Consolidating ahead of payrolls

Ahead of the belated release of the US September jobs report markets are set to remain range bound, with most assets consolidating recent moves. For instance, the VIX “fear gauge” edged higher following steep declines while US Treasury yields gained a few basis points helping the USD index to push slightly higher. Equity investors will have one eye on earnings reports hoping that the recent run of positive Q3 US earnings surprises continues.

The consensus for US September non farm payrolls is 180k, with a low of 100k and high of 256k according to Bloomberg and unemployment rate likely to remain 7.3%. The data will have important implications for Fed tapering expectations, with the outcome likely to help support expectations that the Fed will not begin tapering until early next year.

Like other asset classes little movement is expected in FX markets ahead of the release of the US jobs report. A payrolls outcome around the consensus will have little market impact but it appears that the consensus is skewed towards a weaker outcome, suggesting a bigger FX reaction should there be an above consensus outcome (around 200k+).

Both the EUR and JPY are struggling to make further headway against the USD. There is nothing of note on the data front from the Eurozone or Japan today suggesting that attention will be mainly centred on US data. Stabilisation in US bond yields leaves the USD in better form against both currencies and given that a lot of bad news is now priced into the USD its downside looks more limited although much will depend on today’s jobs data.

The AUD is the outright winner in terms of gains versus the USD so far this month alongside other commodity currencies, NOK and NZD. AUD has benefitted from receding expectations of interest rate cuts, and firmer Chinese data alongside improving risk appetite. While I have been far more bullish than the consensus on AUD, it may be worth taking profits on recent gains versus USD as consolidation is likely in the short term. I see more scope for gains in AUD versus NZD over coming weeks, however.

USD firm but running into resistance

Happy New Year!

The consensus view for 2013 favours equities over bonds helped by expectations of a sustained improvement in risk appetite as tail risk diminishes further. Additionally relative valuations support the consensus. So far equities are on track although it may be a mistake to make a strong judgement based on the first week’s trading.

The US December jobs report provided more evidence that the US economy will trundle along this year at a modest pace of growth. Meanwhile, the US fiscal cliff agreement may have played into a tone of firmer risk appetite but the fact that in less than two months there may be even greater tensions on the debt ceiling and spending cuts suggest that a one way bet of improving risk appetite can by no means be guaranteed.

The USD has begun the year in firm shape appearing to break free from the constraint of improving risk appetite at the turn of the year. In part its strength especially against the JPY can be attributed to higher US bond yields which in turn was pushed higher by less dovish than expected Fed December 11-12 FOMC minutes last week. Given that yields are running into technical resistance the USD may find less support from this source over coming days.

A light data week will give little directional impetus to the USD, with highlights including trade data, consumer credit and small business confidence. Instead the USD will take its cue from various Fed speakers who will likely provide more elaboration on their views on an eventual exit from QE. The USD is likely to remain firm in the short term although we would be wary of extrapolating trends based on early year moves.

In contrast to the limited US data schedule there are plenty of data releases and events in Europe to digest this week including the European Central Bank Council meeting. The ECB is unlikely to ease policy at this meeting, with those in the Council against a cut unlikely to have shifted their stance although a rate cut, possibly in March remains on the cards. Data releases will continue to show weakness although importantly sentiment surveys will stabilise rather than drop further.

Sovereign debt issuance may take more importance for the EUR this week, with Austria, Belgium, Italy, Germany, Italy and Spain all scheduled to issue debt. Given the better risk environment a generally favourable reception to the debt issues will give the EUR some solace, likely preventing the currency from sliding further. Strong EUR/USD technical support is set to come just below 1.3000 at 1.2996.

Equity flows to Asia surge

Equity flows to Asia have begun the year in solid form. Although not quite as strong as in 2010 the pace of recent acceleration in flows has been more rapid, suggesting that it will soon overtake the year to date inflows seen over 2010. In total Asia has registered around $4.955 billion in foreign equity inflows. Korea has received the biggest inflows at $2.4 billion followed by India $1.04bn and Taiwan $1.03 billion.

The Indian rupee (INR) has been a clear beneficiary of such flows while the Korean won (KRW) has also strengthened. I suspect that official resistance may have limited Taiwan dollar (TWD) gains but clearly the risk on start to the year has resulted in strengthening inflows and in turn stronger Asian currencies.

Unless there is a disaster in Greece or elsewhere in Europe next week there is little to stop the short term trend but I remain wary over coming weeks and am cautious about extrapolating this trend forward. Like in 2010 and 2011 equity flows began the year strongly only to drop over following weeks and currencies were not slow to follow.

Resilient Markets

Risk assets have registered a good start to the year despite ongoing tensions in the Eurozone. US stocks rose overnight, with the S&P 500 extending its rally to 4% year to date. Evidence that markets are becoming increasingly resilient to bad news emerged from the muted reaction to sharp downgrades in growth forecasts by the World Bank, with the world economy expected to grow by 2.5% this year compared to a June forecast of 3.6%.

US markets also reacted positively to news that the US NAHB Homebuilders index rose to its highest level in more than 4 years and while industrial output expanded, albeit less than expected. Markets will continue to keep one eye on earnings to ascertain whether the equity rally can be sustained, with at least 48 S&P 500 companies reporting earnings this week including Morgan Stanley Bank of America, Intel and Google today. So far, relatively more companies have fallen short of expectations than have beaten expectations.

