Markets Driven by Recovery Speculation

Recently markets have been driven by speculation that the global economy is starting to recover which has resulted in higher risk sentiment among investors. Investors have shrugged aside warnings from the European Central Bank that recovery will be slow and are seeking higher yielding investments and currencies. This has affected currency exchange rates especially the euro to dollar exchange rate.

Euro Benefits From Increased Risk Appetite

The euro has benefited from higher risk appetite in the last three trading sessions pushing the euro to a high of 1.3830. The US dollar posted losses after the release of the minutes of the Federal Open Market Committee which indicated that the Fed will continue to purchase mortgages and other debt which will result in unprecedented deficits for the United States.

Geithner Says Financial System “Starting to Heal”

Currency exchange rates have been affected by stock market rallies which have many investors believing that global recovery is imminent. This has affected the pound to dollar rate pushing it to multi month highs. Fundamental economic factors such as the stock market rally and improved outlook for manufacturing are fueling the rise in risk appetite. Remarks by US Treasury Secretary Timothy Geithner that the financial system was “starting to heal” coupled with a successful share offering from the Bank of America also helped to raise risk sentiment and affected global currency exchange rates.

Investors Leave Dollar Denominated Deposits

Wednesdays trading saw the euro to dollar exchange at $1.3774 after hitting a high of $1.3830. The pound vs. dollar exchange rate rose sharply to $1.5746, a six month high against the dollar. Traders said that currency exchange rates have been influenced by investors leaving dollar denominated deposits and into higher risk assets.

This week currency markets are following the lead of equities markets and this is expected to continue throughout the week.

Euro Zone Economy Contracting Worse Than Expected

Dismal figures from the Euro Zone have prompted a flight to safe havens benefiting both the US dollar and the Japanese Yen. Figures released show that the Euro Zone economy contracted 2.5% quarter on quarter for a 4.4% year on year contraction the worst on record and have had an adverse effect on the euro to dollar exchange rate. Economists had predicted a 2.0% contraction for the Euro Zone. The German economy, the Euro Zone’s largest, contracted by 3.8% in the first quarter. Experts had predicted a decline of 3.0%. Germany posted the sharpest decline since reunification in 1990.

US Industrial Production Declines

Also affecting currency exchange rates was US data that showed that US industrial production declined 0.5% in April and unchanged consumer prices pointing to static consumer demand. Dallas Fed President Richard Fisher said that actions by the Fed had rescued the economy “from the edge of the abyss.” He also stated that he expects recovery to be slow, “I envision a slow recovery. Not a V-shaped snapback — nor even a U-shaped one — but a very slow slog.”

Recovery Expectations Premature

The recent rally prompted by the ‘green shoots’ theory of economic recovery affected both stock markets and currency exchange rates. Many experts and forex traders had warned that expectations of recovery were premature. Recent figures have indicated a slower rate of economic decline but global recovery remains elusive. The euro to dollar exchange rate which had reached $1.37 recently has now fallen 0.4% to $1.3581. European shares were up 0.0.4% on Friday but US stock futures indicated a lower start on Wall Street.

Dollar Falls vs. Yen

While the dollar to euro rate has risen, the dollar to yen exchange rate has fallen 0.9% to 95.08 after hitting a two month low of 94.78. Safe haven demand has benefited both the dollar and yen as investors pull back from riskier investments. Next week factors that will affect currency exchange rates include US housing data and the German ZEW report.

Financial Times Says US Credit Rating in Danger

All indications are that this week will not be a good one for the US dollar. It would appear that most forex traders and investors are subscribing to the ‘green shoots of recovery’ theory. A media report that said the credit rating of the US is threatened by huge deficits also put the greenback under pressure. Standard and Poor’s said that the costs of propping up government enterprises like Fannie Mae and Freddie Mac could cost the US 10% of GDP threatening the US’s triple A credit rating.

Markets in Buoyant Mood

The buoyant mood in financial and stock markets has also affected currency exchange rates globally. On Tuesday the euro to dollar rate rose 0.9% to a seven week high of $1.3695. The Pound was up 1.4% to $1.5336, it’s highest since January. The pound was bolstered by positive retail sales data, and stronger housing and industrial production figures.

