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.

Swiss franc under pressure

The US debt ceiling continues to garner most attention in markets, with US Treasury Secretary Geithner warning in a letter to Congress about the adverse economic impact of the failure to raise the ceiling. President Obama gave a similar warning, but with current extraordinary measures due to run out between mid February and early March timing is running out.

While Fed Chairman Bernanke echoed this assessment markets found some relief in his speech as it did not repeat the views of some Fed officials in hinting at an early ending of QE. Bernanke qualified his comments by stating that believes that inflation will stay below 2% over the medium term.

EUR/USD could not hold onto highs around 1.3404 but the currency pair does not looks as though it is running out of momentum. As sentiment towards the Eurozone periphery continues to improve and inflows into Eurozone assets increases the EUR is finding itself as a key beneficiary. However, the strength of the currency will only reinforce the weak economic backdrop across the region, which eventually will come back to bite the EUR.

Indeed data today is likely to confirm that the German economy recorded a weak pace of growth over 2012 finishing the year with a contraction in activity over Q4. Our forecast of no growth in the Eurozone this year could face downside risks should the EUR continue to rise. This is unlikely to stem the near term upside for EUR/USD but adverse growth and yield differentials compared to the US will mean that gains in EUR/USD will not be sustained.

The long awaited move higher in EUR/CHF appears to be finally occurring. EUR/CHF is trading at its highest level in over a year and looks set to make further gains. The fading of Eurozone crisis fears, better global economic developments and search for yield, are combining to pressure the CHF versus EUR although USD/CHF is trading near multi month lows.

Additionally improving sentiment outside of Switzerland is not echoed within the country as domestic indicators have worsened recently such as the KoF leading indicator, adding further pressure for a weaker CHF. Recent inflation data revealing a 0.4% YoY in December, the 15th month of annual declines have reinforced the fact that the currency is overly strong. EUR/CHF looks set to move higher, with the December 2011 high of 1.2444 the next target.

Highlights this week

Better than expected Chinese data over the weekend, speculation that Greece is close to reaching its debt buyback target and even some signs of progress in reaching a resolution to avert the fiscal cliff set up risk assets for a generally positive start to the week. Talks between the administration and senior Republicans will continue this week but it appears that some senior Republicans are willing to give up their objections to tax hikes on the very wealthy.

The November US jobs report released at the end of last week which revealed a 146k increase in payrolls and a drop in the unemployment rate to 7.7% is likely to have little influence at the turn of the week. The report was met with a muted reaction. While on the face of it the data was better than expected, downward revisions to past months and a surprising lack of impact from Hurricane Sandy left markets somewhat perplexed.

However, not everything is rosy. Last week’s sharp downward growth revisions to Eurozone growth by the European Central Bank (ECB), a plunge in US consumer sentiment and comments from Italian Prime Minister Monti that he intends to resign will cast a shadow over markets, restraining any upside.

Although activity will likely continue to thin as holidays approach there is still plenty too chew on this week. In the US the Fed is set to continue purchasing USD 85 billion of longer dated securities following the end of Operation Twist but this should come as little surprise to the market and therefore will yield little reaction. There will be some encouraging news on the consumer as retail sales bounce back in November.

Across the pond the European Council meeting beginning on Thursday will be in focus, with banking union and bank recapitalisation among the topics up for discussion. Given the hint of monetary easing by the ECB markets will scrutinise upcoming data for the timing but a likely increase in the German ZEW investor confidence survey in December and stabilisation in the Eurozone composite purchasing manager’s index will not prove compelling enough to warrant an imminent rate cut.

Elsewhere in Japan the upcoming elections will mark the highlight of the calendar over the weekend although the weaker than expected Q3 GDP reading this morning (-0.9% QoQ) and expected deterioration in the Tankan survey later in the week will maintain the pressure for more aggressive policy action and a weaker JPY.

EUR took a hit from the ECB’s dovish stance last week and will not take too kindly to the news of Monti’s intended resignation after the fiscal 2013 budget in Italy. EUR/USD 1.2880 still marks a solid support level for the currency.

