Risk currencies buoyed

Positive developments helped to buoy markets. Although US durable goods orders were weaker than forecast a jump in US consumer confidence to its highest since February 2011 gave equity markets and risk assets in general a lift. Even in Europe the news was encouraging as Italy managed to auction 10-year debt at a cheaper rate than previously while Portugal passed a third review of its bailout programme and noted that unlike Greece it would need a second bailout.

There was some negative news however, with the European Central Bank (ECB) temporarily suspending the eligibility of Greek bonds as collateral for its funding operations and Ireland calling a referendum on the European fiscal compact. Nonetheless, hopes of a healthy take up at today’s ECB second 3-year Long term refinancing operation (LTRO) will keep markets in positive mood in the short term.

The USD index continues to look restrained when risk assets are rallying. Given the positive equity market mood overnight it is no surprise that the USD came under further pressure while the EUR looks firm ahead of today’s 3-year LTRO by the ECB. Fed Chairman Bernanke’s testimony will give the USD some direction but we do not expect him to deliver any big surprises. EUR/USD will continue to rally if we are correct about a strong EUR 600-700 billion take up at the LTRO but the currency pair will meet resistance around 1.3550.

JPY has lost ground against various cross including USD, EUR and AUD. Much of its weakness is related to widening yield differentials but our models reveal that USD/JPY in particular has overshot its implied value. Unless US yields widen further versus Japan, JPY could even rebound over coming days. EUR/JPY has breached its 200 day moving however, which is a bullish signal for the currency pair. A generally firm EUR tone likely to be maintained in the short term will also be exhibited versus JPY.

Warnings by Swiss National Bank head Jordan reiterating his stance of defending the EUR/CHF floor of 1.20 has done little to push the currency pair higher. EUR/CHF has enjoyed a strong relationship with movements in interest rate differentials. This implies that it will take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Eventually EUR/CHF will move higher but over the short term it is unlikely to move far from the 1.20 level.


Euro pain, Australian and New Zealand dollars vulnerable

EUR appreciation has been painful for many, especially those looking for a turn in the currency over recent days. Unfortunately, for these investors, the EUR may yet strengthen further in the short term before any reversal is seen. Indeed, using valuations to justify a bearish view may not be a particularly strong argument at present given that the EUR trade weighted index is trading close to its historical average level while IMM data reveals that the speculative market remains significantly short EUR.

Additionally, my quantitative models reveal that the short term ‘fair value’ for EUR/USD is close to 1.40. While longer term fair value is undoubtedly much lower, it could take some time before the EUR declines to such levels. This is not encouraging news for EUR bears but there are some signs that the upmove in EUR/USD may not persist. Currently EUR/USD is trading above its 100-day moving average but since July last year, it has failed to remain above its 100 day moving average level for more than a few days.

There are definite signs that commodity currencies are topping out. Both the AUD and NZD have failed to extend gains over recent weeks. Perhaps valuation concerns are finally begging to catch up with these currencies (both are close to 2 standard deviations from average purchasing power parity while my quantitative models reveals a divergence with short term fair value) while speculative positioning according to IMM data remains at high levels. AUD and NZD even look stretched relative to interest rate differentials.

A wider than forecast January trade deficit in New Zealand did not bode well for the NZD but near term direction for both currencies will still depend on the gyrations in risk appetite given the strong correlation that both AUD and NZD have with risk aversion. Notably the the improvement in risk appetite has stalled in February, leaving AUD and NZD exposed to lofty valuations.

Euro on the front foot

The G20 meeting of leaders in Mexico over the weekend did not make much progress in terms of increasing the size of the International Monetary Fund (IMF) or increasing support for the Eurozone. A decision on this has been delayed until the next meeting on 19-20 April. Instead attention has turned to the various bailout votes across Eurozone countries and discussions over increasing the firewall (by boosting the size of the bailout fund) around the Eurozone periphery. Germany continues to oppose any increase in the firewall. Sentiment will hinge this week on the outcome of these events rather than data releases.

The USD has come under growing pressure but this is as reflection of a stronger EUR rather than inherent USD weakness. Data releases in the US have continued on a positive track yet the USD has failed to benefit as higher US bond yields have been matched elsewhere. Business and consumer confidence measures over coming days are also likely to reveal some encouraging outcomes while the Beige Book will report improvement in economic activity but the USD will continue to be restrained.

The EUR is looking increasingly stretched from a fundamental perspective yet technical indicators show it to be on a stronger footing. EUR/USD will find strong resistance around the 1.3550 level and the currency could still stumble over coming days depending on the outcome of Wednesday’s ECB Longer term refinancinf operation (LTRO).

