EUR: Rating Agencies Cause Trouble For Euro

It was a relatively quiet day in the foreign exchange market with the EUR/USD fluctuating within a 50 pip trading range up until Moody’s dropped the bomb by cutting Portugal’s sovereign debt rating to junk. The announcement caught the market by surprise because everyone has been focused on Greece but having been criticized for being too lenient during the financial crisis, rating agencies are now overly ambitious in fear of falling into the same trap. Unfortunately this has been at the expense of the euro and near term financial market stability. In the hour following Moody’s announcement, the EUR/USD plunged 100 pips. Rating agencies are yielding unusual power on investor sentiment and for the past 24 hours, their cautiousness and concern has translated into a lack of desire to own euros. In the case of Portugal, Moody’s felt that the country was facing “formidable challenges in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.” These troubles could make it difficult for the country to borrow at sustainable rates and to stay solvent.  Throughout the European sovereign debt crisis, downgrades by rating agencies have had a diminishing impact on the EUR/USD, but Moody’s stepped in front of its rivals today by downgrading Portugal’s debt rating to Ba2, two notches below Standard & Poor’s and Fitch’s rating. Portugal is still considered a safer place to invest than Greece, because the risk of default is lower, the action by Moody’s reminded everyone that Greece is not the only troubled spot in the Eurozone.

However with that in mind, rating agencies have also been hard on Greece. Standard & Poor’s said this weekend that the bond rollover proposal put forward by France last week would qualify as a selected default because the new 30 year Greek sovereign bond is “worth less than the promised value of the original securities.” This morning, Moody’s warned that debt rollover may force banks to take impairment charges which would erode the value of their debt. Although Moody’s stopped short of saying that this constitutes a selective default, it is clear that rating agencies do not support the current financing plan for Greece and will need a lot more convincing to do so. Unfortunately for the euro and the financial market, Greece is still at risk of default. The ECB and EU have other ways to help Greece if a default was to occur but psychologically even a selective default could cause uproar in the financial markets. The ECB is gearing up for a rate hike this week but Greek troubles restrained investors from buying euros aggressively. Whether the euro gains some legs ahead of the ECB rate decision on Thursday will depend upon additional comments from rating agencies. If we don’t hear anything new from S&P, Moody’s or Fitch, the EUR/USD could begin to trickle higher but if any of these 3 rating agencies continue to express open concern about Greece and the rollover plan that is supported by France and Germany, the EUR/USD could retreat further. As for the ECB, disappointing economic reports could put the central bank on hold after this week’s rate hike. Retail sales fell 1.1 percent in May while service sector activity increased less than the market had expected. Wednesday’s German factory orders report is expected to show additional weakness in the manufacturing sector but that will not stop the ECB from raising rates on Thursday. As recently as this morning, Trichet reminded us that price stability is their number one priority. Although this may be true, the central bank cannot ignore the fact that growth is slowing which could delay additional tightening.

USD: WATCH THE LEADING INDICATORS FOR NFP

The U.S. dollar traded higher against all of the major currencies with the exception of the Swiss Franc which indicates that investors remain nervous, particularly about the situation in Europe. Factory orders was the only piece of U.S. economic data released this morning and the smaller rise in orders was offset by an upward revision to the prior month’s report.  Last week’s ISM report showed manufacturing activity holding up better than most had expected and this explains the lack of concern for the mixed factory orders report. For the U.S., the action heats up tomorrow with non-manufacturing ISM and the Challenger job cuts reports scheduled for release. The last non-farm payrolls number was abysmal and traders will be looking to these two pieces of data for clues on whether the weakness was repeated for a second month. Unfortunately expectations are not very high partly due to the increase in jobless claims last month. The volatility in the financial markets and the slower pace of recovery experienced in many parts of the world gives economists very little reason to expect a strong rebound in job growth. Non-farm payrolls are expected to have increased by 100k in June, more than double the prior month’s report of 54k but well below the 6 month average of 155k. If the employment component of service sector ISM declines, investors will start to price in the possibility of a weak NFP report. If it rises, we could see a nice bump up in expectations. The U.S. is a service based economy which is why the employment component of this report has such a strong correlation with non-farm payrolls. It is not perfect however because in May, the employment subcomponent increased, signaling stronger job growth but as we all now know, job growth slowed materially that month. Nonetheless in the long run, the correlation is strong and so we will be watching the data closely.

GBP: SERVICE SECTOR ACTIVITY IMPROVES NOMINALLY

With a “selective default” looming over the Eurozone, the market is seeking the safety of the US dollar driving the British pound lower versus the greenback while giving the sterling a boost over the euro.  Service sector activity was actually better than expected, rising from 53.8 to 53.9. The bump up was nominal but it is still better than a contraction. Austerity measures have crimped economic activity and prevented a significant increase in hiring, providing a challenge for U.K. consumers as well as the central bank. According to Chris Williamson, chief economist at Markit, who conducted the survey: “Companies kept headcounts largely unchanged, highlighting a reluctance to expand workforces as a result of the uncertain outlook and renewed weakness of the manufacturing and household sectors. Meanwhile, cost pressures remained elevated as higher food, utility and wages pushed input prices higher. With an increase in costs, service providers responded by raising their charges to the consumers. Nevertheless, the competitive pressure kept the rate of inflation in check. On the consumer front, two-thirds of people said they cut back on spending recently, while 52 percent have less hope for the future, according to a survey in the News of the World on July 3. The lackluster growth in UK economy will be one of the main concerns for the BoE in its rate decision on Thursday. All 51 economists in a Bloomberg News survey forecast it will keep the key interest rate at a record-low of 0.5 percent on July 7. As the market awaits the rate decision, the British Retail Consortium will release its price index tonight, which is a measure of inflation.

