GBP/USD struggling above 1.6700

Although the Bank of England meeting is likely to be a non event today from a market perspective GBP/USD is clearly struggling to sustain a move above 1.6700. GBP/USD has breached 1.6700 12 times since mid February but only closed above this level 4 times. Over the near term strong resistance around 1.6769 will cap gains in the currency pair, with GBP continuing to look vulnerable above 1.6700. Some recent misses on the data front have not helped GBP’s cause, suggesting that caution for GBP bulls is warranted. GBP bulls may find more traction versus EUR instead of USD, with EUR/GBP set to come under further downward pressure as the EUR weakens anew. A break below 0.8200 beckons.

Advertisements

JPY, GBP and CHF outlook

USD/JPY blipped above 79.00 in the wake of a report in the Japanese press that states that the Bank of Japan (BoJ) is considering more easing measures at its board meeting on October 30 in order to achieve their 1% inflation goal. Higher US bond yields in the wake of the better than expected US data releases this week are also acting to support USD/JPY.

Given that Japan has effectively been less aggressive than other central bank yet has a fairly ambitious inflation goal, pressure for more aggressive BoJ action should not be surprising. However, in the past the BoJ has underwhelmed and unless US yields continue to push higher, USD/JPY may end up back in its recent ranges. USDJPY 79.23 is a strong initial barrier for the currency pair to cross to establish any move higher.

GBP/USD has edged higher since hitting a low just under 1.60 late last week benefitting in large part from general USD weakness. This is unsurprising given the strong correlation between GBP/USD and the index. However, the true reading of GBP is evident on the crosses and here the picture is far less positive. GBP has lost ground against the EUR and looks set to weaken further.

GBP losses may be limited to around 0.8198 given that interest rate differentials have turned more GBP positive recently. UK retail sales and public finances data today will give further direction and although a bounce back is likely in September sales any positive impact on GBP is likely to be short lived as the currency continues to be restrained by expectations of more BoE QE.

The expectations of a request for Spanish aid and ensuing European Central Bank (ECB) action has managed to alleviate inflows into CHF assets, helping the SNB’s task of protecting its 1.2000 line in the sand for EUR/CHF. Consequently FX reserves growth is likely to slow which in turn will reduce diversification flows from the SNB into other currencies. My forecasts continue to show both EUR/CHF and USD/CHF moving higher by year end.

However, in the short term USD/CHF will edge lower amid general pressure on the USD. Upcoming data releases including trade data today will help give some indication as to whether the SNB’s policy stance is having a positive economic impact. The sharp drop in the CHF nominal effective exchange rate since the implementation of the CHF ceiling will help but there are still many domestic companies calling for a weaker currency.

Euro capped ahead of ECB meeting

Having failed to get above the 1.2650 barrier EUR/USD looks restrained going into today’s European Central Bank (ECB) meeting. Reports overnight of a great ‘plan’ to buy bonds up to 3 years in unlimited size in sterilised fashion, helped provide some support to the currency but further gains will be limited. The ECB has already let the cat out of the bag and FX markets are quite correct to go into the ECB meeting with a dose of caution.

How will the EUR react? Given that much of what the ECB will do today has already been leaked the scope for positive surprises is limited, suggesting any upside for EUR will be capped although comments on yield targets (if any), conditionality, and the seniority issue will be important.

Profit taking, lowered expectations over recent days and uncertainty ahead of the US jobs report tomorrow will limit the damage to the currency, however. A drop to support around 1.2431 is the most that can be expected in the short term.

Unlike a likely rate cut from the ECB the Bank of England (BoE) is set to stay pat having embarked on further asset purchases in July. Weaker growth and upside inflation risk do not make for an enviable concoction. Although I anticipate further asset purchases later in the year, further action today is unlikely. This will mean that EUR/GBP in particular will lack independent direction and continue to track moves in EUR/USD (very strong sensitivity over the last 3-months). Given the potential for some further short term slippage in EUR/USD, EUR/GBP will likely follow suit.

As for GBP/USD it will struggle to sustain a break above this week’s high of 1.5935 unless US payrolls data tomorrow disappoints. Long speculative positioning means that GBP is vulnerable to profit taking especially having strengthened by over 3% since the beginning of June. The 28 August low around 1.5754 will provide near term support.

