EUR upside limited, JPY bears frustrated, AUD capped

Risk assets continue to rally spurred by hopes / expectations of ongoing (Federal Reserve) and additional (European Central Bank) monetary stimulus, the formation of a new government in Italy (however unstable it may turn out to be) and a better than expected outcome for US March pending home sales, bucking the trend of disappointing US data over recent weeks.

Consequently commodity prices have rallied helped by industrial and precious metals while the USD has come under sustained selling pressure. Ahead of the major events over coming days (ECB and Fed meetings, non farm payrolls) the positive risk tone is unlikely to change although US consumer and business confidence measures will be scrutinised to determine whether how sentiment is holding post sequester.

Market relief following the formation of a new government in Italy was evident in the positive reception to Italy’s bond auction yesterday. Although this was no big surprise, it highlights the ongoing power of the ECB’s OMT threat and the calming influence it is has had on peripheral bonds and the EUR.

Even so, a likely policy rate cut by the ECB and potential hints at future non conventional easing will be sufficient to prevent the EUR from capitalizing much on the generally softer USD tone this week. Additionally as revealed in the weaker than expected Eurozone April sentiment indicators yesterday the fundamental argument for both lower policy rates and a weaker EUR remains compelling. In the near term EUR/USD will remain supported above 1.2985, but renewed downward momentum is not far off.

Lower relative US yields continue to undermine USD/JPY. Until the yield differential (in particular 10 year US Treasury vs. Japanese JGBs) widens it is difficult to see USD/JPY regaining sufficient momentum to break the 100 level. The speculative market is clearly geared up for a weaker JPY as reflected in the CFTC IMM positioning data revealing a hefty short JPY position, but if anything this may frustrate any move lower in JPY in the near term.

Nonetheless, the rebound in the JPY recently is likely to prove temporary. Although last week’s unchanged policy decision from the Bank of Japan was largely expected, the gap between current CPI and the BoJ’s 2% target is widening, implying further easing and in turn JPY weakness in the pipeline.

AUD has managed a firm early week bounce but can it be sustained? There is a limited and second tier flow of Australian data over coming days and some caution ahead of China’s official April purchasing manager’s index which may limit the ability of the AUD to make much headway over coming days. Nonetheless, market positioning in AUD looks much healthier (ie less room to cut longs) while the drop in the USD index bodes well for AUD. AUD/USD will be capped around 1.0409 in the near term, with strong support around 1.0221.

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Dollar undermined by lower yield

Risk assets in general appear to have gained traction on the basis that central banks will maintain or expand highly accommodative monetary policies via further asset purchases and balance sheet expansion. The Federal Reserve and European Central Bank will likely provide more fuel to the fire this week, with the former set to maintain its policy settings including USD 85 billion in asset purchases while the latter is set to cut its policy refi rate by 25bps to 0.50%.

Weaker data into Q2 in the US (and the softer than expected reading for Q1 GDP annualised 2.5% QoQ pace revealed last Friday) effectively seals the case for maintaining ultra easy policy at least until later in the year when the Fed is set to taper off asset purchases. As for the ECB are mere rate cut may not be sufficient with attention on any prospects for non conventional easing and rebuilding the monetary transmission mechanism.

Weekend news in the Eurozone was positive, with Italy finally forming a government following two months of deadlock but the week should begin quietly with holiday in Japan and China. In any case market activity is set to be limited ahead of central bank policy decisions and the US April jobs report at the end of the week where a 150k increase in payrolls.

As the US Q1 GDP report revealed the impact of the Sequester via massive spending cuts is increasingly biting into growth and while expectations of ongoing monetary accommodation is helping to buoy markets, growth recovery will need to strengthen to justify the current optimism built into markets. At least there is some realisation, finally in the Eurozone, that recovery may need to be reinforced with less austerity.

FX market activity will remain hesitant ahead the key events this week but overall it appears the USD will lose further wind out of its sails especially as US bond yields continue to drop. The US 10 year Treasury yield dropped to is lowest level this year, a factor that has particularly undermined the USD against the JPY where a failure to test the 100 level has also contributed to a drop in the currency pair. A test of USD/JPY 100 is off the cards unless and until US yields rise again. Lower US yields are helping EUR/USD to stay above the 1.3000 level although this is being mitigated by the fact that German 10 year bund yields are also declining.

GBP jumps, CHF drops

A weaker than expected reading for March US durable goods orders maintained a run of soft US data releases, reinforcing concerns of an economic slowdown over coming months. Indeed, US growth is tracking closet to 1% in Q2 after a more robust looking growth rate in Q1. The data will play into the hands of doves in the Federal Reserve, with the FOMC set maintain its highly accommodative policy settings at next week’s policy meeting.

