Euro Fundamentals Point To Further Weakness, Sterling Maintains Range

Euro: Record Deposits At E.C.B, Further Easing Ahead

The Euro maintained the narrow range from the previous week amid the drop in market participation, but the single currency remains poised to weaken further over the near-term as the fundamental outlook for the region deteriorates. Indeed, commercial banks in Europe parked a record EUR 411B with the European Central Bank overnight, and the ongoing turmoil in the financial system may prompt the Governing Council to ease monetary policy further as the economy faces an increased risk of a major economic downturn in 2012.

In response, German Finance Minister Wolfgang Schaeuble argued that it’s imperative for the EU to stem the risk for contagion, but it seems as though the governments operating under the monetary union are becoming increasingly reliant on monetary support as the EU struggles to restore investor confidence. According to Credit Suisse overnight index swaps, market participants are pricing a 25% chance for a 25bp rate cut at the next policy meeting on January 12, and we may see ECB President Mario Draghi continue to target the benchmark interest rate in 2012 as the Governing Council moves away from its nonstandard measures. In turn, expectations for lower borrowing costs should dampen the appeal of the single currency, and we expect the EUR/USD to resume the downward trend from the end of October as European policy makers struggle to calm market fears. As the EUR/USD fails to push back above the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3100, we may see the exchange rate give back the rebound from January (1.2872), which could expose the 23.6% Fib around 1.2630-50.

British Pound: To Consolidate Further Amid Expectations For More Q.E

The British Pound pared the overnight advance to 1.5699 and the sterling may continue to lose ground during the North American trade as market sentiment deteriorates. As the European debt crisis drags on Britain, Bank of England Governor Mervyn King has certainly become increasingly cautious towards the region, and the central bank head is likely to take additional steps to shield the U.K. economy as it faces an increased risk of a double-dip recession. As the BoE keeps the benchmark interest rate at the record-low, we are likely to see the MPC expand its asset purchase program beyond the GBP 275B target, but we may see market participants treat the sterling as a safe haven in 2012 as the U.K. government remains ahead of the curve in addressing its budget deficit. As the GBP/USD continues to trade within the broad range carried over from the previous month, we should see the pound-dollar continue to consolidate over the remainder of the year, but the sterling may come under increased pressure should we see trader sentiment weaken further.

U.S. Dollar: Index Maintains Narrow Range, Risk Aversion Sets In

U.S. dollar price action was largely mixed on Tuesday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) maintaining the narrow range from the previous week, but we should see the greenback regain its footing during the North American trade as the U.S. equity market opens lower. As risk appetite falters, the shift in market sentiment should prop up the reserve currency, and the greenback may appreciate ahead of the New Year as there appears to be a flight to safety. However, as we’re anticipating to see positive developments coming out of the world’s largest economy, a slew of better-than-expected data could spark a rebound in trader sentiment, and the greenback may struggle to hold its ground should we see a rise in risk-taking behavior. 

Prepared by Zeshan Muhammad Ali Awan