Market angst remains

The same themes continue to worry markets, with Ukraine and China cited on a daily basis as the main causes of market angst. Additionally there is a growing feeling that US equity indices may have topped out given the lack of additional impetus from earnings or economic data.

There is not much on the data front today that will change this dynamic for markets and what there is will be unimpressive, with US retail sales set to have remained soft in February (consensus 0.2%) as bad weather hit spending.

The main market movers overnight have been commodity prices which continue to weaken, with the CRB commodities index falling while the Baltic Dry Index also took a tumble. Gold continues to outshine hitting a high of $1375 per ounce, benefitting from the continued rise in risk aversion while in contrast copper prices dropped to a four year low around $6495 before rebounding slightly.

USD/JPY close to breaching 100

Japan and the JPY continue to garner most market attention as the currency’s weakness continues to extend, leading to pressure in closely correlated currencies and markets especially in Asia, notably in Korea. European tensions have not eased to any significant degree with some praise for Portugal’s attempts to overcome a constitutional court ruling on planned budget cuts but little progress elsewhere including in Italy where there is no sign of any agreement on the formation of a new government.

Equity markets in the US edged higher but direction will come from the host of Q1 earnings announcements over coming weeks as the US earnings seasons kicks in. Commodity prices continue to remain weak, with the CRB commodities index trading its lowest level in several months while the Baltic Dry index also continues to move lower, pointing to a slightly more negative outlook on the growth front.

USD/JPY has continued its ascent following the inspiration provided by the BoJ last week from its surprisingly aggressive new policy measures. The sharp move higher in USD/JPY over recent days is all the more impressive given that the US yield advantage over Japan has actually narrowed over the period while risk aversion has crept higher.

The market is clearly giving BoJ governor Kuroda the benefit of the doubt and it appears that there are plenty of JPY sellers on any rally in the currency. While I am a bit cautious in the near term about the ability of USD/JPY to push much higher it is clear that the trend is well in place for further JPY weakness and it is worth noting that speculative JPY positioning is not yet at extreme levels.

My model on USD/JPY based on yield differential and risk forecasts suggests that USD/JPY will be able to sustain a break above 100 over coming weeks and on this basis I have revised my forecasts. I now expect USD/JPY to reach 104 by end 2013 and 110 by end 2014 from 97 and 101 previously.

I look for further gains in GBP. Against the EUR, GBP has underperformed recently but we do not see GBP weakness persisting especially given the weight of negative factors building up for the EUR. A likely bounce in February UK industrial production today will build on the better than expected reading for UK March house prices as revealed in the RICS data this morning (-1% compared to consensus of -5%) while the BRC retail sales survey also came in better than expected with like-for-like sales rising by 1.9% in March.

The firmer data readings will provide some support for GBP over the short term and will likely help to fuel short covering in a speculative market that is still heavily short GBP according to the CFTC IMM data. I look for GBP/USD to breach technical resistance around 1.5393 over coming sessions, with any pull back likely to be restricted to support around 1.5159.

USD buoyant

After finally returning from a two week trip visiting clients across North America it appears that the USD continues to remain in buoyant mood. I have been highlighting the prospects for a stronger USD against major currencies for some time and this has been borne out by the strong USD performance since early February.

Despite a lackluster performance for US stocks overnight overall sentiment remains largely upbeat as reflected by the fact that my risk barometer has breached its lower threshold and has moved into risk loving territory. Similarly the VIX fear gauge is trading at multi year lows although it did move higher overnight.

The sharp drop in UK industrial production and a warning by the Bundesbank’s Weidmann that the Eurozone crisis was not over added a dose of caution to the market. On a more positive note the Baltic Dry Index is at its highest level so far this year, sending a positive signal for global growth expectations.

While there is still much wrangling in the US over budget proposals, and in Europe, Italian political uncertainty continues, markets remain focused on the positives of improving growth against the background of highly accommodative monetary policies. Nonetheless, the divergence between the US and Europe in terms of growth is set to continue. A likely bigger than forecast increase in US February retail sales in contrast to a bigger than forecast fall in Eurozone industrial production in January will attest to this.

EUR/USD has managed to garner a semblance of stability over recent days, with the currency pair finding it difficult to sustain any decline below the psychologically important 1.3000 level. The drop in EUR/USD over much of February has been more aggressive than implied by the performance of Eurozone peripheral bonds but this is no surprise given that this is not the biggest influence on the currency.

Instead the explanation for the EUR decline is found when viewing the move in US 2 year Treasury yields relative to 2 year bunds. The strong correlation with EUR/USD highlights this relationship, reflecting the impact of lower bund yields and higher Treasury yields. The EUR’s stability over recent days is therefore a function of a slight drop in the US yield advantage.

