Calm ahead of US payrolls and ECB meeting

It’s non-farm payrolls week in the US, with currencies treading water until Friday when the report is released. Ahead of the data there are several other releases on tap which will give clues to the outcome of the April jobs report, including the ISM manufacturing survey and ADP jobs report. The USD has taken a softer tone as risk appetite improved and US bond yields dropped further.

Given the Fed kept open the door to more easing it will act as a restraint on the USD unless markets become convinced that there will no further Fed balance sheet expansion over coming months. In the meantime unless risk aversion spikes again the USD is set to find it difficult to sustain any gains.

It’s always the same story with the EUR, a tale of ongoing resistance to bad news. Weaker Eurozone confidence surveys as well as a downgrade to Spain’s credit ratings did little to weaken the EUR. The key event is the European Central Bank (ECB) meeting on Thursday but despite growing growth worries, a policy rate cut is unlikely as the ECB remains in wait-and-see mode.

Data releases will not be too damaging for the EUR, with monetary and credit aggregate set to rise and German retail sales set to rebound in March. The EUR looks poised to edge higher against this background in the short term, but will be constrained by uncertainty ahead of the US jobs report. Technical resistance to the upside will be found around the 1.3265 area.

The JPY barely flinched when the Bank of Japan announced an expansion of its asset purchase fund by JPY 10 trillion in its aim to reach a 1% inflation goal. Unfortunately for the BoJ the ongoing narrowing in the US Treasury yield premium over Japan JGB yields overwhelmed the negative impact of its action on the JPY.

Overall, my quantitative models continue to show USD/JPY lower over the short term, with a move below 80.00 on the cards. If as I expect, risk aversion also creeps higher, it will imply more short term upside JPY pressure. Trading will be relatively quiet, with no major data on the calendar due to Golden Week holidays in Japan.

GBP rebounds, RBNZ warns about NZD strength

The Fed unsurprisingly left policy on hold while lowering projections for unemployment and raising forecasts for higher near term inflation. The economy is still expected to grow at a ‘moderate’ pace in coming quarters, with the majority of FOMC members anticipating the first tightening in 2014 or beyond. The one sop to markets was the fact that the Fed is prepared to do more in terms of policy enhancement if needed. This helped to buoy risk assets overnight leaving the USD on the back foot. Data releases are thin on the ground today leaving markets to consolidate gains in a relatively ‘risk on’ environment.

GBP came tumbling down from its highs following news that the UK economy entered a technical recession after GDP surprisingly contracted by 0.2% in Q1. However, the drop was short lived, with GBP/USD recovering from its losses, helped by a stellar reading for UK Nationwide consumer confidence in March. Notably however, Nationwide cautioned that the bounce in confidence could be short lived and we would be cautious of reading too much into the data. GBP gains against the EUR look as though they have reached its limit, and our models suggest that EUR/GBP is trading close to short term ‘fair value’.

There was no change in policy from the RBNZ as expected, with policy rates on hold at 2.5%. However, governor Bollard did attempt to talk the NZD lower while highlighting concerns about the global outlook. Concerns about kiwi strength will raise the spectre of FX intervention although it may also mean a delay in rate hikes. The statement was relatively more positive on the domestic outlook. Although rates are ‘appropriate’ according to the RBNZ we still think there is a good chance of a rate hike in Q3. The NZD ignored Bollard’s comments, firming on the back of improved risk appetite. We still see downside risks to the currency, especially as the current risk environment remains fragile.

US dollar restrained, Swiss franc too strong

Better than expected March US new home sales, stable consumer confidence and firmer than consensus earnings, all contributed to boost markets overnight. In Europe, decent demand for Dutch, Spanish and Italian debt auctions helped to reassure markets in the region. Apple earnings added to the good news, contributing to more than 82% of S&P 500 companies topping estimates so far for Q1 2012 earnings.

Despite encouraging news on the data and earnings front US equities only registered small gains, failing to echo the larger gains in European equity markets, suggesting that investors remain cautious. Ahead of the Fed FOMC outcome today trading is likely be relatively restrained, with the risk rally struggling to make much headway.

The Fed FOMC rate decision will be critical to determine USD direction over coming sessions. Assuming that the Fed does not alter its policy setting but instead only tinkers with its economic forecasts, the USD will escape any further selling pressure. Any reference or hint to further quantitative easing would play negative for the USD but I do not expect this to occur.

