Monday July 26, 2010

With the weekend cushion behind the European banking stress test results the euro is treading water to start the new trading week. The response to the tests has been remarkably calm with reaction centered on the stringency of the process given that fewer banks failed to leap the hurdle. The fact is, however, that investors have been so extremely keen to dwell on risk that they could be accused of looking beyond what is reasonably warranted. And with the numbers out in the open and banks' holdings largely now disclosed perhaps it's time to move on from this leg of the financial crisis instead of standing around analyzing the carcass left after the tests.

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Euro - So far the euro has remained within a narrow range against the dollar of between $1.2958 and $1.2889. During the course of the past three weeks the single currency has continued its ascent in the knowledge that the balance sheet survey was underway. The reality is that in the aftermath of the crisis certain supervision reforms have been made and the health of the banks has become known to local authorities. Capital repairs have been made. The fear is largely in the minds of investors insistent that a lurch lower for the economy could result in a decimation of the banking system leading to a double-jeopardy in which crisis begets crisis. It's time to embrace the revelations of the tests and move forward with what we know. It's time to stop holding economic progress to ransom on account of fears that may never unfold.

U.S. Dollar - And while the euro treads water, the dollar is left clinging to a life raft sitting close to its lowest levels in three months with the dollar index is sitting at 82.46 to start the week as investors consider whether to revert to selling dollars on the slowdown theory or whether to take issue with the euro once again. However, in the aftermath of the test results there is an element of risk-on in the markets with riskier assets all rallying. Asian stocks were higher, which has filtered through to Europe where banking stocks also breathed a sigh of relief on the results.

 

Aussie dollar - During the week the government will reveal the second quarter inflation report for Australia and with risk seemingly back on the table overnight the Aussie reached its best level against the dollar in 10-weeks and continues to edge towards 90.00 U.S. cents, where it hasn't traded since May 13. During the interim and on account of challenges to global recovery the Aussie reached 80.66 cents. In today's trade as investors consider the widening yield spreads against the U.S. curve bolstered by the prospect of further domestic interest rate increases the Aussie is trading at 89.74 cents. It is actually marginally weaker against the Japanese yen at ¥78.14.

Japanese yen -The Japanese yen remains strong this morning despite political noise from leaders of minor political parties calling for the Bank of Japan to do more to stimulate demand and openly calling for a weakening of the unit. Those minority voices are becoming increasingly important following the loss of support for Naoto Kan's DPJ party in recent upper house elections. His existing coalition partner fared just as badly and he's actively courting new parties. Yoshimi Watanabe as head of Japan's Your Party today called for policies aimed at beating deflation including a weaker yen. To start the week the yen is gaining versus the dollar where it stands at ¥87.14 while it also gained about a half of one yen against the euro at ¥112.47.

British pound - The improved tone to the markets after the stress tests boosted the pound to its strongest level against the dollar since April puncturing resistance at $1.5500 in early trading. Investors have recently been relieved after signs that the economy remains on a recovery track in the knowledge that a tough round of spending cuts and tax increases acts as a possible economic headwind. The pound also rose to 83.26 pence per euro.

Canadian dollar - In early trading the Canadian dollar has ascended above last week's intraday highs to reach 96.70 U.S. cents proving that it's tough to keep the loonie pinned down. The path for the Canadian unit is between the two views that bubble to the surface. The first is that the loonie remains hitched to the fortunes of the United States economy to its south. Intermittently fears for a double-dip keep dragging it down. However, the data coming out of Canada keeps showing rude independent health with demand for its commodities keeping the unit easily propped up. During the course of the last three months the Canadian dollar has fallen from 99.79 cents to as low as 92.14 cents.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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