Euro May Rise on German IFO Gains But Overall Outlook Remains Bearish (Euro Open)

The Euro may see short-term gains ahead with Germany’s IFO Business Climate indicator expected to rise for the third consecutive month in June since hitting a record low in March. However, economic growth and interest rate expectations continue to favor a bearish Euro bias against the US Dollar.

[U][B]Key Overnight Developments[/B][/U]

[B]• Japanese Merchant and Industry Sentiment Rises But Outlook Remains Dour
• World Bank Cuts Economic Growth Forecast, Says Risk Aversion to Continue[/B]

[U][B]Critical Levels

The [B]Euro[/B] trended lower in the overnight session, losing as much as -0.6% to the US dollar. The [B]British Pound[/B] tested as low as 1.6447 but rebounded to stand relatively unchanged ahead of the opening bell in Europe.

[U][B]Asia Session Highlights[/B][/U]

Japan’s [B]Tertiary Index[/B] rose 2.2% in April following a -2.8% decline in the previous month. Although an improvement in percentage terms, the result would still puts merchant sentiment at the lowest level in 5 years and firmly within the downward trajectory that has held since the index topped out in August 2007. Meanwhile, the Ministry of Finance’s [B]BSI Large All Industry[/B] gauge of business confidence printed at -22.0 in the second quarter, rebounding from a record low at -51.3 registered in the three months to March.

Current signs of stabilization in business and consumer confidence likely owe to the government’s record-setting $25 trillion yen stimulus package as well as the rebound in share prices (the Nikkei benchmark index has surged 39.4% to date since early March). Looking ahead however, the outlook seems shaky at best: the dismal outlook for global trade volumes in 2009 and 2010 will mean that a robust recovery for the export-dependent Japan will remain elusive for the time being, leaving output and employment levels at the lower end of the spectrum. Minutes from the last Bank of Japan policy meeting saw policymakers note that exports will “level out” due to inventory adjustments, meaning little chance of a meaningful rebound in global demand, while private consumption will “remain relatively weak…as the employment and income situation [becomes] increasingly severe.”

The [B]World Bank [/B]cut its economic growth forecast, saying global GDP will shrink -2.9% in 2009 versus forecasts of a -1.7% decline reported in March. The forecast for 2010 was also lowered, with the Bank calling for the world economy to add 2% versus previous estimates of a 2.3% expansion. Global trade volumes are now expected to fall -9.7% in 2009 versus March’s -6.1% contraction. The report accompanying the revisions said that “While the global economy is projected to begin expanding once again in the second half of 2009, the recovery is expected to be much more subdued than might normally be the case.” Bank President Robert Zoellick and company also seem to think that risk aversion remains a factor in financial markets, saying “investors’ flight from perceived danger [is a] trend that is very likely to persist through the end of 2009.” Such a dynamic stands to benefit safety-linked currencies, particularly the US Dollar and the Japanese Yen.

[B]Related Articles[/B]: Australian New Motor Vehicle Sales Surge Most in 4.5 Years; ECB President Trichet Says No More Stimulus
[B]Euro Session: What to Expect[/B][/U]

Germany’s [B]IFO Business Climate[/B] indicator is expected to rise to 85.0 in June, the third consecutive improvement since the metric hit a record low at 82.2 in March. The forward-looking Expectations component of the survey is seen rising for the seventh straight month, hinting at sustainable improvement in firms’ 6-month economic outlook. Still, the reading is expected at 86.9, a print below the 100 “boom-bust” threshold, suggesting conditions are still deteriorating albeit at a gentler pace. Some recovery is to be expected as the government’s 82 billion euro fiscal boost filters into the broad economy, but the big question in Germany as well as most anywhere at this stage is whether growth is sustainable after stimulus cash dries up.

On a comparative basis, the pace of GDP expansion in Germany is expected to underperform that of the US by 3.2% and 1.5% in 2009 and 2010, respectively. Looking at the Euro Zone as a whole, the currency bloc is set to trail the States by 1.5% over the next two years. This suggests the US will lead its European counterparts in unwinding fiscal and monetary stimulus measures and, most importantly, lead in reversing higher the trajectory of benchmark interest rates. Indeed, overnight index swaps reveal traders are pricing in the likelihood that the Fed will raise interest rates by 1.00 – 1.25% over the next 12 months as compared to 0.25 – 0.50% expected from the ECB, arguing for a yield shift in favor of the US Dollar that will put downward pressure on EURUSD.

[I]To reach Ilya regarding this article or subscribe to his email distribution list, please contact him at <[email protected]>[/I]