Euro weakens on stress test warning

The single European currency weakened toward its lowest level in two weeks after an official internal EU document was aired to the media and raised the possibility of a fresh wave of stress tests for regional banks. Dealers also shifted tack in trading the euro with onlookers focused less on the prospects ahead for inflation in light of the ECB's latest rate increase, choosing to look for warning signs that the economy is at risk of suffocating under a blanket of woes.

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Euro – The quarter-point increase out of the ECB this week was accompanied by a blunt warning from President Trichet that policy remained “accommodative” signaling more tightening s dead-ahead. With inflation already likely to have peaked and with the ECB predicting a return to beneath the 2% target ceiling the policy adjustment process is becoming less of a factor, while one good shock is all it might take to unsaddle already fragile European confidence that could derail the euro once more. Bloomberg news reports that it reviewed an internal EU document compiled this week that appears to warn that some banks may fail this year’s round of stress tests. Should that happen according to the report, banks must present a plan that would bring capital requirements back up to par. The report warns of the need for governments to intervene should this happen. At risk are regional banks stretching from Germany to Spain. The euro weakened in response to the report while peripheral government bond spreads continued their blow out against German bunds. At this stage it seems that inflation should hardly be the worry in the months ahead when so many other stresses simply haven’t died down. The euro last traded at $1.4244 and declined against the Japanese unit to ¥115.93.

U.S. Dollar – The dollar index remains underpinned by the occasional need for safety. The equity markets may have rallied this week but one senses that the rally might be fragile or at least vulnerable to the still ugly picture in Europe. The index rose ahead of the non-farm payroll report for June, which is expected to rebound from a 54,000 rise in May that marked the smallest addition to the labor market in eight months. The dollar basket was 0.5% higher at 75.31 before the report which is expected to show a gain of 105,000 new jobs leaving the rate of unemployment at 9.1%.

Canadian dollar – The local dollar remained close to its highest in two months after a strong employment report for June when employers added 28,400 new positions. However, most of those positions were added through part-time employment removing some of the sting to the report. The government added 50,500 workers to the public sector while private sector companies added 21,900 new workers. While it’s nice to see a better than expected reading for the nation, at the end of the day the report is a little more neutral than the headline gain suggests. The Canadian dollar rose to buy $1.0419 U.S. cents at best.

Aussie dollar – The Aussie remains close to its strongest in two weeks against the dollar and advanced for the second week against the yen. However, the unit is having a hard time shaking off the recent shift in sentiment that calls for lower rather than higher ground for monetary policy in the future. The Aussie earlier rose against the dollar but in the minutes before the U.S. employment report trades lower at $1.0765 U.S. cents.

British pound – A dip in the cost of goods leaving the factory gate to its lowest level in nine months hindered the pound on Friday as dealers continue to conclude that the Bank of England might have been wrong had it decided to start tightening monetary policy this year. The pound declined to $1.5950 following the release of June producer prices where the output data ell to a monthly increase of just 0.1%. On a year-on-year basis the core output price index was ahead by 3.2%. The pound remains within a half cent of breaking through its weakest reading against the dollar in two weeks.

Japanese yen – Evidence that the Japanese economy rebounded last month maintained some downside relief for the yen, which eased against the dollar to ¥81.43 building on a break of the dollar’s two-week high against the yen. An Economy watcher’s survey showed a rebound in respondents’ current assessment over the health of the economy by more than was forecast with the index jumping from a reading of 36 to 49.6. Meanwhile the index reflecting the outlook in the months ahead also shot higher from 44.9 to 49.0.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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