If anything I expect the USD to edge higher over coming sessions as risk aversion continues to rise. An expected drop in March durable goods orders today will not give the USD much help, however. I don’t expect the FOMC outcome to mark an end to speculation of more QE, and in this respect the USD will continue to be restrained until there is more clarity on the economy and in turn Fed thinking.

EUR/CHF continues to flat line close to the 1.20 line in the sand implemented by the Swiss National Bank (SNB). Renewed tensions in the Eurozone have if anything renewed the appeal of the CHF, making the job of the SNB even more difficult. The fact that risk aversion has been rising suggests CHF demand will remain firm in the short term. CHF demand is occurring in the face of speculation of a shift in FX stance.

Although the SNB has not hinted at any change in the level of the EUR/CHF floor, market speculation that the SNB will move it higher, possibly to around 1.30 from 1.20, has intensified. The problem for the SNB is that the CHF is substantially overvalued and this in turn is fuelling persistent deflationary risks as reflected in six straight months of declining CPI. Against this background it would not be surprising if the EUR/CHF floor is lifted.

EUR resilience, AUD hit by soft inflation

A distinctly downbeat tone to risk assets in the wake of disappointing manufacturing sentiment surveys in Europe and China and political uncertainties in Europe threatens to engulf markets today. There is very little on the data and events front that will change this as markets refocus to the outcome of the Fed FOMC meeting tomorrow. Consequently risk assets will remain under a degree of pressure in the short term unless the Fed delivers any fresh hints of more quantitative easing tomorrow.

A round of weaker than expected readings for Eurozone purchasing managers indices has led to a renewed wave of pessimism towards the Eurozone economy and selling in Eurozone assets. The collapse of the Dutch government over budget cuts and the results of the first round of French elections only added to the malaise. Once again however, the EUR remains resilient and has hardly flinched in the wake of bad news in the region.

I believe it is only a matter of time before the EUR succumbs to growing pressure, especially given a likely widening in its growth gap versus the US. Today’s bond auctions in Spain, Italy and Netherlands will be in focus but ought to provide little relief for the EUR, with the currency likely to edge towards 1.3057 support versus USD.

Australian Q1 CPI inflation data came in much softer than expected, with the trimmed mean CPI coming in at 0.3%, half the consensus expectation and well within the Reserve Bank of Australia’s target range. The data seals the case for the RBA to pull the trigger at its 4 May monetary policy meeting. The main imponderable is the magnitude of the rate cut. A 25bps cut had already been priced in but speculation of a 50bps move is likely to have grown.

Nonetheless, I believe the market is overly dovish, with a lot of easing already priced in (100bps in the current cycle). I don’t agree with market pricing, suggesting that eventually the AUD will recover as rate expectations correct. However, wariness ahead of the RBA meeting and deterioration in risk appetite will keep the AUD under restrained in the near term. AUD/USD support is seen around 1.0226, with a break below this leading to a test of 1.0145.

Dollar still in a stupor

The increase in the International Monetary Fund’s (IMF) funding by $430 adds another layer of firepower to provide help to the Eurozone periphery should it be required. Nonetheless, many other worries continue to afflict markets suggesting that any positive boost will be short lived. There are plenty of data and events this week including central banks in the US, Japan and New Zealand. Additionally US corporate earnings will remain in focus while bond auctions in the Eurozone will also provide direction. I continue to see risk aversion creeping higher against this background.

It is unlikely that the FOMC meeting tomorrow and Wednesday will provoke any change in the currently low FX volatility environment given that policy settings will remain unchanged, with the majority of FOMC members likely to look for the first tightening at the earliest in 2014. The Fed is therefore unlikely to wake the USD out of its stupor and if anything a softening in durable goods orders, little change in new home sales and a pull back in consumer confidence will play in favour of USD bears over coming days. Even a relatively firm reading for Q1 GDP will be seen as backward looking given the slowing expected in Q2.

The EUR will have to contend with political events as it digests the aftermath of the first round of the French presidential elections. The fact that the political process will continue to a second round on 6 May could act as a constraint on the EUR. Various ‘flash’ purchasing managers indices (PMI) readings and economic sentiment gauges will offer some fundamental direction for the EUR but largely stable to softer readings suggest little excitement. Consequently EUR/USD will largely remain within its recent range although developments in Spain and Italy and their debt markets will have the potential to invoke larger moves in EUR.

