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It's official, the German economy is single handed propping up the Eurozone after its economy grew five times more than forecast in the first quarter. Growth expanded by 0.5% on the quarter, pushing the annual growth rate to 1.2%, which is fairly healthy considering how dire the growth outlook is elsewhere in the currency bloc. We know that some large German companies like BMW had their best ever quarter in the first three months of the year, thus there were signs that Germany could do better than expected. But what is surprising is that even though Italy contracted more than expected at 0.8% in the first quarter, the Eurozone managed to avoid a recession and registered flat growth overall between January and March.

Germany vs. disaster?

This complicates the outlook for the currency bloc. Today's data highlights the two-speed economy in the region, which makes it even harder for markets to value the euro. Germany has a good growth mix and a very low deficit. In contrast to the US, Germany looks like a paragon of fiscal virtue. Since Germany is the largest economy in the currency bloc, it makes sense that euro-based assets reflect this strength. However, the troubles in the periphery and in Greece in particular, could cause the end of the Eurozone - so how do you price in such contrasting situations: strong German growth on the one hand and disaster on the other?

Why is the FX market not in panic mode?


There is no definitive answer to this. The one thing we have pointed out in the past is that volatility remains incredibly low, and below the highs reached back in autumn 2011. The Vix index is currently around the 21/22 level, yet back them it surged to 48.00. Thus, either the backdrop has stabilised since then, which means the Greek political crisis is more manageable than it was a few months back, or a strong Germany is enough to placate investors. A strong Germany that may be willing to tolerate higher inflation than in the past could allow the ECB to either 1, cut interest rates or 2, pump the currency bloc with more liquidity. Investors love liquidity, hence this may be one of the reasons why the FX world is not in panic mode just yet.

Rather we are seeing the bulk of Eurozone stress manifest itself in European stock markets in particular the Spanish Ibex, which is back at its lowest level since the dotcom crash. In Italy the FTSE MIB index is at its lowest level since the financial crisis in 2009. The market cap of the entire Ibex has dwindled to EU 261.4bn. In perspective, Germany's economy is EU 2.5trillion, thus Germany does have the financial firepower to support Spain and protect the currency bloc. But until it steps up to the plate the financial sector in Europe is likely to remain under considerable downward pressure. The European banking index has fallen by more than 20% since March, while the US banking sector is down by 7% in the same time period, highlighting the problems afflicting the region.

The symbiotic links between European sovereigns and the banking sector means that Spanish banks, in particular, are likely to remain vulnerable while Spanish 10-year bond yields are above 6%. Likewise, Italian banks were downgraded again last night by Moody's, which will make it harder for their stock prices to rally any time soon.

Market moves:


EURUSD managed to recover today after the positive GDP surprise. It is currently testing resistance above 1.2850, although it hasn't managed to sustain gains above here. If the bulls do manage to get some traction then we could see 1.2955 - the 62.8% retracement of the January low to February high. On the downside, support lies at 1.2780 - the long-term trend line support from the June 2010 low.

The commodity currencies have been messy today as the markets try to price in the conflicting signals from the currency bloc - both heightened political risk in Greece and better than expected growth data. The commodity/ yen crosses haver bounced off their recent lows. In the short term CADJPY found support at 79.60 although stiff resistance lies at 80.35 - the base of the Ichimoku cloud.

Sterling has recovered this morning after selling off post the stronger Eurozone GDP data. The pound has been a beneficiary of safe haven flows from the Eurozone, so it may weaken if the economic data out of Europe surprises to the upside. 1.6050 acted as good support in GBPUSD. EURGBP failed to break above 0.80 after the data release, but it continues to recover after falling as low as 0.7950. We believe this pair will find it hard to make headway above 0.8015/20 a cluster of hourly sma resistance, and we look for this pair to grind lower for as long as the Greek political crisis remains unresolved and the prospect of a disorderly Greek exit from the currency bloc remains on the table. 0.7750 - the 100-month sma - is likely to act as a major support level.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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