USD/JPY continues to probe higher but extreme short market positioning will likely limit the ability of the currency pair to push higher. On the topside 83.15 will market strong resistance for the currency pair.

AUD and NZD look generally well supported, with Chinese data over the weekend giving further support although for AUD/USD 1.0519 will continue to act a tough technical barrier to crack.

USD under broad based pressure

There remains a great deal of angst in markets due to the lack of resolution to the US fiscal cliff, which is putting pressure on overall market sentiment as reflected in the multi day rise in the VIX fear gauge over recent days. The fact that both the US administration and senior Republicans are giving little ground in discussions suggests a deal is not in sight although the pressure for compromise will intensify as year end approaches.

The news in Europe is a little better as reflected in the narrowing in peripheral bond yields. There will be little directional influence on markets today, with trading likely to be subdued ahead of the US jobs report on Friday, with any news on the fiscal cliff also closely watched.

The USD continues to come under broad based pressure, with the USD index having lost around 2% of its value since 16 November. The lack of traction in terms of resolving the fiscal cliff and the weaker US data this week, namely the November ISM manufacturing index have weighed on the currency.

How much of the USD move is due to position adjustments as year end approaches fast or renewed confidence in the EUR is debatable but it is clear that the USD looks like it will end the year in a bad state. The ADP jobs report today may give further direction but it seems unlikely that pressure on the USD will abate ahead of the November payrolls data on Friday.

While the EUR’s gains are beginning to look overdone, the momentum for the currency continues to be to the topside as short positions continue to be covered into year end. The EUR’s appreciation is taking place hand in hand with the drop in peripheral bond yields. A positive reception for Greece’s debt buy back as well as Spain’s request for aid for its banking sector has also helped the currency.

Rumours of a German debt downgrade have done little to diminish the EUR’s appeal. An upcoming meeting of EU finance ministers next week ahead of the EU leaders’ summit to try and make some progress towards banking supervision is also hoped to deliver some good news. A test of sentiment will come from a Spanish bond auction today but this is unlikely to be much of an obstacle to the EUR. Near term EUR/USD resistance is seen around 1.3172.

Putting the brakes on the CNY

Markets are becoming increasingly headline driven, with risk appetite gyrating on any fresh lead on fiscal cliff developments. Initially risk assets dropped in the wake of weaker than expected US new home sales data and renewed fiscal cliff concerns but reversed course following more encouraging comments from US House speaker Boehner and President Obama who both indicated that a deal was moving closer to fruition. The comments also sparked a drop in the USD while gold prices came under pressure.

Meanwhile, Eurozone peripheral bond spreads continue to tighten in the wake of the Greek debt deal as tail risks continue to decline. An Italian debt auction may test the market’s new found confidence today. Incidentally the deal will be put to the vote tomorrow in Germany. Data releases are generally taking a back seat to fiscal cliff developments but once again there will be stark contrasts between Europe and the US, with weakening economic sentiment indicators in Europe on the one hand and an upward revision to US Q3 GDP on the other.

Currencies will continue to track the gyrations in risk, but in large part remain in well defined ranges. EUR/USD reversed its losses as fiscal cliff resolution hopes grew but will struggle on the top side. Comments by Moody’s in its credit review on Greece released this morning will also dent EUR sentiment with the ratings agency noting that Greek debt remains unsustainable even after the country’s debt deal. EUR/USD resistance is seen around 1.3023 while support around 1.2870 is expected to hold over the near term.

USD/JPY pushed back above the 80.00 level overnight but I would prefer to sell the currency pair on any run up to 82.50. While weak data such as the bigger than expected decline in October retail sales (-1.2% YoY) highlight the need for more aggressive policy, the “Abe” effect has largely been discounted and markets may wait for elections on December 16 before deliberating on further JPY direction. Ultimately I remain JPY bears but in the near term the up move looks overextended.

China has put the brakes on the CNY as fixings have been less strong over recent days. Given the strong correlation with many other Asian currencies this is resulting in more restraint across the Asian FX spectrum. The most impacted currencies will be the KRW and TWD, as they possess the highest sensitivities to CNY. A slowing in the pace of portfolio inflows, with notably South Korea and Indonesia seeing outflows of equity capital over the month, will also restrain Asian currencies.