The bigger than expected drop in the April German IFO business confidence survey yesterday echoed the weakness in US data but if anything markets reacted positively as the data helped to intensify expectations of a European Central Bank (ECB) policy rate cut which could come as early as next month. Despite the weaker data equity markets and risk assets look generally well supported, with US Q1 earnings releases and monetary policy stimulus expectations helping to maintain the positive tone.

The USD has shaken off both weaker growth data and the subsequent decline in US Treasury yields but may struggle to make much headway until a more positive growth outlook is revealed by data releases. In this respect Friday’s Q1 GDP data will be somewhat backward looking despite a likely robust outcome of a 3.0% QoQ rate of growth set to be revealed. Markets instead will focus attention on next week’s manufacturing reports and jobs data.

Ahead of the US payrolls data we’ll be able to digest the Fed’s thinking on the “soft patch” on the economy and whether they believe it will extend much further. The USD index will likely consolidate ahead of these events, with the early April high of 83.494 likely to cap gains.

GBP/USD has struggled to make much headway over recent weeks. Nonetheless, the downgrade of the UK’s credit ratings by Fitch to AA+ from AAA+ had very little impact. The release of firmer than expected UK GDP data today, with the UK economy missing a triple dip recession has helped GBP to bounce strongly. I remain constructive on GBP but would prefer to play GBP versus CHF where the upside momentum is strengthening.

Both EUR/CHF and USD/CHF have made substantial headway over recent weeks and look to extend gains over the near term. Notably the improvement in risk appetite and resilience in Eurozone peripheral bonds highlights the reasons for the lack of CHF demand.

The selection of a new prime minister in Italy will ease political concerns and add to the pressure on the CHF. Additionally a likely softening in the Swiss April KoF leading indicator tomorrow, the 7th straight decline, will reinforce domestic pressure to weaken CHF. EUR/CHF is set to head towards the year high around 1.2690 over coming weeks.

EUR momentum fading, JPY fails 100, AUD bearish

EUR/USD is losing some upside momentum, with the currency pair likely to be more constrained in the days ahead. Weak April Eurozone purchasing managers’ indices (PMI) set to be revealed today taken together with an expected decline in the German IFO business survey suggest no support for the EUR on the data front especially as the data will point to lower policy rates.

Additionally although the latest CFTC IMM data shows that the speculative market is still short EUR, the magnitude of short positioning is at its lowest in several weeks implying less scope for short covering. Yield differentials point to more downside risks for EUR/USD too especially given the widening in US Treasury / German bund yield differentials over the last week (ie US Treasuries offer a relatively more attractive yield). A test of EUR/USD 1.3001 support is on the cards in the very near term.

After sliding close to 30% from mid September last year the JPY appears to be having a little difficulty cracking the psychologically important 100 barrier despite the green light to do so in the wake of the G20 meeting. In anticipation of the move short speculative JPY positions have increased to their highest in several weeks.

However, domestic investors have yet to pour money overseas, with weekly portfolio data revealing that since the start of the year any Japanese outflows have been more than compensated by portfolio inflows; net inflows have totalled JPY 13.3 trillion. Once Japanese investors increase overseas investments the move in USD/JPY will accelerate but for now expect to see a much more gradual move higher.

AUD has lost a lot of ground over recent days damaged both by a plunge in commodity prices and also by weaker Chinese and domestic data including a recent in the unemployment rate and a budget which remains in deficit. AUD took another hit from a weaker than expected reading in the private sector reading of Chinese PMI today. March quarter CPI inflation data tomorrow in particular will help to determine whether the RBA cuts policy interest rates on May.

The data is unlikely to prove supportive of a rate cut with an increase in the annual rate of inflation set to be revealed. While this may help to alleviate some downward pressure on AUD/USD the technical picture remains bearish, with a test of support around 1.0202 likely, which if broken would open the door for a test of the 2013 low around 1.0116.

Green light for a break of USD/JPY 100

Growth concerns came back to the fore in the wake of disappointing releases in the US and China as well as a downward revision to global growth forecasts by the International Monetary Fund. Data releases this week will not do much to allay growth fears. Although the advance reading of Q1 US GDP is likely to reveal a firm 3% QoQ annualised outcome the momentum in the US economy clearly tailed off towards the end of the quarter as more forward looking data releases attest to. The US and global economy is likely to pick up steam as the year progresses but admittedly recent data releases point to a similar pattern as recent years of firm Q1 activity followed by weakness later.

Meanwhile in Europe, purchasing managers’ indices and the German IFO business sentiment survey will show some further moderation, while credit conditions remain constrained indicating a downbeat outlook over the rest of the year. Consequently pressure for a policy rate cut from the European Central Bank is likely to intensify, with a cut likely by the end of this quarter. EUR/USD continues to trade above its 1.3001 technical support level but momentum is fading. Weaker economic data this week will likely undermine the EUR further.
gold
Following last week’s strong volatility in commodity and gold prices in particular some stability is likely over coming days, with gold retracing some of its losses and regaining the USD 1400 level. Equity markets finished the week in firmer mood after falls earlier in the week but the plethora of US Q1 earnings scheduled over coming days will help to determine whether the gains can be held. So far earnings have beaten expectations on balance, but notably expectations have been fairly low in the first place.

