Euro Firms on Greek Debt Hopes…Again

The U.S. dollar was whipsawed by headlines about Greece’s debt negotiations with its EU/IMF/ECB lenders. Earlier this week, news that EU officials had postponed a decision until Monday sent the single currency to a three-week low against the greenback. Then yesterday, Greek officials said the finishing touches were being put on a deal that would be announced on Monday. The headline-driven trade has resulted in extremely choppy conditions over recent sessions. Going forward however, the dollar still appears poised to trend higher as America’s economic recovery outpaces its major G10 rivals, while uncertainty about the debt crisis and a looming recession in Europe should keep the single currency on the defensive.

Comments yesterday that suggested a deal to help Greece avoid a messy debt default was close lifted the single currency off of a three-week low against the U.S. dollar. Indeed, any agreement that would lower the probability of Athens missing its next debt payments in March would likely result in additional near-term gains for the euro. However, private sector bond holders must still agree to substantial haircuts on their Greek debt holdings, an outcome that is wrought with uncertainty as well.  The prospect of recession in the 17-member bloc, which became more likely after this week’s confirmed economic contraction in Q4, will complicate efforts to get budget deficits under control and likely result in additional ECB policy easing in the months ahead. Consequently, the euro’s medium-term outlook remains negative, regardless of the near-term developments in Greece.

The rally in risk assets overnight sapped the low yielding and safe-haven yen of support, pushing the currency to a new three and a half-month trough against the greenback.

Sterling benefited from the broad improvement in risk appetite and from an upside surprise to U.K. retail sales, which dampened some expectations for recession.

EUR: The euro bounced off of a three-week low against the U.S. dollar yesterday after news emerged that the “final touches” were being put on a EU-Greek debt deal that would extend Athens the latest tranche of its bailout and help the nation avoid a destabilizing default in March. The news pushed the euro and risk assets sharply higher, despite the fact that a deal for Greece has been “close” for much of the past few weeks. While the EU and IMF are not likely to let a destabilizing Greek default put the already shaky euro zone economy into a tailspin, the event risk that a deal is not put together in the 11th hour increases with every passing day. One possible holdup is the fact that private sector bondholders must still agree to massive write-downs in their Greek debt holdings, something they have resisted over recent weeks. The euro is benefiting from traders not wanting to be caught short ahead of the long weekend in the U.S. On balance, the still very high level of uncertainty and event risk is likely to keep the euro’s upside limited.

JPY: The yen fell to a new three and a half-month low against the otherwise weaker U.S. dollar overnight. Earlier this week, the Bank of Japan announced that it would increase its asset purchases in support of its struggling economy, news that sent the yen lower against nearly all of its major rivals. As risk assets rallied on the heels of news that a Greek debt deal was close, the yen added to its losses from earlier this week. Its low yields and historical safe-haven appeal make the yen (along with the U.S. dollar) one of the market’s favorite funding vehicles for trades in higher yielding assets, especially during periods of relative economic and financial market optimism. While the fundamental backdrop for the yen continues to deteriorate, the currency could quickly recoup its recent losses if conditions in Europe worsen and investors rush to cover their short JPY positions.

GBP: The pound benefited from the broad improvement in market sentiment overnight as well as from an upside surprise to economic data, which lowered the risk of an imminent recession in the U.K. British retail sales rose by 0.9%(m/m) in January, confounding expectations for a decline of 0.4%(m/m). The figures added to a recent batch of U.K. data that has surprised to the upside and suggested additional policy easing by the BOE may not be needed.

USD: U.S. consumer prices rose by 0.2%(m/m) in January, slightly cooler than the 0.3%(m/m) expected. Ex-food and energy, CPI rose by 0.2%(m/m) exactly as forecast. The data should continue to take a backseat to headlines from Europe, especially ahead of the long weekend here in the U.S.

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