Euro and yen downside risks

The lack of progress on a second bailout for Greece will keep markets nervous, leaving risk assets vulnerable to further slippage. The USD will be a beneficiary in this environment. Weak Eurozone GDP data for Q4 2011 released today will contrast with relatively firm data including industrial production and the Empire manufacturing survey in the US, leaving the story of US economic outperformance intact.

EUR has lost steam and looks vulnerable to a further correction lower. The fact that EU finance ministers have cancelled a meeting due to be held today means that markets will have to prolong their wait for an agreement on a second bailout package for Greece.

News that Greece’s political leaders will send a commitment to European officials today that they will implement further austerity measures will give some reassurance that things are moving in the right direction but a looming deadline for debt redemption in March will mean heightened nervousness.

Admittedly the market is still short EUR but positioning has moved close to its 3-month average suggesting a less potential for aggressive short covering. Following the downgrade of ratings of several Eurozone countries yesterday and a likely drop in Q4 2011 Eurozone GDP today, caution will be the prevalent theme today, leaving EUR/USD on the back foot and opening the door for a test of technical support around 1.3026.

The Bank of Japan’s decision to increase its asset purchase program and set an inflation goal had an immediate negative impact on the JPY. A sharp drop in GDP growth in Q4 last year, persistent deflation pressures and more aggressive action from other central banks pushed the BoJ into action.

Will there be any follow through on the JPY? USD/JPY had already been under some upward pressure in the wake of the widening in US bond yields versus Japan. The move by the BoJ will result in even more of a widening in yield differentials especially given that the BoJ actions means there will be an increase in official purchases of Japanese government bonds, helping to suppress JGB yields.

In the near term USD/JPY has broken above its 200 day moving average level, paving the way for a test of the 31 October 2011 high around 79.55. Further out, our bond forecasts show that both US and Eurozone 2-year bond yields will increase relative to Japanese yields over the coming months, supporting our forecasts of USD and EUR appreciation versus JPY.

Data releases in focus

For a change the markets may actually concentrate on data releases today rather than political events in the eurozone. The October US retail sales report and November Empire manufacturing survey are likely to paint a less negative economic picture of the US. The data will help to dampen expectations of more quantitative easing in the US but we will be able to hear more on the subject from the Fed’s Bullard and Williams in speeches today.

Overnight the Fed’s Fisher poured more cold water on the prospects of further QE by highlighting that the economy is “poised for growth”. While speculative data in the form of the CTFC IMM data shows a drop in USD sentiment to its lowest in several weeks we do not expect this to persist. The USD will likely benefit from the data today and we see the currency retaining a firmer tone over the short term especially as eurozone concerns creep back in.

The vote by German Chancellor Merkel’s party to approve a measure for a troubled country to leave the EUR opens up a can of worms and will hit EUR sentiment. But rather than politics there are several data releases on tap today that will provide some short term influence on the EUR, including Q3 GDP and the November German ZEW survey. FX markets will likely ignore a positive reading for GDP given that the outlook for Q4 is going to be much worse. The forward looking ZEW survey will record a further drop highlighting the risks to Europe’s biggest economy.

T-bill auctions in Spain and Greece may garner even more attention. Following on from yesterday’s Italian debt sale in which the yield on 5-year bond came in higher than the previous auction but with a stronger bid/cover ratio, markets will look for some encouragement from today’s auctions. Even if the auctions go well, on balance, relatively downbeat data releases will play negatively for the EUR.

When viewing the EUR against what is implied by interest rate differentials it is very evident that the currency is much stronger than it should be at least on this measure. Both short term (interest rate futures) and long term (2 year bond) yield differentials between the eurozone and the US reveal that EUR/USD is destined for a fall.

Europe’s yield advantage has narrowed sharply over recent months yet the EUR has not weakened. Some of this has been due to underlying demand for European portfolio assets and official buying of EUR from central banks but the reality is that the EUR is looking increasingly susceptible to a fall. EUR/USD is poised for a drop below the psychologically important level of 1.35, with support seen around 1.3484 (10 November low).

