Euro Falls Further on Merkel Comments

USD

 Risk sentiment lifted briefly earlier today after a better than expected bills auction in Belgium and Spain, and a surprise upside in the ZEW sentiment survey. A slow-down in Retail Sales, however - which only grew by 0.2% YoY in November when 0.6% had been expected - led a decline in risk appetite which supported the dollar. From then on the dollar climbed, pretty much for the rest of the session. Fears of a possible downgrade or euro-zone countries by rating's agencies fuelled more safety demand, as Fitch announced it was reviewing their ratings following the lack of a comprehensive solution being found at the E.U summit in Brussels. The dollar has climbed further after the FOMC announced no change in policy and it is likely to be interesting only in the commentary which may give hints on the outlook for future policy decisions. However changes in the Fed funds rate or the asset purchase programme remain unlikely given the improved economic metrics in the last month, which showed a fall in the unemployment rate to 8.6%, inflation easing to 3.6% vs 3.9% in the previous month, and manufacturing upbeat at 52.7 vs 50.8. The dollar is likely to continue its current trend higher if the improved outlook holds and the crisis deepens in Europe, as it will benefit from increased haven-demand without the expense of devaluation through easing. 

EUR

The euro continued descending after a brief respite in the morning when yields at auctions of 12 and 18-month bills in Madrid and Brussels fell from previous sales and the euro-zone ZEW survey bounced with a print of -53.8 vs -59.1 previous, however, the upbeat mood soon soured after reports Angela Merkel had said she refused suggestions of any increase in the funding limit of the EFSF, exacerbating fears about the fund's lack of credible fire-power. The journey south for the single currency continued as Fitch joined Moody's and S&P in warning about a possible downgrade of several or all of the euro-bloc given the "lack of a comprehensive solution from the summit." The euro fell further against the greenback in the evening after the FOMC decision not to change the Fed funds rate or increase its asset purchase programme reaffirmed renewed optimism about the U.S economy and limited the possibility of further easing measures which might weaken the dollar. Industrial Production will headline the economic docket tomorrow and is expected to show a slight dip to 2.1% vs 2.2% YoY in October, however, the focus will remain the debt crisis and any possible down-grades.   

GBP

The pound fell as risk appetite worsened following comments from Angela Merkel in which she rejected any suggestions of increasing the size of the European bailout fund, thus fuelling fears that it would be inadequate to consume a full-blown default by a major E.U nation such as Spain or Italy. Continued pressure from rating's agencies, however, hurt risk appetite, however, as they continued to place the E.U on negative watch and a downgrade could push borrowing costs over the limit of affordability. Sterling faired better than the single currency, however, as Cameron's distancing from the continent appears to have paid off and markets see U.K as a safe-haven with a credible deficit reduction strategy in place, although lingering doubts about growth remain. Nevertheless the sudden rise versus the euro on Tuesday was testament to the relative safety investors see in gilts compared to euro-zone sovereign bonds - even German bunds. Wednesday sees the release of important employment data for the U.K which if it shows a continued increase in the unemployed may weaken sterling as it will show growth is slowing unacceptably and there is a greater chance the BOE will use monetary easing to offset the slowdown.   

JPY

The yen rose as risk sentiment fell and investors sought safety. The main catalysts to the drop in ?sentiment were European drives - with comments from Angela Merkel in which she refused to agree to increasing the size of the bailout fund and rating's agencies warning of another potential downgrade of the euro-zone bloc as the most significant. A lower than expected print in U.S Retail Sales also hit risk appetite and helped the yen rise higher. On the data front the only release was Japan Manpower Survey which showed a rise to 11.0 from 10.0. There is much busier docket tomorrow, however, with Industrial Production and then in the evening the Tankan Investor Survey which is expected to fall to -2 vs 2 previous in the 4th quarter, whilst non-manufacturing is expected to stay the same at 1 and Large Manufacturer's Outlook is expected to fall to -3 vs 4 previous. These lower prints may stimulate yen demand further as they will reinforce a negative view of the economy which is already consistent with a perception of existing structural weaknesses.