Euro Vulnerable as Looming Currency Crisis in Latvia Threatens Contagion (Euro Open)

The Euro may see selling pressure in European hours as a developing currency crisis in Latvia threatens to spill over into Western Europe. Overnight data offered conflicting releases from Japan, seeing the Current Account narrow more than expected while merchants’ economic outlook surged to the highest since September 2007.

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

[B]• Japan’s Current Account Surplus Shrinks as Exports Tumble
• Eco Watchers Survey Sees Merchant Sentiment Surge in May[/B]

[U][B]Critical Levels[/B][/U]

The [B]Euro[/B] corrected a bit higher in overnight trading, testing the 1.40 level against the US Dollar. The [B]British Pound[/B] trended gently downward, testing as low as 1.5921 to the greenback.

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

Japan’s [B]Current Account[/B] surplus narrowed more than economists expected in April, printing at 630.5 billion yen from 1485.6 billion in March. Forecasters were calling for an 850 billion yen result ahead of the release. Trading terms declined -54.5% from a year before as shrinking global demand weighed on exports. Indeed, overseas sales fell -40.6% in annualized terms, outpacing a -37.8% drop in imports. The International Monetary Fund has forecast that world trade volumes will contract by a whopping -11% this year and recover just 0.6% in 2010, spelling continued trouble for export-sensitive countries like Japan: companies are likely to maintain lower output levels, keeping a lid on a recovery in the labor market to keep disposable incomes low and hold back spending. Indeed, a survey of economists conducted by Bloomberg sees unemployment continuing higher at least through the second quarter of next year.

Meanwhile, the forward-looking component of Japan’s [B]Eco Watchers Survey[/B] surged to 43.3 in May from 39.7 in the previous month, the highest since September 2007. The metric polls barbers, taxi drivers, and other retail service providers to gauge underlying trends in consumer confidence. Merchant sentiment was likely boosted by the government’s record 2 trillion yen ($20 billion) fiscal boost. It remains to be seen if the improvement is sustainable after this effort is exhausted.

[U][B]Euro Session: What to Expect[/B][/U]

Switzerland’s [B]Unemployment Rate[/B] is expected to tick higher for the seventh consecutive month in May, rising to 3.6% in from 3.4% in the previous month, the highest since January 2006. Growing joblessness will weigh on disposable incomes and weigh on spending, putting a lid on overall economic growth. Hiring is likely to remain tame in the months ahead with firms keeping output low as demand remains lackluster from Switzerland’s key trade partners in the European Union. Indeed, the Swiss government’s official forecasts and those derived from a survey of analysts conducted by Bloomberg agree that the unemployment rate will hit 5% next year.

In the Euro Zone, the [B]Sentix Investor Confidence[/B] indicator is expected to rise to -31.0 in June from -34.3 in the previous month, the highest reading since October. The boost is likely to come as traders price in the European Central Bank’s decision to expand monetary easing efforts beyond benchmark interest rates. However, it is important to note a negative reading implies analysts remain overall bearish, though comparatively less so.

On balance, the [B]Euro[/B] may look past the data docket as recent developments in eastern and central Europe darken the near-term outlook: a looming currency crisis is emerging in Latvia, threatening to force devaluation and break a peg to the Euro unless rush efforts from the ECB and the IMF succeed in securing an adequate international aid package in the days ahead. Western European banks are heavily invested in Latvia as well as neighboring Lithuania and Estonia who also peg their currency to the Euro; if the currency collapses, the value of Western European investments in the region will go with it, putting intense strain on lenders already battered by losses from the subprime crisis. Needless to say, such a scenario could weigh heavily on the single currency, forcing yet more concessions to the US Dollar after Friday’s sharp decline.

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