US Dollar Upside, Euro tensions

Following the famine that was last week this week will see a feast of data releases, which hopefully will give some clearer direction to currency markets. The key eurozone data focus for FX markets will be the German February ZEW survey and it should highlight that investor confidence is bouncing back smartly. This will be accompanied by data showing a slight acceleration in GDP in the eurozone in Q4 2010. Good news, but the reality is that the EUR is being driven more by peripheral bond tensions and relative yields.

Although the EUR may get a brief lift from the news of the resignation of Egypt’s President Mubarak this will likely prove temporary. Given that tensions are beginning to creep higher EUR/USD may struggle to make any headway this week and will more likely slip below 1.3500 for a test of 1.3440 as sentiment sours. Even the usual sovereign interest may look a little more reluctant to provide support this week. The net long positioning overhang as reflected in the CFTC IMM data suggests some scope for a squaring in long positions, likely accelerating any downside pressure.

As usual data releases are failing to have a major impact on the JPY whilst interest rate / yield differentials suggest the JPY should be much weaker. One explanation for the stubbornly strong JPY is the strength of recent portfolio inflows to Japan, especially into its bond markets. This could reverse quickly and IMM positioning suggests that the potential for a shakeout of long positioning looms large, something that many Japanese margin traders are well positioned for according to TFX data. USD/JPY 84.51 will provide firm resistance to a move higher in the short-term.

GBP will be guided by the Bank of England Quarterly Inflation Report on Wednesday as well as the January CPI and retail sales data. The Report will reveal that inflation moderates over the medium term, even if short-term projections are shifted higher. Consequently, interest rate markets may even pare back overly hawkish expectations for UK rates, leaving GBP vulnerable. Nonetheless, markets maybe somewhat more sceptical or at least nervous in light of a likely increase in UK CPI, albeit mostly due to the increase in value added tax (VAT) at the turn of the year. Moreover, GBP may find some solace from a rebound in retail sales in January.

Overall, GBP/USD will take its cue from EUR/USD and the currency is vulnerable to a sustained drop below 1.6000 this week. The fact that GBP/USD IMM positioning is at its highest since September 2008 suggests a lot of scope for a sell-off. EUR/GBP looks like its consolidating in an even narrower range between 0.8400-0.8500.

Another positive slate of US data releases and likely more pressure on US bond markets this week suggest that the USD will find further support, with the USD index likely to take a shot at the 79.00 level. Indeed a further improvement in both the Philly Fed and Empire manufacturing surveys is expected, providing more evidence of strengthening manufacturing momentum, will be borne out in the hard data, with a healthy gain in industrial output expected. Similarly a healthy reading for US retail sales will support the evidence that the US consumer is in full recovery mode.

The positive impact on the USD may be dampened however, by benign inflation readings this week, supporting the view that US policy rates will not be raised for a long time yet. This is likely to be echoed in the Fed FOMC minutes this week. Nonetheless, speculative positioning suggests plenty of scope for short USD covering, with the latest CFTC IMM report revealing the biggest net short position since October 2010. has been nominated in’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at

Euro support unwinding

The USD is set to end the year in firm form aided by rising US bond yields. Yesterday’s data supported this trend. The Empire manufacturing survey beat expectations rebounding nearly 22 points in December and industrial production rose 0.4% in November although there was a downward revision to the previous month. This was against the background of soft inflation, with headline and core CPI rising 0.1%, indicating that the Fed will remain committed to its $600 billion program of asset purchases.

EUR/USD dropped below support around 1.3280, weighed down by various pieces of negative news. Moodys downgrade of Spain’s credit ratings outlook dented sentiment but the bigger sell off in EUR followed the move in US bond yields. The prospect of EUR recovery over the short term looks limited. The issue of finding agreement on a permanent debt resolution fund continues to fuel uncertainty and will likely come to a head at the EU summit starting today.

