Risk aversion edging higher

As the reverberations from China’s poor trade data, weaker loan growth and money supply, as well as continued tensions in the Ukraine ahead of a referendum next Sunday, spread through the market, risk aversion continues to edge higher according to our risk barometer.

Lingering questions over the weather impact on the US economy are also capping risk appetite even after the better than expected US jobs report at the end of last week. Although there is no sign of any panic selling of risk assets at present the tone is decidedly cautious.

Consequently safe haven assets remain in demand, with for example gold prices holding up well and US Treasury yields being capped. Additionally industrial commodity prices have taken a hit, with iron ore prices under major pressure.

There is little on the agenda today that will give a clearer picture for markets, with the Bank of Japan policy meeting and UK industrial production data, the key events for the day. As a result, caution is likely to prevail.

GBP/USD struggling above 1.6700

Although the Bank of England meeting is likely to be a non event today from a market perspective GBP/USD is clearly struggling to sustain a move above 1.6700. GBP/USD has breached 1.6700 12 times since mid February but only closed above this level 4 times. Over the near term strong resistance around 1.6769 will cap gains in the currency pair, with GBP continuing to look vulnerable above 1.6700. Some recent misses on the data front have not helped GBP’s cause, suggesting that caution for GBP bulls is warranted. GBP bulls may find more traction versus EUR instead of USD, with EUR/GBP set to come under further downward pressure as the EUR weakens anew. A break below 0.8200 beckons.

USD undermined, GBP supported for now

Despite its overnight bounce the USD index is trading close to its lowest levels this year undermined by a series of weaker economic data and related to this a failure of US bond yields to push higher. Alongside this relatively soft USD tone is a generally subdued and range bound tone to FX markets in general.

Even my quantitative models suggest little impetus for big moves in EUR/USD and USD/JPY. However, I expect this to change over coming weeks. Once the US economy shakes off the shackles of poor weather conditions the USD will be in a better position to recoup its recent losses.

In the near term Fed Chairman Yellen’s testimony today will garner some attention but the speech is unlikely to break the USD or FX markets out of their malaise.

GBP is holding up well, taking advantage of a subdued USD tone. As a consequence of firmer data the market appears to be gearing up for an eventual rate hike, with Bank of England members sounding more upbeat, even if it is unlikely to occur anytime soon.

Consequently over the near term GBP looks well supported although eventually we expect the currency to settle back to earth. In particular 3 month interest rate differentials with the USD appear to suggest that GBP/USD gains are overdone.

This doesn’t mean that its time to sell now but market positioning has turned more positive over recent weeks, above its 3-month average, suggesting further short term gains will be more gradual, with strong GBP/USD resistance around 1.6745.

Positive tone to be sustained

A quiet start to the week following the President’s Day holiday in the US saw mixed performances among European equity markets overnight. There was however, a continued improvement in risk appetite as indicated by a further decline in the VIX “fear gauge”.

The impulse provided for today’s sessions is limited although markets are likely to get off to a positive start. The USD managed to show some stability following recent pressures, albeit at a low level, while gold prices remained supported above the key 200 day moving average level.

The main event today is the Bank of Japan policy decision which will be watched closely following yesterday’s release of disappointing Q4 GDP data.

The German February ZEW survey is also on tap, with a relatively stable reading likely to be registered although attention appears to be more on the new Italian Prime Minister Matteo Renzie rather than on economic data.

Additionally UK inflation data for January is set to reveal that inflation has dropped below target highlighting that the BoE is going to be in no rush to hike policy rates over coming months

GBP losing ground

The Bank of England is set to keep policy rates and asset purchases unchanged today This will offer little comfort to GBP following its recent falls from its highs around 1.6669 versus USD. GBP has also lost ground against the EUR but this is unlikely to persist. GPB was not helped by the lower than expected purchasing managers index (PMI) manufacturing survey in January although confidence in the manufacturing sector remains at a high level.

In the wake of a quicker decline in the unemployment rate than expected (the unemployment rate fell to 7.1% in the three months through November) the BoE is faced with the risk that their current forward guidance proves inappropriate. The BoE has set a rate of 7% at which it would consider raising policy rates and this could be hit very soon. Given that the BoE is highly unlikely to want to hike policy rates any time soon Governor Carney will need to allay concerns over the prospects of higher policy rates by altering its forward guidance.

Manufacturing and industrial production data tomorrow will give further direction, with healthy gains expected to provide some support to GBP. However, given that the policy meeting today is likely to prove to be a non event the Quarterly Inflation Report next week will quickly move into focus.

GBP/USD appears to be gravitating towards its 100 day moving average around 1.6252 but major technical support is seen around 1.6220.

Follow

Get every new post delivered to your Inbox.

Join 577 other followers

%d bloggers like this: