Euro/Dollar update

Over the past couple of weeks the foreign exchange market has been hit by various news items that could change the foreign exchange scenario in the months ahead. In the Euro area, investor attention has focused on the negative Greek national accounts figures, which triggered a downgrade by Fitch from A- to BBB +, and, although to a lesser extent, on Spain, which saw its outlook revised down from stable to negative by Standard & Poor's, a move that follows the January downgrade from AAA to AA+ by the rating agency.

Nevertheless, Greece’s market environment is very different from that of Spain. On the one hand, Greece, which is plagued by a severe credibility crisis due to the lack of a clear plan to slash the high public deficit and upset by growing internal tensions, could pull itself out of recession only with the support of the European Union and by paying a high price in terms of unemployment and economic growth for several years. On the other hand, Spain, one of the hardest-hit countries over the past two years, should not see its credibility undermined going forward, although economic growth is expected to remain more sluggish than that of the EU due to the need to revamp its economic model based on the real estate market and to the loss of competitiveness in recent years. Therefore, last week’s fall of the euro against the U.S. dollar - the single currency slipped below the 1.47 mark from the 1.51 level touched a week earlier - wasn’t totally unexpected. Investors were even surprised at the euro’s slight decrease against the US dollar, as clear evidence that the problems facing Greece are not a real threat to the Eurozone economy. Indeed, the country’s GDP accounts for only just over 2% of the Euro area GDP.

The troubles affecting the Greek economy, therefore, may only confirm that the economic upturn in the Euro area will likely be slower than estimated by the data released in the past few weeks. Germany’s industrial production and factory orders for October showed that the economic recovery may decelerate in the coming months as the positive effect of the fiscal stimulus that has supported the central part of 2009 wanes. The idea that the Fed and not the ECB will be the first central bank to raise interest rates during 2010, even though the ECB is in the early stages of an exit strategy (decided in the December meeting) might therefore take concrete shape among operators

The above-mentioned view had already started to circulate among operators last Friday after the publication of the U.S. labour market report for November, which showed that non-farm payrolls were almost flat (compared to consensus expectations of a loss exceeding 100 thousand units) and the hours worked per week increased. Furthermore, the Euro/Dollar exchange rate should also bear the brunt of its overvaluation against the PPP calculated by the OECD (approximately 30%), which was usually been accompanied by a price realignment. Overall, the US Dollar seems highly likely to begin to stage a gradual rebound against the Euro. In the face of fresh turmoil in world financial markets leading to higher risk premiums, the dollar would retain its safe haven role.