Investors Respond to EU Summit

The European Union (EU) came very close to a consensus on how to build a framework for a fiscal union and the news helped to boost currencies against …

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The European Union (EU) came very close to a consensus on how to build a framework for a fiscal union and the news helped to boost currencies against the U.S. dollar, despite holdouts in the United Kingdom and the Czech Republic as well as growing uncertainty about the future of Greece. Even so, the U.S. currency outlook is positive based on hopes of more economic growth, which is also expected to buoy Canadian and Mexican currencies. For more on this continue reading the following article from TheStreet.

The dollar is heading lower as Asian and European equity markets rallied in response to the relatively constructive outcome from the European Union summit, along with month-end flow rebalancing. The EuroStoxx 600 is nearly 1% higher as a result, with banks up 1.3%.

The euro looks set to begin the North American session just shy of 1.320. Support appears to be building in the area of 1.3077 to 1.3080, with resistance expected near 1.324. The antipodeans are among the best-performing major currencies against the dollar, with the Australian dollar paring Monday’s losses and now trading around 1.066.

Belgium raised a lower amount than expected and saw its borrowing costs rise at this morning’s bill auction. Meanwhile, over the past two days four countries (Japan, Germany, France and the U.S.) have reported weaker-than-expected consumption figures, highlighting the challenge of sustaining aggregate demand amid the ongoing deleveraging cycle and the regional push for austerity.

The first European Summit of the year ended with a shroud of uncertainty hanging over Greece. Officials are sounding an optimistic note that an agreement will be struck before the end of the week, but an agreement will simply shift the focus from the terms to the participation rate and the recognition that even a haircut of some 70% on a net present value basis is insufficient to put Greece’s debt n a sustainable path. All EU members, save the UK and the Czech Republic agreed in principle on four key elements that form the basis of the scaffolding of what will eventually be a fiscal union.

First is a debt brake, enshrining a balanced budget (0.5% structural deficit maximum) with automatic corrective measures to kick-in on violation.

Second, if the brake law is too soft, the European Court of Justice can impose a 0.1% of GDP fine.

Third, the burden is shifted. Sanctions will be imposed on violators unless a qualified majority over-rules as opposed to now when sanctions are only imposed if a qualified majority agrees (hence in practice no sanctions).

Fourth, countries agree to include collective action clauses into new bonds as of Jan. 1, 2013, earlier than previously discussed. The issue now goes to the individual countries for approval with the caveat being approval is necessary to secure aid. This is likely the case for Ireland and an approval in France may be controversial as well amid the ongoing election cycle.

The North American session is likely to be driven by marco data with the market impulse coming from Chicago PMI and to a lesser degree Canadian GDP. Overall, the Chicago PMI should support a firm outlook for the US economy, with the consensus expecting it to rise to 63.0 in January from 62.2 in December. The previous breakdowns have been supportive of moderate economic activity.

The key to watch will be the forward-looking new orders component, which showed a moderate deceleration from November to December. The trend in employment is likely to be supported by seasonal job growth, while the outcome is likely be consistent with a resilient pace of job growth.

U.S. data in line with expectations is likely to be supportive of risk appetite in general and currencies that are linked to U.S. growth in particular. This includes the CAD and MXN but would also likely be supportive of the other dollar bloc currencies.

The central bank of Colombia surprised the markets yesterday with a 25 basis point hike to 5.00% – only one out of 32 forecasters expected the result. The decision was premised on elevated "international prices," historically high Q3 growth numbers, and continued inflation pressures. We suspect that the hike implicitly means that the central bank stands ready to act in order to prevent the COP from appreciating too fast.

The peso is up over 6.5% this year against the dollar, one of the top performing emerging markets currencies.

In Taiwan, the economy has entered into a technical recession after contracting 0.25% quarter over quarter and growing just 1.90% year over year in Q4, far less than the 2.8% expected. The slowdown was particularly acute in manufacturing and construction sectors, with foreign trade softer.

Our relatively benign view of the slowdown in China moderates the downside risks we see for the Taiwanese economy. The TWD is up around 2.5% against the dollar this year, an average performance compared with its regional peers.

We have no great expectations or see any big risks for Taiwan at the moment and expect the currency to continue performing in the middle of the pack for now.

This article was republished with permission from TheStreet.

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