CHF under pressure

In sharp contrast to AUD but for the same rationale (improving risk appetite and low volatility) the CHF has succumbed to pressure. Comments this week by Swiss National Bank officials highlighting their resolve to enforce the CHF cap, their belief that the currency is still overvalued, and are prepared to take further steps, highlight that the Swiss authorities wish for a much deeper correction lower in the currency. This is unsurprising as the CHF real effective exchange rate has been on a strengthening path over recent months, much to the likely chagrin of the SNB.

The fact that Swiss CPI inflation dropped back into negative territory on a YoY basis in February reinforces the need to further weaken the currency. Steps such as negative deposit rates and/or FX intervention cannot be ruled out. In the meantime, USD/CHF looks set to test resistance around 0.8930 (26 Feb high).

AUD supported but be wary of profit taking

AUD/USD broke above its 200 day moving average (0.9137) encouraged by upbeat comments about economic growth prospects from Reserve Bank of Australia Governor Stevens. The fact that AUD remains supported despite higher risk aversion overnight is encouraging.

A run of better than expected data including Q4 GDP, retail sales, trade and jobs report have underpinned the currency. Additionally bad news is good in the case of the China impact on AUD as weaker data has led to growing expectations of a stimulus package to boost China’s economy.

Against the background of some improvement in risk appetite, and low volatility, the AUD looks like an attractive bet. My view has been consistently constructive on the AUD over past months and I remain of the view that there are further gains in store although in the near term profit taking is expect to emerge around resistance at AUD/USD 0.9342.

Equities weaker, US yields lower, USD softer

The US Federal Reserve’s rejection of capital raising plans by several banks taken together with further confrontation between the US and Russia and a disappointing US durable goods orders report were sufficient to result in a sell off in equity markets, lower US yields and a weaker USD.

Gold failed to benefit in yet a further sign that its bull run has ended, with the metal honing in on its 200 day moving average at 1296.71. On the US data front headline February US durable goods orders beat expectations (2.2%) but core orders (-1.3%) were weaker than expected.

Although the lead for Asia is a weak one markets may still find some resilience due to expectations of policy stimulus from China. Similarly dovish talk from the European Central Bank will offer further support to market sentiment while undermining the EUR somewhat. On the data front today the main releases are US Q4 GDP revision (upward revision likely), and UK retail sales (rebound likely).

USD/JPY volatility at an extreme low

USD/JPY will continue to struggle to break higher in the short term, with the currency pair restrained by capped US yields. Indeed US Treasury yields have slipped over recent days. The range bound trading pattern for USD/JPY has resulted in a declining trend in both implied and realized volatility. The drop in volatility has been particularly sharp, with 1 month volatility at an extreme level according to our z-score analysis.

The implication is that it is cheap to USD/JPY volatility although it may need a trigger from a further increase in US yields and / or major improvement in risk appetite to spur an increase in volatility. Comments by the Bank of Japan’s Iwata yesterday that its not necessarily good if the JPY keeps depreciating is not conducive for higher volatility in the currency pair but likely further stimulus from the BoJ alongside wider yield differentials with the US, will mean that downward JPY pressure will resume soon at a more rapid pace in the months ahead.

High degree of investor caution

Although risk aversion has declined from recently elevated levels there is still a high degree of caution from investors who are unwilling to take long term bets. The causes of market angst have remained unchanged over recent weeks namely Ukraine tensions, weaker growth in China and US data that has performed below expectations.

It is therefore unsurprising that in the wake of a weaker than forecast reading for Chinese manufacturing confidence yesterday and talk of more sanctions against Russia, European and US equity markets fell overnight and Asian equities have began the day on softer footing.

The Markit US manufacturing purchasing managers’ index (PMI) edged lower, but unlike the Chinese PMI, which remained below the 50 boom/bust level, the US reading was healthy at 55.5 in March. The Eurozone equivalent edged lower but continued to show that recovery was still in shape, with the March reading at 53.

The reverberations from Fed Chairman Yellen’s comments last week also inflicting some damage, with gold prices in particular succumbing to pressure and verging on a test of the 200 day moving average around 1296.83. A heavy slate of data today includes the German March IFO survey, UK CPI inflation, US March consumer confidence and February new home sales.

Eurozone data releases this week

There are several first tier Eurozone data releases on tap this week including March flash purchasing managers indices (PMIs), preliminary HICP inflation and the March IFO business confidence survey.

We look for a slight increase in the “flash” composite PMI, with the data restrained by concerns about China and the Ukraine. Inflation in March could move lower, while the German IFO survey is expected to flat. The data will not be particularly spectacular but ought not to detract from the fact that growth momentum in the Eurozone is picking up.

Lower inflation may provide more support to lower policy rates from the European Central Bank but some of the pressure on the ECB to ease policy rates may have eased given the decline in the EUR last week.

After last week’s sharp drop EUR/USD is likely to consolidate around 1.3800 over coming days.

US dollar to consolidate gains

Markets last week were spooked by comments from Fed Chairman Yellen and the upward drift in Fed Funds projections which appeared to indicate a rate hike would take place around the spring of 2015.

This week will give the chance for Fed officials to either downplay or reinforce Yellen’s comments. There are several Fed speakers on tap over coming days including Stein, Lockhart, Plosser, Bullard, Pianalto and Evans.

Despite Yellen’s comments US equity markets ended the week higher despite Russia’s annexation of Crimea. US bonds yields also firmed over the week while the USD rebounded.

Sentiment this week will depend in part on further Fed commentary as noted above, Chinese data and also whether tensions between the West and Russia intensify. Reports that Russia has built up a “very sizeable” force on its borders with Ukraine do not bode well in this respect.

US data this week will look less weather impacted and will err on the positive side. Consumer confidence is set to be unchanged in March, while February new home sales are set to decline but durable goods orders are set to rise. Q4 GDP is likely to be revised higher and personal income and spending will reveal healthy gains in February.

Overall, the USD is expected to consolidate its recent gains will some improvements on the data front will interest rate markets will remain under pressure.

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