Ahead of today’s critical decision from the German Constitutional Court, of interest is that the dollar’s demise has continued to gather momentum. Despite some real trepidation regarding how the judges in Karlsruhe will rule, the single currency is now not that far away from the 1.29 level. To put the recent price action into perspective, the euro is now trading above the 200d moving average for the first time since late October 2011. Also, USD/JPY fell below 78.0 to a 7m low, cable is at a 4m high near 1.610 and the Aussie is just under 1.05. One rationale for the continued decline in the greenback rests with an expectation that the Fed will announce substantive QE tomorrow. Also worth noting is that in the aftermath of Mario Draghi’s OMT announcement, Euro-denominated corporate bond issuance has suddenly taken off – on Monday, there were 11 deals priced worth at least EUR 500m, the highest for a single day since the inception of the single currency. In the first six sessions of the current month, some EUR 26bn of corporate bond deals have been priced up, and there is plenty more to come given investor appetite for yield and the fact that European securities markets have essentially been shut for the past half year. As international investors rush to participate, it is little wonder that the euro is rising rapidly and the dollar is weakening. One final nail in the coffin for the dollar was Moody’s threat that it might lower America’s debt rating if Congress fails to implement a comprehensive budget deal.
What we can expect from the Fed. Over the past few weeks the main focus of currency markets has been on some of the positive developments emerging out of the eurozone. Draghi’s OMT initiative elicited a particularly positive response when the details were announced last week. However, it is also the case that the dollar has been subject to consistent selling pressure - since late July, the dollar index has fallen by 5%, a sizable decline that has attracted less critical comment than might have been expected. One of the main catalysts for the dollar’s downward drift has been the continuing malaise in the labour market, and the Fed’s vow to do something about it. On Thursday, the FOMC will likely extend their interest rate guidance out past 2014, and commit to more asset purchases. Fed officials are clearly concerned over the lack of growth; they also fear that if Washington fails to arrest the fiscal cliff before the end of the year then the economy could easily fall back into recession. Although more QE is definitely coming, less clear is what the size and timing will be. One interesting suggestion is that Bernanke will opt for an open-ended approach on this occasion, where he announces QE but does not specify how much or when. Strategically, this gives risk assets and high-beta currencies some reassurance that the Fed will be there as a backstop in case the economy deteriorates. At the same time, it might take some of the heat off Washington, as politicians would be safe in the knowledge that in the event of inaction, the Fed would be ready to respond. Should the Fed implement this open-ended approach, then the dollar could be expected to lose some further ground. In addition, it might help the single currency push on towards the 1.30 level.
The euro waiting game. Ahead of today’s long-awaited decision from the German Constitutional Court regarding the legality of the ESM and the fiscal union, the single currency continued to push higher yesterday. The ESM requires 90% approval from the capital requirements which underpin the euro’s founding structure, so Germany remains pivotal with a capital contribution of just over 25%. There’s no doubt that the euro remains vulnerable to any delay or worse rejection by the constitutional court. What would be a greater headache would be if the court put any conditions on their ruling… perhaps a small risk, but one worth keeping an eye out for. If a rejection were to be seen, then it would be a long haul for Merkel to both work towards an eventual acceptance by the court and also seeking to make the current temporary rescue fund more permanent. Ironically, if this sent peripheral yields higher, it would make it more likely that either Spain or Italy would be forced to seek a bailout and thus trigger the ECB’s “outright monetary transactions”, but it would not be a welcome development and would place an even greater burden on the ECB.Economic Calendar Look ahead with FxPro’s free comprehensive economic calendar powered by Econoday.