The euro has had a mixed start to the morning. EURUSD was comfortably above 1.3600 during the Asian session, but when European markets came back to work after the weekend a sell-off started. The reason for this was a report in the German press that quoted Eurogroup Chairman Jean-Claude Juncker saying that European leaders had no intension of boosting the size of the EFSF rescue fund. However, that wasn't exactly what he meant: Juncker said that the fund will receive extra collateral to allow it to lend to its full capacity EUR440bn, currently it can lend less than EUR300bn in order to maintain its triple A rating. So effectively, this move is an extension of the current funds available. EURUSD seems to have found support at 1.3555/60 and may re-test 1.3600.
FX markets have essentially shrugged off political developments in Europe's periphery. The collapse in the Irish government isn't considered critical by the markets because all political parties bar one very small party has agreed to pass the Finance Bill before the upcoming general election. This is needed before EU/IMF bailout funds are released to Dublin. Likewise, the Portuguese Presidential election went off as expected with the incumbent winning the race. Although sovereign risk fears have moderated in recent weeks, this hasn't been reflected in bond yields. Portuguese 10-year bond yields remain perilously close to the 7 per cent threshold that would require them to apply for bailout funds. Instead the shift in sentiment has been reflected in the single currency. There has been a sharp reversal in EURUSD speculative positioning, with more traders going long the euro last week.
There were a lot of euro-supportive comments from EU officials this weekend. German Fin Min Schauble said that Germany wants to move towards a permanent solution to the sovereign debt crisis in the coming weeks. Likewise, ECB president Trichet said that monetary policy and temporary support for peripheral nations are separate; this suggests that monetary policy could be tightened at the same time as more support for peripheral nations is implemented. This supports the argument that the ECB may raise interest rates later this year to combat inflationary pressures. Right now Germany's pledge to protect the Eurozone coupled with a perceived hawkishness from the ECB is driving euro strength.
This week is fairly data-light for the Euro-area, instead attention will focus on the US and UK. Both countries report Q4 GDP, which will be pivotal to determining interest rate expectations going forward. There are also Bank of England minutes and a Federal Reserve meeting that will give us more insight into the tone of debate at both central banks.
Elsewhere, fourth quarter producer prices in Australia came in weaker than expected, which could weigh on Tuesday's CPI data. It appears that the inflation profile for Australia has shifted, which reduces the pressure on the RBA to hike rates. This is weighing on AUDUSD and the crosses. It could be hard for the Aussie to break above parity any time soon if inflation starts to moderate.
Look out for the Davos meeting this week. It usually contains interesting commentary rather than market-moving events, but it has some extremely high profile speakers and the markets will be taking note. It's also still earnings season. McDonalds and Texas Instruments report results today, while Yahoo, Verizon and Johnson & Johnson are tomorrow's highlights. Stocks have started the week fairly flat, and with the dearth of US data releases in the next couple of days all eyes will be on Wednesday's FOMC meeting and Q4 GDP on Friday, which will be a major determinant of dollar direction going forward.
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Kathleen Brooks| Research Director UK EMEA | FOREX.com
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