Range-Bound Euro
Investors remain caught in two minds heading into Thursday’s EU Summit which has trapped the euro in a very tight range around 1.25, while implied-volatility continues to drop. We continue to see scope for disappointment however, with few chances of major policy breakthroughs, given the political hurdles. Yesterday’s publication of European Council President Van Rompuy’s “vision for the EMU” contained no surprises, and highlighted the importance of a financial and a fiscal union with “greater pooling of decision making on budgets, commensurate with the pooling of risks”. However, as expected, details on how these plans could be implemented were conspicuously absent. EU officials stated that further work “to develop a specific and time-bound road map” may come in a report in December, with an interim report due in October. So, for this week, we would expect an agreement only on a broad framework based on the Commission’s proposals, with details hopefully emerging by the next Summit in the autumn. German Chancellor Angela Merkel already expressed her reservations to the proposals, reportedly saying that they have the wrong balance of shared liability and control. Sentiment was certainly not helped by Egan-Jones, which downgraded Germany’s sovereign rating to A+ from AA- (negative outlook) on Tuesday, widening the gap with the major ratings agencies. Though the EURUSD reaction was rather muted, the downgrade will likely magnify fears of further ratings actions in the Eurozone and reinforce Germany’s opposition to any notion of shared liability. In this context, the difficulties involved in finding common ground acceptable to both the creditor and debtor nations of the Eurozone are aplenty, reaffirming the prospect of a lengthy and arduous period of negotiations that will likely keep investors on edge. Against this backdrop, we stick to our 3m and 12m EURUSD forecasts of 1.20 and 1.15, respectively. On Wednesday, data flow was thin, UK CBI June distributive trades survey jumps to +42, from +21, vs expectations of +10. UK economics notes that this is a big move up, but is because of the Queen’s jubilee and is unlikely to be sustained. Ahead today, durable goods orders are due in the US while Merkel and Hollande will hold a pre-summit meeting.
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