Various policy events will also help dictate EUR direction including national parliamentary votes on the Greek bailout and the EU Summit. Theoretically a large uptake by banks at the LTRO could result in more EUR liquidity and a weaker EUR but the reality is quite different. Improved sentiment in peripheral bond markets as LTRO funds are used to buy local debt are helping the EUR to push higher, with its short covering rally gaining more traction.

GPB has come under pressure in the wake of a stronger EUR, but we still expect EUR/GBP’s charge to falter. My quantitative models show that the currency pair is overbought and we will likely struggle to break above 0.85. If it does, EUR/GBP 0.8562 will prove to be a strong resistance level. UK data this week will likely give some support to GBP, with the manufacturing purchasing managers index (PMI) set to strengthen further. However, the release of a relatively dovish set of Bank of England (BoE) Monetary Policy Committee (MPC) minutes has helped to undermine GBP for the time being, meaning that any recovery will be limited in the near term.

Euro extends gains, yen pressured

The EUR found another spurt of life following the release of the stronger than expected February German IFO business confidence survey yesterday. The data helped make up for the disappointment related to the manufacturing and service sector surveys. However, while it may have alleviated concerns about weakening growth in Germany it only serves to highlight the disparities in growth across the Eurozone.

I continue to believe the EUR may struggle to sustain gains. In the near term, after breaking above 1.3320 resistance, EUR/USD will face further resistance around 1.3460. Nonetheless, my 2012 year end forecast of EUR/USD 1.26 shows that despite growing growth pressures in the Eurozone economy the EUR will still find underlying support from a healthy external balance and continued EUR buying from Asian official investors.

Over the near term upcoming votes in various countries on the second Greek bailout deal will provoke some nervousness while Greek reform implementation risks will also act to dampen EUR sentiment.

JPY has faced significant degree of pressure since the beginning of February. As noted previously one of the biggest sources of upward pressure on USD/JPY has been the widening in US – Japan 2-year bond yield differentials. US bonds currently yield around 19 basis points above Japan, the highest gap since August 2011. The widening yield gap already appears to be prompting foreign outflows from Japanese bonds, with outflows registered in six of the seven past weeks. These outflows have helped contribute to the weakness in the JPY.

The fact that the BoJ will step up its purchases of Japanese government bonds (JGBs) will also add to the downward pressure on the JPY as it will mean a further widening in US – Japanese yield differentials. Over the short term USD/JPY may face some resistance above the 80 level and I suspect that it will lose some momentum but maintain my view that it will reach 85.0 by the end of the year.

EUR/GBP upside overdone, CHF overly strong

Disappointing Eurozone service sector and manufacturing purchasing managers’ confidence indices as well as a contraction in Chinese manufacturing confidence sets the scene for a drop in risk assets. In addition in the US, existing home sales rose less than expected taking into account revisions to previous data.

Meanwhile scepticism over Greece’s ability to implement agreed upon reforms and reported resistance from Germany to increasing the firewall around peripheral Eurozone countries has delivered a further dose of negativity to markets. The market was probably looking for an excuse to sell after a strong rally and found plenty in yesterday’s news.

GBP has followed on the coat tails of the EUR over recent weeks, with the currency showing little independent direction. Reflecting this is the fact that EUR/GBP had until recently been trapped in a 0.83-0.84 range. As with the EUR I see downside risks to GBP over the short term against the USD.

Against the EUR, GBP will largely track the movement in yield differentials as it has done over recent months. Relatively dovish MPC minutes, with two members voting for bigger amounts of quantitative easing helped to put GBP under further pressure but the move higher in EUR/GBP look overdone.

My medium term view continues to show GBP appreciation versus EUR and current levels highlight a good opportunity to go short EUR/GBP. Markets are rewarding central banks that are proactive in their policy prescriptions. I exect this to result in some GBP resilience even if the BoE announces more QE.

EUR/CHF has continued to hug the 1.2000 line in the sand enforced by the Swiss National Bank. Ongoing Eurozone doubts even after the agreement of a second bailout for Greece mean that the CHF remains a favoured destination for European money. This is reflected by the fact that EUR/CHF has been highly correlated with Risk Aversion over the past 3-months.

It will take also take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Indeed, as reflected in the KoF Swiss leading indicator and manufacturing PMI data, the economy is heading downwards. Assuming that there will be an eventual improvement in risk appetite, CHF will weaken given the strong correlation between EUR/CHF and risk aversion over the past 3-months.

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