Even in the Eurozone the news has been slightly more encouraging than of late, with reports that a deal between Greece and private creditors on the extent of debt writedowns could be reached by the end of this week. Moreover, the International Monetary Fund (IMF) is reported to be raising $500 billion in new funds for bail out funds, another factor that has helped to shore up market sentiment. The net result has been to see peripheral bond yields ease further and the EUR to strengthen, helped by the fact that the market is extremely short.

There is still plenty of event risk on the horizon, however, including debt auctions in Spain and France today although these ought to pass relatively smoothly. US data are likely to be mixed today, with benign inflation keeping the door open to more Fed quantitative easing (QE) while a gain in the Philly Fed manufacturing survey will continue to reveal signs of economic recovery. In the short term risk assets look supported but given the risks ahead any bounce still looks to be short-lived.

Euro sentiment dives to a new low

Equity markets in Europe began the year in positive mood, with gains led by the German DAX index following the release of firmer than expected readings for Eurozone purchasing managers indices (PMI). Chinese data which showed an increase in its PMI also helped to boost sentiment. The Eurozone data however, remained at a weak level, contracting for a fifth month in a row, and still consistent with Eurozone recession.

It seems unlikely that equity gains will be sustained over the rest of this week, with risk aversion set to remain elevated against the background of ongoing Eurozone debt and global growth concerns. Indeed, both French and German leaders in their new-year messages warned about the risks ahead. A meeting between Germany’s Merkel and France’s Sarkozy is scheduled for January 9th ahead of an EU Finance Ministers summit on January 23rd. It is unlikely that there will be any significant policy decisions in Europe before then.

Meanwhile, press reports noting that Germany is pushing for an even bigger write down of Greek debt than previously agreed will only add to risk aversion over the short term. The report in the Greek press highlighted the prospect of a 75% write down of Greek debt a far cry from the 20% proposed some months ago. Eurozone markets continue to be haunted by the prospects of credit downgrades by major ratings agencies at a time when many countries have to issue large amounts of debt to satisfy their funding requirements.

Against this background the EUR is set to remain under pressure, with a notable drop below EUR/JPY 100, its lowest level in over a decade registered. Reflecting the deterioration in sentiment for the currency, EUR speculative position hit an all time low at the end of last year according to the CFTC IMM data. This is unlikely to reverse quickly, with sentiment set to deteriorate further over coming weeks and months as the EUR slides further.

Germany Caught in the Contagion

Equity markets came off their lows overnight despite a 236 point drop in the Dow Jones, but sentiment remains extremely fragile and any let up in pressure on risk assets will prove temporary. A weak bond auction in Germany highlights the severity of contagion across Europe. If the core is being hit then there is no safe haven in Europe anymore. On a positive note it might just make German officials finally realise that they need to act quickly to provide solutions to the crisis.

Weak data notably outside the US adds to the malaise, with in particular China’s HSBC November weaker purchasing managers’ indices coming in below the 50 boom/bust level. Europe’s weaker purchasing managers indices highlight the prospects of looming recession while the news in Germany is not only bad on the bond front bad also on the data front. Today’s German November IFO survey will continue in the same vein, with further weakness in this business survey expected.

Bearing in mind the US Thanksgiving holiday today thin liquidity will mean that conditions are ripe for exaggerated market moves. EUR/USD has already sustained a drop below the important 1.3500 level as even the underling strong Asian demand appears to have been pulled back. More downside is expected but technicals suggests that it will be hard trudge lower, with near term support seen around 1.3285 (10 day Bollinger Band). The near term range is likely to be 1.3285-1.3505 although given the US holiday the range may be even tighter.

Aside from the IFO attention today will focus on a meeting between Chancellor Merkel, President Sarkozy and Prime Minister Monti. As usual expect a lot of hot air but little action. Also note there is a general strike in Portugal today protesting against austerity measures in the country.

Eurozone contagion spreading quickly

Contagion from the eurozone debt crisis is spreading quickly, threatening to turn a regional crisis into a global crisis. As highlighted by Fitch ratings further contagion would pose a risk to US banks. Consequently risk assets continue to be sold but interestingly oil prices are climbing. Taken together with comments earlier in the day from the Bank of England that failure to resolve the crisis will lead to “significant adverse effects” on the global economy, it highlights the risks of both economic and financial contagion.

Predominately for some countries this is becoming a crisis of confidence and failure of officials to get to grips with the situation is resulting in an ever worsening spiral of negativity. Although Monti was sworn in as Italian Prime Minister and Papademos won a confidence motion in the Greek parliament the hard work begins now for both leaders in convincing markets of their reform credentials. Given that there is no agreement from eurozone officials forthcoming, sentiment is set to worsen further, with safe haven assets the main beneficiaries.

EUR/USD dropped sharply in yesterday’s session hitting a low around 1.3429. Attempts to rally were sold into, with sellers noted just below 1.3560. Even an intensification of bond purchases by the European Central Bank (ECB) failed to prevent eurozone bond yields moving higher and the EUR from falling.

Against this background and in the absence of key data releases EUR will find direction from the Spanish 10 year bond auction while a French BTAN auction will also be watched carefully given the recent increase in pressure on French bonds. Having broken below 1.3500, EUR/USD will aim for a test of the 10 October low around 1.3346 where some technical support can be expected.

US data releases have been coming in better than expected over recent weeks, acting to dampen expectations of more Fed quantitative easing and in turn helping to remove an impediment to USD appreciation. While the jury is still out on QE, the USD is enjoying some relief from receding expectations that the Fed will forced to purchase more assets. Further USD gains are likely, with data today including October housing starts and the November Philly Fed manufacturing confidence survey unlikely to derail the currency despite a likely drop in starts.

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