The euro's rebound could continue into next week as fears about Europe's bank and debt woes ease, and as technical momentum stays positive after the currency climbed to a two-month high against the US dollar. Greater clarity on the European bank stress tests, strong economic data out of the euro zone, along with growing worries about a US recovery have pushed the euro up more than 6 percent since it hit a four-year low of $1.1875 in early June.
While analysts reckon the impact of the debt crisis on the euro zone's financial system and the economy will remain evident for a long time, they said much of the bad news had been priced in during the euro's rapid fall earlier this year. "At this stage, you probably need some downside surprises to put renewed downward pressure on the euro," said Robert Lynch, currency strategist at HSBC in New York. "There are still prospects for a further recovery. Keeping in mind of course that the currency pair has already come up five cents in a week, which is not small," he added.
Mikkel Thorup, chief investment officer of Capricorn, a Switzerland-based currency management firm which oversees about $260 million, said given the euro's recent sharp move, a correction back to $1.25 may be in order over the next day or two before it moves another leg higher. "Market sentiment has definitely improved a bit. Maybe we can try to reach $1.30" over the coming weeks, he said.
On Friday, the euro hit a two-month high of $1.2722, according to Reuters data, and was last at $1.2646, down 0.4 percent as investors booked profits before the weekend. The euro has risen 0.7 percent against the dollar this week at current prices and gained 3.4 percent so far this month.
STRESS TESTS Investors are awaiting the results of European bank stress tests, which are scheduled to be released on July 23. "Indications are that the stress tests may be more credible and meaningful than initially feared, and yield some constructive results," said UBS strategist Beat Siegenthaler. "If that was the case, the euro may continue to climb higher and risk could benefit globally, at least in the short term."
Euro zone finance ministers are expected to discuss next week the policy response countries will take if the tests show problems, an EU source said. One-month euro/dollar risk reversal was last at -1.45, well off extreme levels in early June, though still showing a bias to euro puts and dollar calls. It implies more investors are betting the currency will fall than rise, but short-term bearishness has decreased.
Some analysts said that the euro's recent rally is nothing more than a short-term bounce, pointing to the wide gap between 1-month and 1-year risk reversals in the euro/dollar, which indicates traders are still willing to pay a higher premium to buy the right to sell the euro in coming months. As long as the euro/dollar holds above $1.2600, the market will remain "technically bid," strategists at BNP Paribas said. A break of $1.2720 opens potential to $1.3120, they added.
US, CHINA DATA Investors will also scrutinise key economic data out of the United States and China next week for clues about the outlook for the global recovery. Recent US data showing slowing growth in the services and manufacturing sector, weakness in housing and a stagnating jobs market has worried investors, although most economists say it is too early to call a "double-dip" recession.
US economic indicators due out next week includes retail sales, Empire State manufacturing activity, producer and consumer inflation, net capital flows, and consumer sentiment. The minutes from the Federal Reserve's last meeting will also be released.
If US data is consistent with the idea growth is going to be more moderate, "then that might be something that proves less helpful to the dollar than more," said HSBC's Lynch. In China, second-quarter gross domestic product data is scheduled for Thursday, with all 32 economists polled by Reuters predicting a moderation in China's year-on-year growth rate, though the expansion rate could still be in the double digits. June exports and imports figures are due out Saturday. See preview.
Despite expectations for a slower growth from China, Capricorn's Thorup said he likes the Australian dollar. The Aussie rallied 4.1 percent versus the greenback this week, the biggest weekly rise since May, 2009. "As long as markets are willing to put on just a bit of risk, then the Aussie versus the US dollar is a good play both for the carry and for currency appreciation," he said.
Investors also will closely watch the dollar/yuan exchange rate after the largest US labour group urged Congress on Friday to pass legislation to fight China's currency practices, a day after the Obama administration again declined to label Beijing a currency manipulator.
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