Euro Hurt by ECB Rumours Concerning Bond Buying and Bank Stress Test Failures

The euro exchange rate (EUR) complex fell against both the British pound and US dollar after it was announced the ECB is on well on track to pump billions of extra euro into the stuttering Eurozone economy.

The euro initially held near the upper end of recent ranges against the dollar as investors took advantage of last week’s pullback in the dollar to buy back the euro after nearly three-months of steady selling.

Fesh weakness was prompted mid-week when fresh speculation on the health of the Eurozone's bank started to flow through to markets.

Euro rate today: FX spot levels for reference on Wednesday

• The euro to dollar conversion rate: 0.45 pct lower at 1.2659.
• The euro to pound conversion rate: 0.17 pct lower at 0.7878.

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Euro Banks to Fail Stress Tests?

There is a great deal of speculation regarding the euro at the present time.

Several banks possibly failing ECB's stress tests as well as the better than expected US inflation numbers put pressure on the EUR on Wednesday.

Fixed income investment firm Pimco's global banking specialist, Philippe Bodereau, expects 18 banks will be seen to have failed the European Central Bank's stress test of 130 regional lenders when results are published by the ECB on Sunday.

Bodereau, who manages $4.3 billion in the Pimco GIS Capital Securities Fund, said in an interview on Wednesday the failures would likely include some German and Austrian cooperative and public sector banks, as well as weak regional lenders in the southern periphery.

The ECB Hurts the Euro

The big news for the euro over the past 24 hours was a rumour suggesting the ECB is considering buying corporate bonds on the secondary market and may decide on the matter as soon as December with a view to begin purchases early next year, several sources familiar with the situation told Reuters.

The news prompted Eurozone stocks to rally and reminded currency markets that the ECB is to take a more proactive approach on financial markets.

"The pressure in this direction is high," said one person familiar with the work inside the ECB told Reuters. An ECB spokesman, however, said of such purchases: "the Governing Council has taken no such decision."

However, some ask whether markets have over-reacted, and thus the euro is oversold in the short-term. Lloyds Bank Research say:

"It’s not exactly clear why the market has viewed this as EUR negative especially as 2y rate spreads held firm in favour of the EUR yesterday."

The US Dollar is Set to Advance Further vs the Euro

Looking ahead, "while near-term volatility and market swings will keep price action choppy, the euro’s medium to longer-term outlook remains challenged," notes Omer Esiner at Commonwealth Foreign Exchange.

BNP Paribas reckon the recent softness in the US dollar complex could be about to end.

"We see the mid-October collapse in US rates and the pullback in the USD as largely disconnected from the macro backdrop. The Fed is entering a blackout period ahead of the October meeting so it will be up to the US and global data to help determine whether the Fed sticks with its original taper plan," BNPP argues.

"We remain on the sidelines for the moment but a continued improvement in market sentiment would in our view make the risk-reward for long USD positions versus the EUR and JPY increasingly attractive," BNPP advises.

Or Will the Dollar Soften Into Year-End?

Long-term USD bulls at TD Securities confirm they remain dollar buyers long-term.

However, the prospect of USD weakness in the near-term should not be discounted.

In a note to clients released today TD tell us that the USD typically softens modestly in the last two months of the year according to seasonal analysis.:

Interestingly, since 1974, the USD has declined 63% of the time (average –1%, according to Bloomberg data).

"From current levels, a 1% fall would put the index on track to test the 38.2% retracement support of the July/September rally (84.07) in the next few weeks," according to Shaun Osborne at TD Securities.