Risk appetite appeared to be gaining ground in Asian hours but the FTSE 100 index has given back many of its opening gains since the start of the London session. Similarly the EUR is softer with selling pressures capping EUR/USD at 1.2720 early in the session. Mirroring the step back from risk, the JPY is also a touch stronger on the crosses, though AUD/JPY has found solid support at 77.20.
The better tone noted in stocks this week can be explained as a corrective reaction to the strong losses registered since April. At the start of this week, the S&P 500 was down 15% from its April 2010 high. Even though stocks have been climbing this week, overall evidence that risk appetite is returning has been patchy; with the bond markets looking mixed despite the better tone in stocks. In all it seems that investors are unconvinced about the potential for further gains in risk near-term. While fears over a double dip recession in the US are likely to prove overdone, there is still plenty scope for negative news in the coming months. Firstly the market needs to come to terms with the likelihood that growth in the industrial world is likely to be relatively slow during the next few years. Also expectations regarding the potential for Chinese growth this year are currently being moderated. Added to this, the impending publication of stress tests for European banks could yet create difficulties for the EUR.
Speculation that European stress tests would not be tough enough to trip many banks was linked to gains in banking stocks yesterday. This enthusiasm, however, may be short-lived. The market has been demanding stress tests as a means of increasing transparency. If tests are not tough enough the current suspicions that are hindering the ability of some banks to fund themselves in the open market could persist. In effect this could prolong negative risk for the EUR. In an effort to offset talk about soft stress tests, this morning EC President Barroso has commented that the stress tests are credible. He also reassured the market that the EU will be available to help if the stress tests produce casualties. Until the results of the tests are published, the market is likely to be wary of aggressive long positions on the EUR. That said Euribor has edged higher again this morning. While this supportive of the EUR, ECB President Trichet yesterday made it clear that there was no intention by the ECB to signal higher rates. Money market conditions have been usually volatile due to last week’s expiry of the June 2009 ECB EUR 442 bln loan, though conditions are likely to settle in the forthcoming week.
Sterling has clawed back some ground vs the EUR this morning despite disappointing trade data and softer than expected PPI. The total trade balance widened to its worse level since before the financial crisis, throwing cold water on hopes that the weaker position in sterling over this period would produce an export led recovery for the UK. While there are signs that the German economic recovery is gaining ground, the relatively soft position of the Eurozone demand is weighing against a strong recovery in UK exports. Meanwhile imports have strengthened suggesting UK domestic demand may be recovering. PPI data were softer than expected. This should help sooth fears that underlying inflation pressure in the UK are rising. While sterling turned lower vs the USD on the release of these data, EUR/GBP was dragging lower by the softer tone in EUR/USD .
Canadian employment data and housing starts are due this afternoon.