The outlook is mixed for the Dollar after a 4 week rally and a sharp correction over the past few days. On Friday the Dollar closed out at 1.2565 against the Euro and 1.4457 against the Pound. There is a view that the Dollar’s rebound has been overly reliant on its role as a safe haven and not on strong economic fundamentals. The worse than expected jobless figures last week reiterated this point of view although this did come after a string of improving economic figures over the preceding weeks. However, even if this were true it is unlikely that the risky situation in Europe will stabilize overnight and Equity markets are unwinding at a dizzying rate. The lows from which the S&P 500 rebounded on Friday were lower than the lows made on ‘Fat-Finger’ Thursday and this downward momentum does not bode well on the intermediate timeframe, so potentially there may continue to be demand for the Dollar safe play.

   The Euro continued to rise as some of the immediate concerns over Euro zone default eased. During Friday’s trading the Euro closed up at 1.2565 against the Dollar and 0.8688 against the Pound. The news that the German parliament had unanimously approved its 147.5 billion portion of the 750 billion Euro EU bailout package helped to give the package credibility and confidence began to return. The SNB intervention last week which helped the Euro in the Swiss Franc pair and talk of other central banks including the ECB, the Fed and the BOJ all preparing for intervention if the need arose also helped bolster the Euro. Further news of Spain’s intention to impose a pay cut on civil servants a gave the impression that some of the hardest hit peripheral countries are making good on their promises, but this was tempered slightly by the announcement of intended strikes by Spanish unions, and some analysts fear that anger might spill over into popular unrest as happened in Greece. There are other signs too that not is all well in Europe as it was also announced by Germany that they are calling for discussions on orderly insolvencies and the news earlier in the week of a ban on naked short selling of 10 top German financial institutions and Euro bonds. Also, economic data reported a decline in business confidence and the Euro zone PMI composite dropped faster than expected.

   After being downgraded by S&P on Thursday to ‘negative’, figures released in the UK on Friday were interpreted as marginally more positive by most analysts. The Pound ended up against the Dollar at 1.4457 and up against the Yen at 130.11. Public sector net borrowing was down to 10bn from an expected 10.9bn in April but nevertheless posted a record high for the month, so whilst bad the data was not as bad as had been expected. Tax revenue increased encouragingly, including income tax receipts, and social security expenditure also reduced which showed the economy might be starting to get back on its feet. Total borrowing for the year through March was down from 163.4bn to 156bn. These figures showed a slightly more positive outlook for the UK, where higher that expected debts had been expected from the last government as rumours of profligate spending in the weeks running up to the election have emerged. The metric M4 Money Supply, which measures the amount of money flowing in the economy and is often seen bell weather for the success of quantitative easing stalled in April and made no increase but whether this is a significant sign of contraction in the economy remains to be seen – YoY it has fallen from estimates of 3.8% to 3.3% which is quite high and another reason why QE has not been completely ruled out by the BOE. Whilst there were some encouraging glimmers of hope the UK is not out of the rough yet.

   Yen crosses rebounded in overnight trading making up some of Thursday’s loses. US Dollar Yen closed at 89.99 and Euro-Yen at 113.09. The Yen opened strongly but gave back early gains as the day progressed. In a statement, Japanese finance minister Naota Kan said excessive strengthening of the Japanese currency wasn’t desirable and this gave some investors the impression that the Japanese might intervene if the Yen continued to strengthen overly. Towards the end of the session the Yen weakened further against most currencies as risks associated with the European Sovereign debt crisis were seen to have been a little exaggerated in the short term and risk appetite returned.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst