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Euro under Pressure; Traders Expect RBA to Hike Rates 25 Basis Points

By James Hyerczyk

The Euro remained under pressure on Monday despite an announcement by Greece, the European Union and the International Monetary Fund that a 3-year bailout package has been reached which will provide as much as $146 billion for the ailing nation.

The bailout agreement which was highly expected failed to restore confidence to the Euro, most likely because speculators still believe the sovereign debt problems in the Euro Zone are likely to spread to Spain, Portugal and Ireland.

Each recent rally in the Euro has been met by more selling pressure which has triggered a break to a new low for the year. This pattern is expected to continue as the direction of the Euro is clearly in the hands of the shorts. Recently released Commodity Futures Trading Commission Commitment of Traders data shows that hedge funds and other large speculators are dictating the direction of this market. The report shows that these large traders increased net wagers on a Euro drop by 25% to 89,013 contracts in the week ended April 27th.

Clearly if large traders believed that the bailout package was going to save the Euro, the number of net shorts would have decreased. The increase in the number of net shorts indicates that bearish traders are gaining confidence in the possible demise of the Euro. Last week the S&P Corp. downgraded the debt rating of Spain and Portugal. This action helped throw fuel on the fire as it no doubt confirmed to the bearish traders that they were trading the Euro from the right side.

Although the Greece bailout package may be providing the nation with some breathing room, the market is saying that traders remain cautious. It is easy for the policymakers to require beaten countries like Greece to agree to more austere financial measures, but it is another thing to make them follow the new rules.

The Euro is also under pressure from traders who simply believe that the Euro Zone is going to be mired in this financial crisis for some time. In addition to expectations of contagion in the region, some bearish traders are increasing bets that the European Central Bank will not be able to raise interest rates during a time period when most major industrial nations are considering rate hikes. Other traders believe that the situation in the Euro region will grow to the point where credit markets become locked up much like they were during the height of the Lehman debacle. Putting everything together, it looks as if the situation is likely to worsen which means downside pressure will remain on the Euro.

The weakness in the Euro and concerns about European sovereign debt issues also spread to the GBP USD on Monday. Not only do British Pound investors have to be worried that its sovereign debt will get downgraded by a credit ratings service, but they also have to deal with the possibility of hung parliament after the May 6th election.

According to recent polls, the U.K. election is too close to call. This means that the election may result in no party having a majority in parliament. Without a majority calling the shots, it seems unlikely that the parliament will be able to tackle its sovereign debt problems and its budget deficit. Without guidance and direction, the government may be unable to come up with a viable plan to fight its fiscal issues. If this occurs, then look for the U.K. debt rating to be slashed at some point this year. This action will compound the weakness in the British Pound and drive the currency lower.

While the European Central Bank has its hands tied regarding interest rates, the Fed is slowing moving closer to raising rates. This is increasing speculation that the Euro will weaken, driving up demand for dollar-denominated assets. Stronger gold, crude oil and stocks rose on Monday, helping to boost the Canadian Dollar. This helped the USD CAD weaken after a couple of days of speculation that this pair would rise because of the possibility of an intervention by the Bank of Canada.

Late last week, BoC Governor Mark Carney said that a high priced currency can have an impact on inflation and monetary policy. This seemed to be a subtle hint that the Canadian Dollar was getting a little too high. It also served as a verbal intervention, leading to a short covering rally in the USD CAD.

Traders should watch this currency pair carefully over the near-term. Although expectations are for the BoC to begin increasing interest rates as early as June, the USD CAD may get volatile as the two bearish and bullish forces clash. If demand for higher risk drops, driving stocks lower, then look for the Canadian Dollar to fall. Renewed interest in higher yielding assets could drive the Canadian Dollar back toward parity.

Tonight, the Reserve Bank of Australia is expected to announce its policy statement. Traders expect the RBA to increase its benchmark rate by .25 basis points to 4.50%. For months the RBA has said that it will continue to hike interest rates until they reach a normal level. According to RBA Governor Stevens, the normal range is 4.50% to 5.00%.

Recent policy statements suggested that the growing global economy is the main reason to increase rates. Recent economic reports suggest that inflation is high. This is another reason why the RBA is expected to increase rates.

The debt problems in Greece and the Euro Zone have not had an impact on Australia, but the RBA may take this into consideration when discussing the rate hike. Unless it sees the problem having an effect on the Australian economy, don't expect it to get in the way of an interest rate hike. Furthermore, China is expected to tighten rates soon. This issue may be raised by Australian policymakers, but is not expected to hurt the economy to the point where an interest rate hike isn't warranted.


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