Fade gains in the euro

The USD’s drop over recent days has almost wiped out half its rally since October 17. Only the JPY has lost ground over this period. More modest weakness is in prospect for the USD in the short term although I do not look for the currency to drop sharply. Given their strong correlations with the USD index any decline will bode well for EUR, GBP, SEK, CHF, CAD and several emerging market currencies.

Most commentators are ascribing USD weakness to the improving risk appetite but the USD index has maintained a low sensitivity to my risk aversion barometer, suggesting that the relationship is tenuous at present. The reality is that there is probably a bout a profit taking rather than any major shift in USD sentiment and this is set to continue for the time being.

EUR/USD’s impressive resilience over recent weeks highlights the hurdles to anyone wanting to short the currency. Underling EUR support remains firm as reflected in the recent turnaround in the Eurozone basic balance position (direct investment + portfolio flows + current account) while there may also be an element of FX reserves recycling flows providing support of the EUR.

Additionally the market has been giving Eurozone officials the benefit of the doubt with regard to a Greek debt sustainability solution and the lacklustre reaction of the EUR following the Greek deal this morning highlights that much was already priced in. The deal which effectively lowers interest rates that Greece has to pay on its debt while giving it more time to pay the debt paves the way for a EUR 34.4 billion loan tranche in December.

Finally, the threat of ECB Outright Monetary Transactions (OMT) activation continues to threaten to provide a major back stop to any EUR pressure. At current levels the upside for the EUR looks far less compelling. I suggest taking profits / fading the rally on any test of resistance around EUR/USD 1.3030 and EUR/GBP 0.8120.

USD pressured, limited gains for Asian currencies

Risk assets registered a positive performance over the past week despite the plethora of events / issues that remain unresolved. However, it’s back to business today with talks over Greek’s debt sustainability and resolution towards distribution of its next loan tranche set to resume.

Meanwhile, markets will digest the results of elections in the Spanish region of Catalonia which have fuelled greater uncertainty in the wake of the gains in seats for pro-referendum parties who won 87 of the Catalan parliament’s 135 seats. However, the results did not provide the strength of support for pro independence parties as had initially been feared, suggesting some relief for the EUR.

Together with the failure to make any progress on the EU budget it is clear that there are still many layers of uncertainty lying ahead for European markets. Nonetheless, optimism appears to be winning the day as the EUR and peripheral bonds shake off such concerns. The risk going forward is that the market is hoping for too much, with the risk / reward dynamic skewed asymmetrically in the wake of any failure to reach agreement especially regarding Greece.

News of healthy US Thanksgiving spending will be followed by data releases this week that are set to provide further signs of improvement although markets will remain focussed on any progress towards resolving the fiscal cliff. An upward revision to US Q3 GDP, gains in durable goods orders, and new home sales in October will provide encouraging news contributing to a tone of firmer risk appetite. This will be echoed by the Fed’s Beige Book.

Economic news in Europe (expected lower economic sentiment index) and in Japan (fourth consecutive decline in industrial production) will highlight the comparative outperformance of the US economy while adding pressure for more aggressive policy measures elsewhere.

The net FX impact of the market’s optimism is to sell USDs leaving it vulnerable in an environment of improving risk appetite. Nonetheless, given that the market is now pricing in a resolution to several of the issues noted above, USD weakness may prove limited from current levels. EUR/USD is set to face resistance around the 1.3023 level while USD/JPY will face strong resistance around 83.20.

Asian currencies have benefitted from the firmer tone to risk appetite (most except IDR and INR are strongly correlated to risk) but gains have been limited over the past week as central banks in the region increasingly resist further strength. The lack of upward trajectory in the CNY has been a key driver for the slower pace of appreciation of Asian currencies over recent days and I expect this trend to continue.

China may even countenance some softening in the CNY into year end suggests limited upside for Asian currencies into year end despite a firmer risk tone. The INR remains the major underperformer, with the currency continuing to suffer from domestic considerations, and benefitting the least from any improvement in risk appetite.

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