It was a “risk on” beginning of the week as equity markets rallied, commodities prices rose, and G10 bonds and USD came under pressure. Stronger manufacturing PMIs helped to boost confidence in the global economic recovery, with solid PMIs revealed in China, and across the rest of Asia, UK, and the US. The US ISM manufacturing which rose to its highest since April 2006 also revealed a rise in the unemployment component, consistent with view of an unchanged reading for December payrolls.
In the Eurozone the PMI matched the flash release and remained in expansion territory though there was some slippage in Germany, Spain, and Italy, underscoring the likely underperformance of the Eurozone economy relative to expectations of faster recovery in the US. Nonetheless, the PMIs continued to show a picture of expansion, with the Eurozone PMI at its highest in 21-months.
The USD lost ground against the background of improved risk appetite and looks set to fall further abruptly ending its short covering rally. The USD appears to be finding little support from interest rate expectations, with the correlation between most currencies and relative interest rate differentials remaining relatively low for the most part (just -0.04 over the past 3-months between the USD index and US rate futures). The correlation between the USD and US 10-year bond yields looks somewhat stronger however, and could offer some relief to the USD if yields continue to push higher.
Speculative (CFTC Commitment of Traders) data reveals just how massive the shift in USD positioning has been over recent weeks, with net aggregate USD positioning (vs EUR, JPY, GBP, AUD, NZD, CAD, CHF) registering its first net long USD position since May 2008. The swing in positioning has been dramatic, from -167k contracts on 15 September 2009 to +8.7k in the week ending 29th December 2009. The data also reveals the sharp deterioration in sentiment for the EUR to its lowest since September 2008. Likewise net JPY positions have shifted to their biggest net short since August 2008.
What does this imply? The market is very short EUR and JPY but the JPY has much further to go on the downside as it increasingly retakes the mantle of funding currency. In any case compared to historical positioning JPY shorts are not so big suggesting more room to increase short positions.
The EUR has moved into a short term uptrend, with the MACD (12,26,9) having crossed its signal line and positioning supports further upside. EUR/USD will need to take out strong resistance at 1.4459 (December 29) before it can embark on a more significant move higher. Asian currencies also look set to take more advantage of a resumption of USD weakness, especially in the wake of strong risk seeking capital flows into the region. KRW, TWD, IDR and PHP look bullish technically.