Profit-Taking Fuels Risk Appetite Recovery and US Dollar Pullback

DailyFX   |  May 25 2012 2:27 EDT

The US Dollar edged lower as profit-taking sparked a correct upswing in higher-yielding currencies and a recovery in risk appetite, but remains posed to resume gains amid ongoing euro debt uncertainty.

Fundamental Headlines

- Merkel May Be Persuaded On Euro Debt-Sharing Compromise – Bloomberg

- Frozen Europe Means ECB Must Resort To ELA For Banks – Bloomberg

- Europe Slowdown Adds More Tension To Greek Drama – Reuters

- Bankia Set To Ask Spain For More Than $19 Billion – Reuters

- Japan Consumer Prices Rise 0.2% As BoJ Target Stays Distant – Bloomberg

European Session Summary

The US Dollar (ticker: USDOLLAR) edged lower against its major counterparts as profit-taking sparked a corrective upswing in higher-yielding currencies and risk appetite recovery. This follows a week of risk-off trading amid concerns of a Greek exit from the euro zone and a flurry of weak manufacturing data from China and Europe. Nonetheless, the US Dollar remains well within its overall uptrend.

Europe’s debt crisis remains at the forefront of investors’ minds, as Wednesday’s EU Summit in Brussels failed to bring about any new developments. The summit ended with a deadlock on the issue on a collective debt pool as German Chancellor Angela Merkel refused to back joint euro-area bonds. Under fire from her euro zone partners, Merkel softened her stance in overnight talks, leaving open the possibility of a compromise on debt sharing.

Meanwhile, the top event in the Asian markets was the release of Japan’s report on consumer prices. Core inflation had continued to increase for the third straight month, rising 0.2 percent in April from a year ago. However, this remains a far cry from the Bank of Japan’s (BoJ) target inflation of 1 percent. Earlier this week, the Bank had refrained from adding further monetary stimulus though it reaffirmed its commitment to maintaining its accommodative monetary policy. As the nation continues to battle low inflation, we are likely to see building pressure on the BoJ to do more with its stimulus measures.

Looking ahead, we should expect a quiet weekend with some rhetoric from European leaders as they attempt to reassure markets after a bumpy week. With the U.S. market closed on Monday, we should see volatility return on Tuesday with a slew of economic data due out from Europe next week. In addition to Greek exit fears, the market will keeping a close watch on developments in the Spanish banking sector. With Bankia, Spain’s fourth largest bank, asking for a 15 million euro bailout from the government, we could see rising speculation that Spain may be driven to seek international aid. This could lead to fresh uncertainty in the euro zone and prompt calls for further easing by the European Central Bank (ECB) in the coming weeks.

Taking a look at credit, the European debt market faced increasing pressures amid capital funding problems within Spain’s banking system. Spanish and Italian 10-year bond yields soared 14.8 bps to 6.311 percent and 9.7 bps to 5.666 percent, respectively.

EURUSD 5-min Chart: May 25, 2012

Charts Created using Marketscope – Prepared by Tzu-Wen Chen

The euro recovered against the greenback ahead of the US trading session, boosted by a pullback in the US dollar. Higher-yielding and risk-correlated currencies such as the New Zealand and Australian dollar led overnight gains against the US dollar as profit-taking bolstered risk appetite. The Kiwi rose as much as 0.75 percent against the greenback to a session high of $0.7584, while the Aussie gained nearly 0.39 percent against the US dollar to $0.9797.

--- Written by Tzu-Wen Chen, DailyFX Research