Greenback continues to suffer

The Dollar has made consistent losses this week and the continued stalemate on the subject of extending the US debt ceiling, the greater the problem for the currency. Without a doubt, it appears that the Greenback is taking the brunt of the pressure compared to other assets. For example, although US treasury yields have edged higher, there appears no sense of panic in US bond markets.

Failure to agree on the debt ceiling does not naturally mean a debt default however it will increase the chances should an agreement not be reached in the weeks after. Nevertheless, the impact on US bonds maybe countered by the increased potential for QE3 or safe haven flows in the event that no agreement is reached.

The worst case scenario for the USD remains no agreement on the debt ceiling ahead of the August 2 deadline but a short term solution that appears to be favoured by some in the US Congress may not be that much better as it would effectively be seen as ‘kicking the can down the road’.

The better than expected package to help resolve Greece’s debt problems last week dealt a blow to the USD as the almost perfect negative relationship between the USD and EUR over recent months. Furthermore, the debt ceiling deadlock is making matters worse. However, the situation can change very quickly and should officials surprise us all and find agreement the USD could rally sharply.

Things are not looking great for the EUR as most of its gains have mostly come by courtesy of a weaker USD rather than positive EUR sentiment. The news hardly bodes well for the EUR, with data in the Eurozone looking somewhat downbeat. For example, the Belgian July business confidence indicator dropped to a 9-month low in line with the weaker than expected outcome of the July German IFO survey last week.

In addition, there are still several questions about last week’s second Greek bailout agreement and contagion containment measures including parliamentary approvals and lack of enlargement of the EFSF which could keep markets nervous until there are clear signs that implementation is taking place successfully.

A clear indication that the EU agreement has failed to inspire as much confidence as officials had hoped for is the lack of traction in terms of narrowing peripheral bond spreads, with the exception of Greece. This partly reflects a renewed ‘risk off’ tone to markets but this is not the sole reason.

EUR/USD has extended gains benefiting from USD weakness rather than any positive sentiment towards EUR, breaking above 1.4446, the strong multi-month corrective channel resistance, signalling a bullish move. The next level of technical resistance is around 1.4568 but direction will continue to come from the debt ceiling talks.