Given that the trend of firmer US data and weaker Eurozone data is set to continue, this stability is likely to be short lived. Our quantitative model suggests EUR/USD may rally in the short term but we suggest selling into it.

GBP/USD’s decline has continued unabated and there appear to be little to stand in the way of further weakness apart perhaps from the fact that a lot of bad news is priced in. Sentiment for GBP has clearly deteriorated as reflected in the CFTC IMM data revealing four straight weeks of negative positioning. The deviation with the 3 month average positioning has widened significantly, highlighting the pace of the move but also that the drop is beginning to look excessive.

Nonetheless, the bigger than expected drop in January industrial production data revealed yesterday has helped to compound the negativity towards the currency in the wake of deteriorating economic data and in turn heightened expectations of more BoE quantitative easing. Strong technical support around GBP/USD 1.4767 may hold in the short term but momentum indicators are showing no sign of a slowing in GBP selling pressure.

For GBP bulls (if there any left) there may be more value in looking to eventually re-enter long positions against EUR but we would not rush into this trade. .

Bullish INR but other Asian currencies held back

Although the European Central Bank (ECB) left policy rates unchanged the post meeting press conference effectively opened the door to a rate cut in Q1 next year following sharp downward revisions to growth projections and well below target inflation projected over the medium term. A major casualty of the shift in ECB tone was the EUR which dropped over one big figure from a high of around 1.3089. Technical support for EUR/USD is now seen around 1.2885.

The Baltic Dry Index has continued to decline over recent days sending an ominous signal for growth ahead. Meanwhile, once again politics cast a shadow over European markets as Italy’s government overcame a confidence motion, with ex Prime Minister Berlusconi’s PDL party threatening to withdraw support and bring down the government.

Trading is likely to remain thin today as markets await the US November jobs report. The report will undoubtedly be soft (consensus is for an 85k increase in November payrolls) but as much of the weakness in jobs growth will be due to Hurricane Sandy the market impact is likely to be muted leaving a likely constructive tone to risk appetite going into next week.

Asian currencies continue to take direction from the CNY, with the lack of upside traction in this currency leaving most Asian currencies within ranges despite the fact that equity flows to Asia have been very strong over recent days, with inflows of over $2 billion registered this week alone. The implication is that central banks in the region have become increasingly active in preventing Asian currency strength.

One currency that has a limited influence from the CNY is the INR and this currency continues to outperform on reform hopes. The passage through India’s lower house of parliament allowing foreign investment into retailers was encouraging and hopes have grown that it will be followed by passage in the upper house. Further gains in the INR are seen over coming sessions, with a short term break below USD/INR 54.00 looming.

USD under pressure, AUD resilient

Risk assets registered further gains in the wake of speculation that Spain is close to requesting aid and stronger than forecast US Q3 earnings and economic data. US earnings have beaten expectations at 73% of the 48 companies reporting while US industrial production rose by a bigger than expected 0.4%. Meanwhile German resistance to a full Spanish aid appears to be crumbling as the door opens wider to a formal Spanish request for a credit line.

Additionally German data was a big more encouraging as the German ZEW investor confidence survey recorded its second straight monthly gain. Aside from rallying global stock markets the Baltic Dry Index continued its ascent and even gold prices showed some stability around the $1750 level. There is little to distract from the more positive market tone today, with US earnings and the EU Council meeting in focus.

The USD has come under renewed pressure as risk appetite improves. Firmer US data has contributed to improving risk appetite which in turn would usually be expected to weigh on the USD. However, better data may also act to lessen expectations of the magnitude of Fed QE, which should play positive for the USD. This is the theory but in practice the USD relationship with risk aversion has slipped while a lot of QE expectations were already built into the currency.

I don’t see the pressure on the USD intensifying much further. Conversely the EUR remains very well supported as hopes grow of a Spanish request for bailout funds. I believe expectations of concrete action at the EU Summit beginning tomorrow are overdone, with significant decisions on Spain and Greece only likely in November. EUR/USD will struggle to break above resistance at 1.3180.

AUD bears failed to garner support yesterday as the currency easily overcame a blip lower in the wake of the RBA minutes yesterday. While sounding dovish there was little new in the minutes, with no fresh information on future policy actions. In any case markets have already priced in further easing at the 6 November RBA meeting suggesting little further risk to the AUD. Following its failure to build on any downside momentum AUD/USD looks set for a test of resistance around 1.0404, consistent with the upside signal from my quantitative model.

One impediment to AUD gains is the fact that speculative market positioning remains long. However, positioning is now much lower than its three-month average and well off its recent highs suggesting that there is less likelihood of a further bout of profit taking or position squaring. Reduced long positioning will allow the AUD to recoup some lost ground.

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