NZD: HIT BY LOWER DAIRY AUCTION PRICES

The Australian, New Zealand and Canadian dollars fell sharply against the greenback despite a 2 percent rise in oil prices. Talk of a Chinese rate hike and the RBA’s concerns about growth weighed on sentiment. The New Zealand dollar dropped the most after a dairy auction showed prices declining. According to the global Dairy Trade auction website, the GDT-TWI Price Index fell 6.7 percent. As one of New Zealand’s most import exports, a lower price for dairy means lower profitability and lower inflationary pressures – which is a lose-lose for the New Zealand dollar. Aside from renewed concerns about a Greek default, high yielding currencies are also trading lower as investors worry about the possibility of another rate hike from China. Even though the latest economic reports show manufacturing and service sector activity slowing, the People’s Bank of China is still on inflation watch. On Monday, the PBoC said inflationary pressures “are still very high,” leading two local papers to interpret this to mean that a rate hike is imminent. In recent months, we have seen a muted reaction to interest rate and reserve requirement ratio hikes by the PBoC because on an absolute basis, China is still importing significantly from their trade partners. However that has never stopped investors from being nervous about the possibility of slower growth in China and weaker demand particularly before rates are increased when European sovereign debt problems are still weighing on sentiment. Meanwhile as reported by our colleague Boris Schlossberg, the “the RBA communiqué issued was an essential repeat of the past several months, however its qualification that,” Growth through 2011 is now unlikely to be as strong as earlier forecast,” lent the statement a slightly dovish cast and sent Aussie tumbling through the 1.0700 barrier. The RBA statement suggests that the Australian central bank may be preparing to lower its 2011 GDP and CPI estimates as slowdown in global growth persists.”

JPY: NEW BUDGET PACKAGE

The Japanese yen weakened against all of the major currencies with the exception of the euro and New Zealand dollar. Japan’s reconstruction minister Ryu Matsumoto resigned a week into his job after publicly scolding the governor of a tsunami-stricken region. This served as another blow to Prime Minister Naoto Kan’s already weak government. He rebuked the governor for arriving late to a meeting, and then said that unless there was a consensus in the prefecture for a reconstruction plan, “we won’t do anything.” His remarks and resignation may complicate Kan’s plan of passing three bills before carrying out on his word to step down. Kan said last week he wants parliament to approve his second disaster aid package, authorize the sale of deficit-covering bonds and enact a renewable energy bill before the end of August. Kan today proposed a 2-trillion ($25 billion) extra budget, spending that would fall short of what is needed to rebuild after a record earthquake and the worst nuclear accident in more than 20 years.    Kan scaled back his package due to rising calls from ruling and opposition parties for him to step down. The political outlook is increasingly uncertain and we don’t know how and when someone will replace Kan and when the third extra budget will be passed. Kan’s approval rating plummeted to 19 percent from 24 percent last month, the Mainichi newspaper reported yesterday. Nearly 44 percent of respondents said that he should resign immediately and 27 percent want him out by next month. Japan’s 30-year bonds dropped for a fifth day on speculation the nation’s improving economy will curtail demand at a 700 billion yen ($8.63 billion) auction of the securities this week. Benchmark 10-year yields climbed to a two-month high after a government report showed wages unexpectedly increased in May. Wages including overtime and bonuses increased 1.1 percent from a year prior, the Labor Ministry said today in Tokyo. Lombard Odier Darier Hentsch & Cie., Geneva’s oldest private bank, plans to double the wealth it manages in Japan to 200 billion yen ($2.5 billion) in five years through tie-ups, underscoring their confidence in Japan’s economic recovery. Additionally, Japanese stocks advanced for a sixth day, keeping alive the longest winning streak for the Nikkei since the country’s March natural disasters. On the docket tonight is Japan’s leading indicators. It is a compilation of indicators and if it prints better than forecast at 99.9% it will confirm continued strength in Japan’s economic recovery.

NZD/USD: Currency in Play for Next 24 Hours

The NZD/USD will be our currency pair for the next 24 hours. Economic data scheduled for release from the United States is MBA mortgage applications for July and challenger job cuts for June at 7:00 AM ET / 11:00 GMT and 7:30 AM ET / 11:30 GMT, respectively. Also from the U.S. is ISM non-manufacturing composite index at 10:00 AM ET / 14:00 GMT. From New Zealand, we expect gross domestic product numbers for the first quarter.

The New Zealand dollar has gained 8.2 percent in the past three months against the greenback, the second-best performing G-10 currency after the Swiss franc. Recently it has been flirting with new record highs and has set a series of highs in the past three months. It is currently trading in an uptrend, which we determine using Bollinger bands. The nearest support is at the 10-day moving average of 0.8200. Should the pair fall below this level, significant support cuold be provided at 0.8100, the point right above the lower first standard deviation Bollinger band, and a price of contention recently. On the upside, first resistance will be encountered at the record high of 0.8329. If the pair breaks out of this price, significant resistance will be at the psychologically significant level of 0.8500.

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