The euro zone debt crisis and its impact on bank balance sheets weighed on the euro Friday and is likely to do so again next week. Meanwhile the possibility that the US Congress will fail to raise the government's statutory borrowing limit by August 2, which may result in a credit rating downgrade, weighed on the US dollar, particularly against the Swiss franc.
--- European bank stress tests show 8 failures out of 90
--- Euro zone summit on Greece set for next week
--- US debt ceiling impasse afflicts dollar
The more investors fear that heavily indebted euro-zone governments will be unable to repay their debts, the more the yields on their bonds rise, dragging down their value in banks' balance sheets, erasing their capital, and increasing the need for yet more bank bailouts by stronger euro-zone governments.
Europe's banks were in the spotlight on Friday when the European Banking Authority released its bank stress-test results, showing eight banks failed a test of their ability to withstand a prolonged recession. Euro zone leaders will meet in Brussels next Thursday to discuss a second bailout package for Greece and the financial stability of the euro area, European Council President Herman Van Rompuy said on Friday. "Next week will be another headline driven week," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.
"On one side of the Atlantic there will be news regarding the status of Greece's second bailout and on the other side is the US debt ceiling and the potential of a ratings downgrade." Rating agency Standard & Poor's late on Thursday said there was a one-in-two chance it could cut the United States' credit ratings if no deal was reached on raising the government's debt ceiling. The move followed a similar statement by Moody's earlier this week.
In late afternoon New York trading on Friday, the euro was nearly unchanged at $1.4148, above a four-month low of $1.38376 hit this week when fears of contagion risks fears were running high. Esiner said he expects the euro to trade between $1.40 and $1.4250 next week.
The euro's outlook is shaky on worries about whether Europe can find a solution to the debt crisis in Greece and prevent contagion to larger countries such as Italy. The costs of insuring heavily indebted southern euro-zone debt against default has risen.
The impasse in the US Congress on the US debt ceiling talks should remain a headwind for the US dollar also.
"The markets at this point are not pricing in a level of risk for the dollar as much as there should be," Esiner said. "A downgrade of US debt will send the dollar tumbling." The ICE US dollar index ended down 0.2 percent at 75.128 on Friday.
"We still believe that authorities will eventually step up to the plate and reach a debt ceiling deal in the US and an aid package for Greece in Europe," said Vassili Serebriakov, currency strategist at Wells Fargo Bank in New York. "This will lead to some calming in market conditions and a return to a strengthening trend for most emerging and commodity currencies," he said.
With prospects for both the euro and dollar muddied by major concerns about debt in the euro zone and the United States, some analysts recommended buying the safe-haven Swiss franc as a hedge.
The uncertainty benefited the safe-haven Swiss franc this week. The US dollar had its worst weekly performance since late May against the Swiss franc losing 2.7 percent. Against the Japanese yen, the dollar fell 1.9 percent, its worst weekly loss since mid-April.