Greek PSI Offer Rejected, But Deadline Extended To February

O/N BULLETS

• Eurozone finance ministers reject Greek PSI offer – deadline set for February 13
• EZ finance ministers agree on text of ESM treaty
• Posen says MPC right to consider more QE

USD

While the catalyst for USD weakness yesterday may have been growing optimism about the Greek PSI deal, the most notable FX development was USD weakness rather than EUR strength. We suspect this is mainly a result of positioning and USD sensitivity to risk positive developments. The Eurozone developments are likely to remain the main focus today, but will continue to determine USD direction in the way they impinge on risk appetite. The USD could still have significant downside on risk positive news (see spotlight below), but there seems little chance of major progress today.

EUR 

In spite of initial concerns about the Greek PSI deal yesterday, EUR weakness was initially quite modest, suggesting that even though the outcome isn’t ideal the worst of EUR weakness may have been seen for the short run as long as there are no major surprises. Nevertheless, the failure to agree suggests downside risks today. The PMI data this morning seem likely to underpin the talk of stabilisation heard from Draghi and euro area finance ministers of late, even though the data from Spain and comments on German growth yesterday underlined the likely weakness of Q4 growth.

GBP 

UK PSNB numbers will be a focus this morning, and the risks may be slightly towards a smaller deficit than expected judging by recent trends. This may limit the upside scope for EUR/GBP on any positive EUR developments, and resistance at 0.8380 seems likely to hold in the absence of surprising EUR positive news. GBP/USD may be more attractive than EUR/USD if risk positive conditions persist.

CAD, NOK

So far the EU decision to impose sanctions on Iran has had limited impact on the oil price, in large part because they will not be introduced until July 1. But the combination of this, the Saudi revision of their oil price target to $100 p/b and the more positive risk tone suggest there is little downside to the oil price in the short run. While correlation has been very limited of late, the prospect of a firmer oil price may provide some relative support for the NOK and CAD going forward, given that they have underperformed other risk positive currencies of late.

Spotlight – EUR/USD has substantial upside risks on position squaring – The EUR has rallied over the last week as short positioning has been steadily reduced, but the potential for EUR gains on position squaring should not be underestimated. The chart below suggests that a full squaring of EUR short positions could easily lead to a rise to 1.40 or above in EUR/USD. Of course, such a squaring of positions is far from certain to happen given continuing concerns about euro zone debt issues, but from a bigger picture perspective there is no significant difference in yield attraction between the USD and EUR and EUR/USD is close to longer term fair value near 1.30, so there is no major reason to be holding USD over euros in more normal circumstances