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2011-06-27 HSBC FX Edge - EURUSD in the Bigger Picture

2011-06-27 HSBC FX Edge - EURUSD in the Bigger Picture

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Currencies27 June 2011
Robert Lynch | +12125253159 | ROBERT.LYNCH@US.HSBC.COMView HSBC Global Research at:http://www.research.hsbc.comIssuer of report: HSBC Securities (USA) Inc.
FX Edge
EUR/USD in the bigger picture
For all of the consternation over Greece and the intense market focus over each step in the process of acquiring thenext tranche of financial aid, the reality is that EUR/USD continues to hold above the 1.4000 threshold, and at currentlevels (1.4215) it remains higher than both its recent average (1.4040 in the year-to-date) as well as longer term averages(1.3622 in the past year, and 1.3814 in the past five years). We highlight that in an attempt to provide some perspectiveon the impact--or by these measures the lack of impact--that the Greek saga is having on the EUR, at least in theselonger term time horizons.
That is not to overlook the more dramatic effects these developments are having on shorter term movements and indeed, risk managers with short term horizons will understandably have a much different perspective on the matter. And it is also not tosay that conditions could not deteriorate and impose more sizeable losses on the EUR. But at 1.4000, the sovereign debt crisisin Europe is not yet generating a "crisis" for the EUR.Greece parliamentary schedule this week All that said, there is no getting around the focus that will remain very much on the minute-by-minute developments inGreece. In that regard, it is important to recognize the steps in the Greece parliamentary process this week in regards to theausterity and privatization program. Parliamentary debate on the program begins today and a full vote is scheduled for June 29.Assuming it passes that vote (and it is expected to do so), Parliament then immediately begins debate on the implementationlaw spelling out the measures in more detail. This is the more critical and potentially more difficult parliamentary hurdle tocross this week and the vote on these measures, currently scheduled for June 30, is a key market event for the week.China still likes the EURChinese Premier Wen Jiabao continues his trip through Europe and made headlines this weekend saying that "China has beena heavy investor in the euro sovereign-debt market," and that "We have bought a lot of euro bonds over the past years and wewill continue to support Europe and the euro," according to the Wall Street Journal. We have continued to highlight the impactthat reserve managers play in providing good demand for the EUR and many other non-USD developed-economy currencies,primarily as a result of their ongoing need to recycle the USD they accumulate through FX intervention. When consideringEUR/USD's ability to hold above the 1.4000 threshold, as we highlighted above, reserve manager demand must be consideredin the equation. And comments like those over the weekend from Premier Wen will only enhance the market's perception thatChina and other large reserve managers will continue to have EUR buying interest, particularly at lower levels.EUR/USD volatility and risk reversals remain near recent extremesIn that regard, we noted last week that the mid-June spike in EUR/USD implied volatility and enhanced premium for EURputs in the risk reversals should both reverse somewhat, assuming we were correct in our assessment that the spot rate wouldnot endure more sizeable losses. Thus far, the spot EUR/USD has indeed held up, but volatility slipped only temporarily earlylast week and has since moved back up towards its recent highs, with 3-month implied vol trading near 13.5% this morning,up from last week's low near 12.7%. In addition, the 3-month EUR/USD risk reversal has extended its recent decline and is
 
HSBC Global ResearchCurrencies27 June 2011
2referenced on Bloomberg this morning at -2.95%, which even more strongly favors EUR puts than the -2.85% area where itwas trading when we highlighted it last week.We still think that both volatility and the risk reversals should retrace some of their recent movements, that vols should comedown a bit and that the premium on EUR puts should move back towards the -2.0% area where they were trading earlier thismonth. But with the Greek aid package still not finalized, it is clear that markets are not yet willing to make that adjustment.Moreover, quarter end pressures may also be impacting flows and prices. Against this backdrop, it may take a while longerbefore the shift in volatility and risk reversals that we expect plays out.US debt ceiling negotiations continueIn the US, the press will monitor today's meetings between President Obama and Senate leaders regarding the ongoingnegotiations to raise the debt ceiling. It would be a surprise if any real progress were announced following today's meetings(Obama meets with Senate Democratic leader Reid at 10:30 ET and with Senate Republican leader McConnell at 17:00 ET),but the outcome will still bear monitoring. There will be additional focus on these developments into July and as the August 2"hard" deadline to raise the debt ceiling is approached. Indeed, it could well be that the coming weeks will see focus shift awayfrom Greece and onto the US fiscal backdrop in a manner that would presumably be more negative for the USD. But at thisstage, with over a month before that hard deadline is reached, the stressed US fiscal backdrop does not appear to be creatingmuch in terms of headwinds for the USD.
 
HSBC Global ResearchCurrencies27 June 2011
3
Disclosure appendix
Analyst certification
The following analyst(s), who is(are) primarily responsible for this document, certifies(y) that the opinion(s), views or forecastsexpressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly orindirectly related to the specific recommendation(s) or views contained in this research report: Robert LynchThis document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for theclients of HSBC and is not for publication to other persons, whether through the press or by other means.This document does not provide individually tailored investment advice and should not be construed as an offer or the solicitationof an offer to buy or sell any securities or to participate in any trading strategy. The information contained within this documentis believed to be reliable but we do not guarantee its completeness or accuracy. Any opinions expressed herein are subject tochange without notice. HSBC may hold a position in, buy or sell on a principal basis or act as a market maker in any financialinstrument discussed herein.Analyst(s) are paid in part by reference to the profitability of HSBC which includes investment banking revenues.HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Researchbusiness. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate andhave a management reporting line independent of HSBC's Investment Banking business. Chinese Wall procedures are in placebetween the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information ishandled in an appropriate manner.
Additional disclosures
1 This report is dated as at 27 June 2011.2 All market data included in this report are dated as at close 27 June 2011, unless otherwise indicated in the report.3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with itsResearch business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operateand have a management reporting line independent of HSBC's Investment Banking business. Information Barrier proceduresare in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitiveinformation is handled in an appropriate manner. 

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