Aussie and Kiwi Dollars Benefit From Risk Appetite

Changing currency exchange rates have also benefited both the Aussie and Kiwi dollars. The Aussie dollar rose 0.9% to $0.7647 while the Kiwi dollar rose 0.6% to $0.6049. The euro to yen rate rose 0.4% to 132.93 and the dollar to yen rate fell 0.4% to 97.18. The Australian dollar rose despite the country’s rising deficit and unemployment. A few traders are urging caution saying that economic figures are “less catastrophic” and do not point to global recovery.

Last Week’s Rally Extended

It would appear that last week’s rally in risk appetite has been extended into this week’s currency trading. US retail sales and industrial figures are expected this week and it remains to be seen how each set of data will affect currency exchange rates. Although some experts are advising caution it would appear that the ‘green shoots of recovery’ theory will dominate currency exchange markets.

Euro Pares Recent Gains

The euro held last week’s gains through the weekend but fell on Monday after European stock markets were down and stock futures pointed to a low opening on Wall Street. Last week’s rally in risk appetite saw the euro reaching multi month highs. Investors brushed off the results of US bank stress tests and the rally in risk appetite continues well into the weekend.

Currency Markets to Follow Stock Markets

Over the weekend the euro to dollar rate held steady at $1.3630 after reaching a seven week high of $1.3660. The euro to yen exchange rate also held steady at 134.21 after hitting a high of 134.80. Many experts doubt that the rise in risk sentiment is sustainable. Sue Trinh of RBC Capital Markets stated, “There seems to a sea-change at work in terms of general sentiment. It will be an interesting week to see how sustainable that is because there’s nothing really in terms of event risk.” She also said that currency exchange rates would look to equity markets for momentum.

Investors Turn Cautious

On Monday investors turned cautious as European shares were down 1.3% and banking shares were down almost twice as much pointing to a lower start on US stock markets. Many investors now feel that last week’s momentum is not sustainable and that the rise in risk appetite was premature. The realization that the recession is still with us and is likely to continue into the foreseeable future has affected investor sentiment and currency exchange rates.

No Significant Data on Tap

No significant economic data is expected this week although Fed Chairman Bernanke’s remarks on Monday could affect markets and currency exchange rates. Most currency specialists expect currency exchange markets to be mainly affected by stock and commodity market performance.

ECB Expected to Cut Rates

Investors are awaiting the results of Thursday’s meeting of the European Central Bank. The central bank is expected to cut rates putting pressure on the euro to dollar exchange rate. So far there is no indication that the ECB will adopt measures similar to those of the US Federal Reserve. Most analysts say that a rate cut from 1.25% to 1% is a certainty and may have a negative impact on the euro to dollar rate.

Risk Sentiment Affects Euro to Dollar Rate

Investors have long known that low interest rates can cause a currency to lose value and any rate cut is bound to adversely affect the euro to dollar rate. Risk sentiment, which has been changing daily, has also affected the euro to dollar exchange rate.

Bernanke Says Recovery to be Slow

On Tuesday U.S. Federal Reserve Chairman Ben Bernanke told congress that the US economy should start growing later in the year but warned that economic activity is likely to be limited companies will be slow to hire new workers. Late Tuesday the euro to dollar rate fell from $1.3313 to $1.3250.

BOA May Need $34 Billion

Concerns about US banks increased after it was revealed that the Bank of America may need $34 billion dollars to cover a capital shortfall. Investors are also awaiting the US job report on Friday which has affected risk sentiment and the euro to dollar rate. Recent economic data has been somewhat positive and many believe that the worst of the recession is over. Data showing signs of recovery has limited losses by the euro which usually benefits from rising risk appetite.

Improved Manufacturing Data

Improved US jobs data coupled with a recovering housing market and improved manufacturing data from China, Europe, and India have all caused increased risk appetite affecting currency exchange rates. Speaking of the job figures Dan Cook of IG Markets in Chicago, said “With everything dependent on the labor market, this was a fantastic indication that maybe we are seeing a turnaround.”

With so many important meetings taking place this week investors will have a full plate of data to sort through. Currency markets have been taking their cue from stock markets and this trend is expected to continue.