Eurozone Hopes Soften Dollar

The dollar continues to trade on the back foot on hopes that eurozone policy makers are moving closer to a solution that will shore up confidence in the region. Developments in Italy over the weekend added to the positive news stream after Italy’s cabinet adopted a package of tax hikes and pension reforms worth 30 billion euros (20 billion euros of structural measures and 10 billion euros of proposals to stimulate growth) to resolve the nation’s debt crisis and to balance the budget by 2013.

What’s more, talk of the European Central Bank lending to the International Monetary Fund for further eurozone support continues to make rounds after a German official suggested they are working on a proposal.

Against this backdrop global stocks have started the week on a positive note, with both Asian and European shares posting modest gains. Eurozone bank shares are up over 2%.

Today, many are keen to monitor the ECB announcement of last week’s bond purchasing after recently failing to fully sterilize the prior week’s purchases. On the data front, final November EZ services purchasing managers index numbers were revised slightly down, while October retail sales came in slightly better than expected, as did the U.K. November Markit-CIPS services PMI.

This week all eyes will be on Europe as the ECB and eurozone leaders hold important meetings. Ahead of these meetings, we continue to expect the euro and other growth-sensitive currencies to remain supported amid the ongoing short covering rally.

Overall, we expect the summit will provide important guidance about the progress toward fiscal integration, which is likely to pave the way for further ECB involvement. Today, we expect the meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy to provide guidance on the proposals that will be outlined at the summit later in the week.

We are looking for signs that the leaders are moving forward in forging a consensus in regards to a strong fiscal union, which is likely to entail a loss of national sovereignty to a supranational regional authority that would monitor budgetary matters. The short-covering rally should continue in the near term as headlines from the meetings will remain supportive, but moving forward the euro is likely to come under renewed pressure as its interest rate advantage is eroded by a more dovish approach by the ECB.

Data and official commentary overnight confirm that the slowdown in the Chinese economy is gaining pace and that the government has moved into a defensive stance (namely "fine-tuning").