with BBC Radio, Bank of England Governor Mervyn King said easing commodity prices 'will bring forward the day when the squeeze on real living standards will come to an end,' but the ongoing slack within the real economy may lead the MPC to ease monetary policy further as it aims to encourage a sustainable recovery. Although market participants see the BoE expanding its asset purchase program beyond the GBP 200B, the majority may look to carry the current policy into 2012, and the GBP/USD may face range-bound price action over the near-term as the fundamental outlook for the U.K. remains clouded with high uncertainty.

The greenback weakened across the board, with the Dow Jones-FXCM U.S. dollar (Ticker: USDollar)index falling back to a low of 9408, and the reserve currency may continue to lose ground throughout the North American trade as the U.S. stock market is expected to trade higher on Tuesday. However, as the economic docket is expected to show a 0.6% drop in new home sales, the data could drag on market sentiment, and we may see a shift away from risk-taking behavior as the fundamental outlook for future growth deteriorates. In turn, the USD may regain its footing on safe-haven flows, and the greenback may consolidate ahead of the Jackson Hole Economic Policy Symposium later this week as market participants speculate Fed Chairman Ben Bernanke to discuss the possibility of expanding monetary policy further.