Euro remains on downward trend as worldwide economy slows

Tom Tong16/Jul/2012Currency Updates

Last week was relatively uneventful in financial markets, at least by the standards of these convulsed times. Equities ended the week generally flat, as a sharp Friday rally in risk assets erased the week’s losses, and commodities rose again. It is significant that in this mildly positive week for risk assets, the euro failed to bounce back; more so given that short positions on the common currency are still at or near records. Positioning this extreme should be expected to provide some support for the common currency, and the fact that it is not tells us that the downward trend is by now firmly established. Also notable last week was sterling’s strong performance, rising against both the euro and the dollar; an outcome which we had not seen for many months.


Last week, the UK bucked the worldwide trend of macroeconomic disappointments with a couple of positive surprises. May industrial production rose by 1.0%, and exports rose 8.9%, almost fully unwinding the previous month’s 9.8% fall. However, both of these measures are highly volatile and we will not be revising significantly our view of continuing flat to negative growth in the UK for the rest of the year. Our view was supported by a weak Markit report on hiring trends, which seems to indicate that the UK job market is starting to deteriorate after a relatively decent performance so far. Sterling, however, was buoyed by the first mildly positive surprises in quite a while, and the pound rose smartly in response, ending the week up about 1% against the euro and roughly half of that against the US dollar.


The details of the European bailout for the Spanish banking systems became clearer last week. While it appears that the sovereign will not, in fact, be held liable for this aid, the conditions imposed on Spain will only be marginally less draconian than those imposed on Greece, Ireland and Portugal. The Spanish Government reluctantly announced yet another brutal austerity package, with across-the-board tax increases and yet another salary cut for public workers. Most of these measures had been explicitly refused by President Rajoy just a few weeks earlier; there can be no doubt that they were imposed directly from Frankfurt and Brussels. Since Spanish internal demand is diving at an unprecedented pace, and external demand for its exports and services is stagnant at best, it is not hard to foresee the result: further collapse of Spanish business and consumer confidence, faster economic contraction, higher unemployment and yet another upwards revision of the deficit targets. Incidentally, the European Commission no longer dares pretend that the farcical targets are feasible, and is busily revising them upwards, as we said they would as soon as they were originally announced.

However, all of these consequences will not become clear for weeks and months, which appears to be well beyond the event horizon of European authorities. So, we expect the crisis to lose some drama and revert to its more chronic state until macroeconomic news forces a new confrontation with reality later in the fall. Currency investors are getting harder to appease, and in spite of the generally positive week for financial markets, the euro continued its downward trend against nearly all major currencies.


It was a remarkably uneventful week in the US, without a single first-tier macroeconomic release. Weekly jobless claims did decline by 35,000 from the previous week, but it appears to be due mostly to a change in the retooling schedule in US auto-mobile plants. Nothing changes the picture we have painted of the US economy: lacklustre growth in employment incomes and consumption, somewhat faster manufacturing growth, and a robust housing recovery, albeit from very depressed levels (all of it still consistent with our recently lowered forecast of 1.5-2.5% growth in 2012).


Written by Tom Tong

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