Euro Erased Last Week's Early Gains to Finish Modestly Higher
By James Hyerczyk
After last week's talk of the need for and the subsequent announcement last week-end of a rescue plan for Greece, the Euro failed to hold on to its early gains and succumbed to speculation that the aid wasn't enough only to finish slightly better for the week.
On Monday the 12th, the EUR USD settled into a range after gapping open and pulling back from its high throughout the New York session, as traders awaited more details about the Greece bailout package. In addition, traders were waiting for Tuesday's Greek Treasury bill auction to see the size of the interest in the country's debt. Investors wanted to see whether there was strong demand for short-term Greek debt or if it was going to have to borrow to keep up with its financial obligations.
The commodity and equity markets gave mixed signals on Monday, Initially, both asset classes rallied as the Euro broke out to the upside. Some traders felt that this new agreement eliminated concerns about Greece's ability to meet its short-term obligations. Some even felt that the funding was enough to ensure that Greece would have enough liquidity to implement its new austere financial measures.
Tuesday, brought a different kind of trade to the market however. Throughout the session, the Euro wavered from up a few pips to down a few pips as very limited news changed hands. This trading action took place shortly after Greece concluded a successful 6-month and 52 week T-Bill auction. Demand was strong and the bid-to-cover impressive. Interest rates were high, but better than they were in the previous week. Traders were now waiting for the next move by Greece. It was either going to be satisfied with the proceeds of the auction or have to use some of the funds available from the European Union bailout package. Investors remained cautious about going long the Euro. There was also strong evidence that hedge funds were continuing to sell rallies.
The U.S. Dollar extended its earlier losses against the Euro on Wednesday, driven by the dovish testimony of Fed Chairman Bernanke. In addition to commenting on the direction of interest rates, Bernanke also emphasized that the economic recovery was still sluggish because of the floundering labor market.
Testifying before the Joint Economic Committee, Bernanke reiterated the Fed's stance that interest rates would remain low for an "extended period." He also said "the income data suggest that growth in private final demand will be sufficient to promote a moderate economic recovery in coming quarter." Finally, he added that "significant restraints on the pace of the recovery remain including weakness in both residential and nonresidential construction and the poor fiscal condition of many state and local governments."
All of this added up to the perception of a weaker Dollar. Investors who were banking on a more hawkish comment aggressively pared their positions.
Prior to the Bernanke testimony, the U.S. Dollar strengthened a little following a better than expected Retail Sales Report. This report was another sign that the consumer was helping the economy to recover, but the strength it generated was short-lived due to the Bernanke comments.
Bernanke's testimony put the dismal Greek financial situation on the back-burner for at least a day. The EUR USD rose due to expectations of lower U.S. interest rates for a prolonged period.
U.S. economic reports on Thursday helped weaken the Dollar after Weekly Initial Job Claims and Industrial Production were less than stellar. The job claims report showed that more Americans filed for unemployment aid while factory production came in below expectations. Both reports signaled that interest rates would remain low.
The night before China reported that its Gross Domestic Product grew 11.9 percent from a year ago. This was slightly better than the median guesses of 11.7 percent. The news that China's economy accelerated more than expected in the first quarter raised concerns that it may be overheating, which prompted more talk of a possible interest rate hike. Traders were also increasing speculation that China would revalue its currency as soon as next week.
On Thursday, after a sharp overnight sell-off, it became clear that market participants were feeling jittery again about the Euro because of concerns over Greece. Investors became increasingly worried that the IMF/EU $61 billion financial aid plan would not be enough to help the Greek economy and restore confidence in the Euro. As the day unfolded it became apparent that the Euro was facing serious credibility issues.
High premiums demanded by investors on Greek bonds rose 400 basis points above the German Bund for the first time since the rescue plan was announced on April 11th. This was the clearest sign that investors were becoming worried again. In addition, after three tries, the Euro was unable to take out the high reached Sunday night at 1.3691. Hedge funds continued to be short and appeared to be adding to their positions on each rally.
By Thursday's close, the course of the Euro remained weak. Next week, several European Union nations will be meeting to approve their contributions to the EU bailout plan. This voting process could be another source of turmoil for the Euro. Not only will these nations have to put up the money to back Greece, but they may have to begin discussions about the possibility of similar problems spreading to Portugal.
Now that traders have had almost a week to digest the EU rescue package, a consensus is building which believes that this plan was nothing more than a short-term fix and that long-term problems still exist. Some sources say the key to a long-term solution to the sovereign debt problems in the EU sits firmly on Germany. Pressure is mounting on Germany to loosen up a bit and make it easier for struggling nations to get the aid they need to survive while simultaneously developing a plan to address financial aid issues which may arise in the future.
Finally, on Friday, a combination of a weaker Euro and a sharp break in U.S. equity markets drove the currency back down through last week's close to fill the gap left open on Sunday. At the end of the day and week, the Euro finished slightly better than the previous Friday. In conclusion, we learned this week what the definition of sell rallies means as the Euro was never able to regain the strength exhibited following Sunday's surge to the upside. We also learned that the sellers are still in control and that it is going to take more than $61 billion to solve this financial crisis.