Life Below 1.30 For EUR/USD

EUR/USD lost its grip on the 1.30 handle earlier this morning when China’s September PMI reading showed that the manufacturing sector in the Asian exporting powerhouse remained mired in contraction territory. Although the index stabilised around 47.8 (the August reading was 47.6) it is still too low to suggest that growth in China is finding a bottom.

Chinese PMI data has roughly followed the trajectory of European PMI data in recent months, so we don’t expect China’s economy to pick up substantially until we get clear evidence that the eurozone economic contraction has reached a bottom.

Europe ends a dreadful Q3
Europe’s own flash PMI readings for September were released this morning; there was some dismal data out of France, the manufacturing survey declined to 42.6, its lowest level since early 2009. Although Germany’s service Sector PMI reading rose to 50.6, back in expansion territory, it was not enough to help the overall eurozone readings. The overall eurozone composite index fell to 45.9 from 46.3 in August. This rounds off the worst quarter for growth in the eurozone since 2009. What is worse is that there is no sign that a bottom is in sight.

There is still a lot of de-leveraging that needs to take place in the currency bloc, including in core countries like France and the Netherlands, which could weigh on growth in these countries in the coming months. Added to this some of the peripheral countries look like they may miss fiscal targets for 2012, which adds pressure on them to boost fiscal austerity next year, which could keep a lid on growth for the long-term. Thus, the eurozone is starting to look like it has neither growth nor fiscal discipline, which is bad news for the euro.

Could more austerity rip the currency bloc apart?
Right now 1.2950 is acting as fairly good support. Below here 1.27 comes into view. We still tend to think that we will remain above 1.25 in this pair for the medium-term as the ECB is likely to step in and force Spain to accept a bailout (thus triggering its OMT programme) in the event of a bout of risk aversion and a sharp increase in credit risk and corresponding decline in the single currency. However, the prospect that countries like Spain may need even harsher austerity measures in 2013/ 2014 is a cause for concern as these countries may not accept more austerity.

We have already seen a wave of protests in Spain and Portugal of late and more austerity is unlikely to go down well. Thus, as we get towards the end of the year there is a real chance that the credibility of the eurozone will be up for debate as it becomes clear by how much some countries have missed their fiscal targets. This could hurt risk, and may cause a deeper decline in the single currency.

But for now Spain can sell debt. Its long-term debt auction today went off without a hitch. It sold more debt than it planned to and yields were lower. The yield Madrid paid to sell the 10-year was 5.66% versus 6.64% it had to pay at an auction at the start of August. But if Spain can easily sell debt does this make it less likely that it will apply for a sovereign bailout and thus will the ECB’s OMT programme remain in the wilderness? If yes, then a “good” result for a Spanish auction could end up being euro negative if investors feel that it makes the periphery less credit worthy in the long term as it delays the ECB taking its place as a lender of last resort.

Too busy watching the Olympics to boost the UK economy…
Elsewhere, the Olympics impacted the 0.3% decline in retail sales in August for the UK. Shoppers were watching the Olympics instead of going to the mall or buying online. In fact online sales were at their lowest level for over a year. CBI industrial trends data recovered to -8 this month from -21 in August, but this index is volatile and it still suggests that the industrial sector remains in the doldrums.

Watch out for US initial jobless claims at 1330 BST/ 0830 ET later today. If they are strong it could reduce the need for a prolonged period of QE3, which is dollar positive in our view. Right now, risky assets might baulk at the prospect that QE from the Fed will be taken off the table as the global economy remains so fragile, so watch out for some volatility later this afternoon.

One to Watch: AUD/USD
This pair has been particularly weak of late; it seems to have based around 1.0370 after falling sharply this week on the back of dovish RBA minutes and also weak Chinese PMI data. If we manage to get back to 1.0440/45 we expect this pair to be sold off once more and would look to establish a short position. 1.0440 is the top of the daily cloud, so below here this cross is no longer in a technical uptrend and it should be a tough resistance level.

We could see back to 1.0350 then to 1.0305 – key support levels. However, if we manage to sustain gains above 1.0450 then it suggests we could re-test the 1.0500 zone in the short-term and a short position would be null and void. For this to happen we would need to see a broad risk recovery, which we don’t believe will happen in the coming days and weeks, thus we believe there is a risk of further downside for this pair.

AUD/USD: Daily chart

Source: Forex.com

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