Added to this Ireland’s main opposition party which will likely play a part in forming a new government early next year wants some of the debt burden shared with senior bank debt holders. The good news in Europe was few and far between but at least Ireland’s parliament backed the EU/IMF bailout for the country. Of course the backing could be derailed following elections in January. Perhaps the most surprising aspect of the move in EUR is that it’s not weaker. The next support level for EUR/USD is around 1.3160.

The divergence between the US and Europe on policy is stark, with loose fiscal and monetary policy in the US providing a significant prop to the US economy, whilst the much tighter fiscal stance and less loose monetary policy threatens to result in more pressure on eurozone growth especially against the background of an overvalued EUR. This divergence will manifest itself next year in the form of US growth outperformance and stronger USD vs. EUR.

The resilience of the UK consumer continues to surprise, with the CBI distributive trades survey coming in strong and rising further to +56 in December. The only problem with the survey data is that is has not tracked official data. November retail sales data today will give further clues to the strength of spending heading into Christmas. More worryingly from the Bank of England’s perspective is the fact that inflation continues to rise despite assurances that the increase in inflation is temporary. At the least the likelihood of more quantitative easing QE from the BoE has evaporated though it is still a long way off before interest rates are hiked. In the meantime GBP continues to underperform both EUR and USD though GBP/USD will find strong support around 1.5512.

Upward pressure on US yields and the USD us unlikely be derailed US data releases today. Housing starts are set to bounce back in November, with a 6% gain expected, whilst the trend in jobless claims will likely continue to move lower. The Philly Fed manufacturing survey is set to lose a little momentum reversing some of November’s sharp gain but will still remain at a healthy level.

Unloved US Dollar

The USD index is now at its lowest level since May 3 and is showing little sign of turning around. The bulk of USD index weakness overnight came via the EUR and GBP, both of which rose sharply against the USD, with EUR/USD breaching its 90 day moving, hitting a high of 1.2955 and GBP/USD on its way to testing its 200 day moving average, reaching a high of 1.5472. Commodity currencies fared far less positively, perhaps feeling the after effects of the weaker Chinese data this week, with the NZD also dented by weaker than expected inflation data in Q2.

The USD was once again hit by US growth worries. To recap, the US data slate revealed a soft reading for PPI, whilst the July Empire manufacturing index dropped 14.5 points, a far bigger drop than forecast. The Philly Fed index also dropped further in July despite expectations of a small gain. In contrast, June industrial production edged higher, but manufacturing output actually fell. There was a bit of good news in the fact that weekly jobless claims fell more than forecast.

The releases extended the run of weak US data, keeping double-dip fears very much alive. The data have acted to validate the Fed’s cautious growth outlook expressed in the latest FOMC minutes but a double-dip is unlikely. Today’s releases include June CPI, May TIC securities flows, and July Michigan confidence. Another benign inflation report is expected. Consumer confidence is set to slip further against the background of soft data and volatility in equity markets whilst TICS data is forecast to reveal that long term securities flows declined in May compared to the $83 billion inflows registered in April.

The move in the EUR is a making a mockery out of forecasts including my own that had expected renewed downside. The relatively successful Spanish bond auction yesterday helped to ease eurozone sovereign debt concerns further, with a likely strong element of Asian participation. I have still not given up on my EUR negative view given the likelihood of a deteriorating economic outlook in the eurozone and outperfomance of the US economy, but over the short-term the EUR short squeeze may have further to go, with EUR/USD resistance seen at 1.3077.

Equity markets were saved from too much of a beating following the release of better than expected earnings from JP Morgan, a $550mn agreement between Goldman Sachs and the SEC to settle a regulatory case, and news from BP that it has temporarily stemmed the flow of oil from the leak from its Gulf well. Agreement on the US financial reform bill, passed by the Senate yesterday and likely to be signed into law by US President Obama next week, likely helped too.

The tone of the market is likely to be mixed today, with US growth concerns casting a shadow on risk trades. Earnings remain in focus and the big name releases today include BoA, GE and Citigroup but early direction could be negative following news after the US close that Google Inc. profits came in below analysts’ expectations. Data in the US today is unlikely to help sentiment given expectations of more weak outcomes, leaving the USD vulnerable to further selling pressure.

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