The JPY is usually quite insensitive to Japanese data releases and this is unlikely to change this week. Key releases include March jobs data, CPI inflation, industrial production and retail trade. Although inflation has moved into barely positive territory the BoJ is still set to increase the size of its asset purchase programme. This will act as a negative factor for the JPY but unless US Treasury yield differentials renew their widening trend against Japanese JGB yields and drop in the JPY will be limited.

AUD risks, CHF speculation, CAD upside

News that the IMF revised up its global growth forecasts, decent demand for a Spanish bill auction and a stronger than expected reading in the April German ZEW investor confidence survey helped to calm market nerves overnight. Some solid US Q1 earnings also supported equities too.

Weaker readings for US industrial production and housing starts were largely ignored. Hopes of an expansion of IMF funds were boosted by the news that Japan will be provide an extra $60 billion. High beta currencies rallied overnight but notably the EUR failed to register gains despite a narrowing in peripheral Eurozone bond yields.

AUD has undergone some major gyrations. The boost from by a strong jobs report last week was quickly undone by a relatively dovish set of RBA minutes, which appeared to confirm the view that a rate cut would take place in May. Of course, as the RBA pointed out the April 24 Q1 inflation report would be essential to provide the final clues to the rate decision.

As a rate cut is already priced in, an upside inflation surprise may actually result in a bounce in the AUD but any positive impetus will have to contend with a more fragile risk environment, yesterday’s risk rally not withstanding. AUD is one of the most highly sensitive currencies to risk aversion and bounced overnight as risk appetite improved but we suspect the risk rally will fade in the short term putting the AUD under renewed downward pressure.

EUR/CHF continues to track the 1.20 ‘line in the sand’ closely, but rumours of a shift in the floor continue to do the rounds. Swiss officials have not confirmed such speculation but have highlighted the impact of a strong CHF in fuelling deflation pressures. The case for a move higher in the CHF ceiling is therefore quite high, but the cost could also be high if speculators test the resolve of the Swiss authorities.

Although the Swiss economy continues to suffer it appears that the pain of a strong CHF is lessening slightly although not enough to ease concerns about the strength of the currency. The March KoF Swiss leading indicator revealed a second straight increase, albeit from a low level. Further gains may be limited however, given the ongoing downward pressure emanating from weaker growth in the Eurozone.

The Bank of Canada left policy rates unchanged at 1% but the accompanying statement appeared to pave the way for higher interest rates. Consequently expectations of rate hikes have been brought forward, with the CAD rallying due to its strong correlation with interest rate differentials. Firmer commodity prices also helped to boost CAD.

Our quantitative models show scope for further CAD gains over the short term, suggesting more gains ahead. Further direction will come from the BoC Monetary Policy Report today, with USD/CAD setting its sights on a test of technical support around 0.9766 in the near term.

EUR bounces, GBP gains limited

Eurozone stress, particularly in Spain continues to act as a weight on market sentiment, with equity markets ignoring a relatively strong US retail sales report. My risk barometer remains at elevated levels and is unlikely to ease anytime soon, suggesting that a cautious tone towards risk assets remains warranted.

Mixed US data releases (firm retail sales but weak Empire Manufacturing) did little to help the USD overnight but the EUR managed to register gains despite ongoing Spanish worries. Fitch ratings stating that Italy’s austerity measures were credible and Moody’s noting that there would not be an imminent change in its ratings outlook for France may have helped the EUR which rose solidly from lows just below 1.30 versus USD.

I continue to see plenty of support for EUR/USD around this level. A heavy data slate today will give further direction but the news will not be so positive out of the Eurozone, with a small drop in the German April ZEW survey expected. Meanwhile, a subdued reading for US housing starts and small increase in industrial production will do little to perk the USD up.

There are plenty of data releases in the UK for markets to get their teeth into including inflation data today, Bank of England minutes tomorrow and March retail sales on Friday. Ahead of the data releases GBP continues to trade with a positive bias against the EUR but has failed to extend gains against the USD.

I do not expect the data to result in a significant change in GBP’s tone, with the MPC minutes in particular likely to reveal a divided view on the need for more quantitative easing. Although we look for a rebound in retail sales in March overall spending is only growing modestly.

After predicting the latest drop EUR/GBP my quantitative model reveals that there is limited scope for further gains in GBP versus EUR over the short term. I had also anticipated gains in GBP versus AUD but there is now limited room for further GBP upside.

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