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The euro has had a good start to the European session in a very important week for Europe. Firstly, French and German leaders meet today in Berlin to discuss how to promote growth in the currency bloc and the financial transaction tax that the UK PM vetoed last month. The other area that may be discussed is private sector involvement/ haircuts for the holders of Greek debt that is expected to be agreed upon this week.
In the past markets have usually led up to these meetings in buoyant mood that a solution to the debt crisis could be found. However, after rounds and rounds of disappointment the markets seem to have learned to temper their expectations and markets seem to hold out little hope of definitive action in the near-term. This meeting is a prelude to the January 30th EU leaders summit and the pressure is building. Europe's bond yields have deteriorated yet again. Italian 10-year bond yields are uncomfortably high at 7.17%, while Spain's 10-year jumped by the most last week in 17-years, and yields are currently above 5.7%.
The euro may have bounced back from 14-month lows at 1.2666 today but activity in the bond market highlights the perils for the single currency. Resistance comes in at 1.2745 in EURUSD and then 1.2790, on the downside support lies at 1.2670 ahead of 1.2630. Prior to the Merkozy meeting that takes place at 1230GMT, we can't see the euro gaining much traction above 1.28.
But in the long-term the outlook for the euro is decidedly bearish, not least because of the sovereign debt crisis, but also because of the dollar, which seems to be shrugging off its mantle as the global funding currency of choice. The Fed's Bullard dismissed the idea of QE3 in a speech yesterday, and the dollar rallied strongly on Friday post the strong payrolls number. Although it is giving back some of its gains today, we expect this week's ECB meeting to highlight the dovish stance at the Bank, which should give the dollar the upper hand over the single currency for some time yet. We expect ECB President Draghi to sound dovish at his press conference on Thursday, thus narrowing the rate differential with the US and weighing on EURUSD in the medium-term.
The German-US 10-year yield differential has fallen by more than 40 basis points in recent weeks as US Treasuries come under pressure (yields rise) as investors reassess their expectations for QE, which is the also helping the dollar to find its feet. Euro negative rate differentials could be an on-going theme of 2012.
Elsewhere, the Swissie has had a strong start to the year even though inflation data for December pointed to the Swiss economy falling deeper into deflation territory. Yet perhaps the data is not yet bad enough for the SNB to raise the 1.20 floor on EURCHF, hence we have seen EURCHF fall off in the last 2 days to below 1.2150 and USDCHF fell as low as 0.9530.
European futures are currently in positive territory possibly boosted by expectations of a Chinese RRR cut. The latest new loans data showed a larger than expected increase for December to Y 640BN, vs. exp of Y 575bn. This suggests that credit conditions in China are loosening and the government is becoming more focused on growth rather than inflation, which is understandably boosting global equity markets.
Europe is key though, and event risk is high today. On top of the Merkozy meeting there are also German and French bond auctions and German industrial production for November.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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