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Forex markets: Dollar and yen the only safe havens against the euro area crisis

 Anticipation ahead of the ECB meeting…..     

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USD (NEER) – Once again this week risk aversion mounted further, fully to the dollar’s benefit, on the back of both (i) the euro area crisis (ii), and disappointing economic data releases in the United States. The dollar should continue to be considered as a safe haven in the short term, at least until uncertainty tied to the euro area crisis lingers.

EUR – The euro depreciated further, breaching 1.25 on the downside and stopping in the EUR/USD 1.22 area. In addition to worries tied to Greece, concerns have mounted over the resilience of the Spanish banking system: specifically, focus is on the awaited proposal for the recapitalisation of Bankia. The outcome of the ECB meeting on Wednesday will be crucial. In the absence of new initiatives or declarations of openness to directly tackle the recent developments of the crisis, the exchange rate could weaken further. The key support before EUR/USD 1.2000 is 1.2150. Downside, barring “serious” developments, should be contained within the EUR/USD 1.18 mark, i.e. the low hit at the height of the Greek crisis in June 2010. On the other hand, if the ECB opts to cut interest rates, the immediate reaction could be a drop, followed however by a potential rebound, as a token of “confidence” in the active role taken on by the central bank, also aided by the impressive size of short euro exposure on the market.

GBP – Sterling also depreciated, from GBP/USD 1.57 to 1.52, both as a result of the strong positive correlation with the EUR/USD, and of some disappointing domestic data: the May manufacturing PMI plunged from 50.2 to 45.9. There is also some anticipation ahead of the Bank of England meeting on Thursday, not so much in terms of rates, which are again expected to stay put at 0.50%, as for a potential expansion of the APF, in light of the recent worsening of the situation in the euro area. We continue not to expect changes in terms of the APF, in line with consensus estimates (which, however, are not unanimous). A no-action decision should not affect the pound. If on the other hand the central bank decides to step up the APF, sterling could weaken further, both against the dollar (to between GBP/USD 1.52 and 1.50) and the euro (to between EUR/GBP 0.81 and 0.82).

JPY – Like the dollar, the yen also benefited from mounting risk aversion, rising from USD/JPY 79 to 77. The BoJ may well decide to wait for market sentiment to stabilise before intervening to halt the yen’s ascent. Therefore, it could decide to hold out until the ECB meeting. In terms of levels, the latest intervention on 31 October took place when the exchange rate was at between USD/JPY 75 and 76.

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