Weekly Review and Outlook: Euro and Sterling Sold off on European Debt Crisis, Dollar Rebounded

By: Milla Shaw in Forex Consultant on Dec. 16, 2010

European debt crisis remained a major theme last week as Euro and Sterling were under much pressure. Indeed, both were sold off sharply after Moody’s downgrades Ireland’s rating sharply by 5-notches from Aa2 to Baa1. Euro and Sterling both made new record low against Swissy and Aussie during the week. On the other hand, dollar jumped, except versus Aussie and swissy, after US president Obama finally signed in law the $858b bill for extending tax cuts for another two years. Rally in longer term treasury yields also helped the greenback but such boost faded towards the end of the week as yield lost steam and dragged USD/JPY back into range after a breakout attempt.

Moody’s downgrades Ireland’s rating sharply by 5-notches from Aa2 to Baa1 on Friday. Moody’s said that “the Irish government’s financial strength could decline further if economic growth were to be weaker than currently projected or the cost of stabilizing the banking system turn out to be higher than currently forecast.” Outlook for rating is also assigned as “negative”. Earlier in the week, Moody’s also warned that it may downgrade credit ratings of Spain and Greece. The EU summit in Brussels ended with financial leaders agreeing to amend the Treaty to create a permanent debt-crisis mechanism in 2013. The boost to the euro and growth assets will be limited as the meeting lack measures to solve problems in the near-term.

While the broad based weakness in Euro was apparent, the situation in Sterling was even worse. BoE pointed out in the financial stability report that the UK economy is still in danger due to the ongoing financial crisis in the eurozone. There are direct exposures in Greece, Portugal and Ireland and an even larger exposure in France and Germany. UK bank shares was sharply off after Lloyds Banking Group shocked the markets by announcing a sharp rise in its likely losses in Ireland. The Bank of England and the European Central Bank Friday announced a temporary liquidity swap facility via which the BOE could provide up to GBP 10 billion to the ECB in exchange for euros, valid through September 2011. The central banks said in a statement that “the agreement allows pounds sterling to be made available to the Central Bank of Ireland as a precautionary measure, for the purpose of meeting any temporary liquidity needs of the banking system in that currency.”

The December FOMC meeting contained few surprises. Despite modest change in the language used, the message was the same as the November one. There were slight upward revisions to the economic outlook while inflation was describing as downward trending. The committee decided to leave the Fed funds rate unchanged at 0-0.25% and the asset-purchase program at $600B. Kansas City Fed President Thomas Hoenig was once again the only member voting against the policy. More in Fed Ended the Policy Year Silently

As expected the SNB left the 3-month LIBOR range at 0-0.75% as appreciation in Swiss franc has weakened the country’s export-led economic growth. Meanwhile, the central bank cut its inflation outlook for 2012 and 1H13 but raised the 2011 forecast modestly. Growth estimates stayed unchanged at +2.5% and +1.5% for 2010 and 2011 respectively. More in SNB Left Target Rate Unchanged To Curb Franc Appreciation.

Technical Highlights

Despite edging lower to 78.83 early last week, dollar index staged a strong rebound towards the end and broke tough 80.40 resistance. That was accompanied by a break of 1.3164 support in EUR/USD as well as 1.5484 support GBP/USD, which both have bearish implications. The development argues that dollar index’s pull back from 81.44 was over after drawing support from 55 days EMA. Also, with 77.97 support intact, dollar index’s rebound from 75.63 is possibly still in progress. Further rise will now remain in favor in dollar index as long as 78.83 support holds for a test on 81.44 resistance first. Break there will confirm rise resumption for 83.56 key resistance zone next.

EUR/CHF’s decline extended further to as low as 1.2719 last week and the break of 1.2765 low indicates that the larger down trend is resuming. Initial bias remains on the downside this week and deeper fall should be seen to 61.8% projection of 1.5138 to 1.2765 from 1.3833 at 1.2366 next. On the upside, above 1.2868 minor resistance will turn intraday bias neutral and bring consolidations. But outlook will remain bearish as long as 1.3204 resistance holds.

In the bigger picture, whole down trend from 1.6287 (2007 high) should be resuming. In any case, medium term outlook will remain bearish as long as 1.3833 resistance holds. The current down trend would likely continue through 1.2 psychological level towards 100% projection of 1.5138 to 1.2765 from 1.3833 at 1.1460, which is close to long term projection level at 1.1516.

In the long term picture, fall from 1.6827 should be resuming whole down trend from 1993 high of 1.8234. Sustained trading below 1.3 psychological level will send the cross further lower to 138.2% projection of 1.8234 to 1.4391 from 1.6827 at 1.1516.