As this holiday shortened week starts the focus of most currency traders remains on the debt markets both in Europe and the US. In Europe the sovereign bonds of peripheral economies continue to be under enormous amount of stress with yields on benchmark 10 year Italian bonds still hovering near the critical 7% level.
Many currency strategists have been calling for ECB to do an SNB-type of intervention by offering unlimited liquidity to the market and even setting hard caps for Italian and Spanish bonds yields. Yet, the central bankers in Frankfurt remain highly reluctant to act so aggressively continuing to stick to their mantra that their only mandate is price stability. Ultimately the ECB is the only institution in Europe that has the power to stop the assault of the shorts. Unfortunately their ambivalence on policy is being reflected by the ambivalence in price of the EUR/USD which continued to oscillate around the 1.3500 level for most of last week.
There are however two possible developments this week that could trigger a short covering rally in the pair. One scenario centers around the idea that the ECB could lend money to the IMF which in turn would use funds to prop up the struggling European credit markets and ease some of the financing problems for Southern European economies.
Although for now this idea remains pure speculation, if out into place the IMF/ECB deal would be able to sidestep many of the structural impediments that have prevented the EZ authorities from acting more assertively so far as the credit crisis continues to spin out of control. Most importantly such a deal would avoid the political risk of trying to amend the EU treaty which would not only prove problematic but may also take a considerable amount of time. The IMF structure would also provide the necessary discipline to affect fiscal reforms in the problem nations and will most likely prove politically palatable to the German populace. In short this was the first credible plan that the market has seen and if it gathers momentum this week then the EUR/USD could trade higher.
One other fact that could help the euro is the disarray on the other side of the Atlantic. In US the super committee in Congress tasked with making $1.2 Trillion cuts in the Federal budget remains at an impasse with neither Republicans nor Democrats willing to make any meaningful compromises on policy. The net result is that US is once again running into is debt ceiling limits without any serious plans to reform the budget. This political acrimony could hurt investor confidence out into question the dollar's status as a safe haven currency. The EUR/USD therefore could benefit by default as markets suddenly realize that Europe is not the only region facing a serious debt crisis.
The writer is Director of Research, GFT. Opinion expressed here is his own and do not reflect the views of Gulf News.