There was plenty of attention on currencies at the G20 meeting but the final outcome left the door open to further JPY weakness while the communiqué highlighted the “unintended negative side effects” for easier monetary policy. Although this was a veiled warning about potential build up of asset price bubbles as central banks ease policy, it is unlikely to sway the Bank of Japan from accelerating its balance sheet expansion. Aside from a probable breach of USD/JPY 100 there is unlikely to be much follow through from the G20 meeting this week.

Gold stabilizes, euro drops

The FX world has become somewhat more disturbing over 2013. Implied currency volatility has risen relatively sharply over recent months breaking its relationship with the VIX ‘fear gauge’ in large part due to the sharp drop in the JPY. Additionally the trend of improving risk appetite that was conducive to lower FX volatility has come to an end.

The inability of risk appetite to improve further has led to a declining correlation between various assets including currencies. This opens the door to other factors driving FX markets, with investor discrimination based on relative yield and growth differentials expected to take increasing prominence over coming months.

A big mover overnight was the EUR which slid on comments from European Central Bank official Weidmann that Europe’s recovery from the debt crisis may take years he hinting at a rate cut. He was joined by the ECB’s Smaghi who noted that the ECB must find ways to avoid EUR gains. EUR is likely to remain under pressure over the short term, especially on the crosses against the likes of GBP. Eventually I expect its ECB Outright monetary Transactions (OMT) threat led resilience to fade as Europe’s weak growth trajectory weighs on the currency, leading to an eventual move to EUR/USD 1.25 by end 2013.

The CHF and JPY languish at the bottom of our forecast grid in the medium term as would be expected given both their low yield and relatively lack of sensitivity to global growth. Both currencies will face pressure from relatively higher yields elsewhere given the growing attraction of yield and they are set to regain their lustre as funding currencies. In this respect the USD will begin to lose its allure as a funding currency especially as markets become increasingly nervous of a tapering off of Fed asset purchases later in the year.

The price of gold has stabilized over recent days in a USD 1365-1395 per ounce range following its sharp fall, with buyers creeping back in especially from jewelry demand, with strong purchases from India and China reported over recent days. My quantitative model suggests that the recent decline in gold prices is overdone and it may bounce back slightly. Nonetheless, the prospects for gold prices in the months ahead are still downbeat as expected strength in the USD, higher US bond yields, and expectations of a paring back in the Fed’s asset purchases weigh on the commodity.

News that Cyprus proposes selling its gold reserves over coming weeks will also fuel nervousness that other peripheral Eurozone central banks will follow suit. Finally, exchange trade funds (ETF) and speculative demand according to the CFTC IMM data continue to show a decline in investor demand. Consequently I we have revised down our forecasts for gold prices to reach USD 1350 per ounce by end 2013

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Growth fears intensify

A bad day for risk assets yesterday threatens to extend further. Weaker than forecast data releases in China and the US weighed heavily on market sentiment supporting the theory that the global economy is repeating the pattern of Q1 strength followed by weakness over the remainder of the year. Growth worries helped to exacerbate the fall in gold prices with the precious metal dropping by 15.5% this month alone while dragging down other commodity prices.

There are plenty of data releases today including CPI inflation in the US, Eurozone and UK as well as the German ZEW investor confidence survey, US industrial production and housing starts. Given market sensitivity to weak data any disappointment will reinforce the risk off tone but this seems unlikely as the data in general is likely to be somewhat better.

AUD was thumped by weaker Chinese data releases and a deterioration in risk appetite. Although the drop has been steep over recent days AUD is unlikely to fall much further, with plenty of appetite for the currency around 1.0300. Nonetheless, AUD/USD has dropped below its 100 day moving average level 1.0414 a breach of which threatens to mark a stronger down move.

For those investors wanting to re-enter long AUD positions I prefer to play the currency on the crosses, especially versus NZD which has also suffered recently. My quantitative model of AUD/NZD suggests some upside scope in the currency pair, with short term fair value seen around 1.24.

USD/JPY’s pull back has extended further as Bank of Japan governor Kuroda’s policy announcement effect has faded and risk aversion has picked up. I look for any slippage in USD/JPY to be limited however, with my quantitative model suggesting that short term fair value for USD/JPY is around 95.68. The currency pair has been undermined by the drop in US Treasury yields over recent weeks resulting in a reduced US yield advantage over Japan.

Moreover, the upcoming G20 meeting this week has also provoked some hesitancy among JPY bears given expected comments aimed at Japan not to engineer a competitive devaluation of its currency. Technical indicators suggest that the primary trend remains higher for USD/JPY, with a break below 96.07 required to signal a change in short term trend.

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