JPY pullback risks, GBP to slip versus USD

A combination of market friendly comments by Fed Chairman Bernanke, a better than expected outcome for the German IFO business confidence survey in March and hopes of a bolstering of the Eurozone bailout fund, have managed to lift risk assets while pressuring the USD. Markets appear to have shaken off, at least for now, growth worries emanating from weaker manufacturing confidence surveys in China and Europe last week.

Nonetheless, while Bernanke maintained that accommodative monetary policy is still required especially given concerns about the jobs market, he did not hint at more quantitative easing, suggesting that market optimism may be tempered in the days ahead. Data and events today include US and French consumer confidence as well as bill auctions in Spain and Italy. US consumer confidence is likely to slip slightly while the bill auctions are likely to be well received.

While I remain bearish on the JPY in the medium term (beyond 1 month), over the near term I believe there is scope for a pull back. The move in USD/JPY has gone beyond what would be expected by the shift in relative yields. This is corroborated by my short term quantitative model which shows that USD/JPY should be trading around 80.

The speculative market is positioned for JPY weakness but also points to some scope for short covering; both CFTC IMM data and Japanese TFX data (a gauge of local margin trading positioning) reveal significant short JPY positions. If as I expect, USD/JPY does pull back it will offer better levels for investors to initiate medium term JPY bearish trades.

Ultimately the JPY will regain its attraction as a funding currency for carry trades and the bigger the shift in relative yield with the US, the more the potential for capital outflows from Japan into higher yielding assets.

GBP has failed to sustain gains above 1.59 against the USD over recent weeks let alone manage to test the psychologically important 1.60 level. The current bounce above 1.59 is unlikely to last. It will require a renewed downtrend in the USD in general provoked by a sharp improvement in risk appetite and/or a drop in US bond yields for GBP to move much higher. Neither seems likely.

Indeed, GBP will be vulnerable to a general firmer USD over the remainder of the year. While I would not suggest playing a bullish call on GBP versus the USD I think there is much more juice in holding GBP versus EUR, with downside risks to this currency pair likely to open up. Indeed, my quantitative models reveal that GBP is mispriced against both EUR and AUD.

Contagion spreading like wildfire

EUR continues to head lower and is is destined to test support around 1.3484 versus USD where it came close overnight. Contagion in eurozone debt markets is spreading quickly, with various countries’ sovereign spreads widening to record levels against German bunds including Italy, Spain, France, Belgium and Austria. Poor T-bill auctions in Spain and Belgium, speculation of downgrades to French, Italian and Austrian debt, and a weak reading for the November German ZEW investor confidence index added to the pressure.

A bill auction in Portugal today will provide further direction but the precedent so far this week is not good. The fact that markets have settled back into the now usual scepticism over the ability of authorities in Europe to get their act together highlights the continued downside risks to EUR/USD. Although there is likely to be significant buying around the 1.3500 level, one has to question how long the EUR will continue to skate on thin ice.

The Bank of Japan is widely expected to leave policy unchanged today but the bigger focus is on the Japanese authorities’ stance on the JPY. Finance Minister Azumi noted yesterday that there was no change in his stance on fighting JPY speculators. To some extent the fight against speculators is being won given that IMM speculative positions and TFX margin positioning in JPY has dropped back sharply since the last FX intervention to weaken the JPY.

However, this has done little to prevent further JPY appreciation, with USD/JPY continuing to drift lower over recent days having already covered around half the ground lost in the wake of the October 31 intervention. Markets are likely therefore to take Azumi’s threats with a pinch of salt and will only balk at driving the JPY higher if further intervention takes place. Meanwhile, USD/JPY looks set to grind lower.

GBP will take its direction from the Bank of England Quarterly Inflation Report and October jobs data today. There will be particular attention on the willingness of the BoE to implement further quantitative easing. A likely dovish report should by rights play negatively for GBP but the reaction is not so obvious. Since the announcement of GBP 75 billion in asset purchases a month ago GBP has fared well especially against the EUR, with the currency perhaps being rewarded for the proactive stance of the BoE.

Moreover, the simple fact that GBP is not the EUR has given it a quasi safe haven quality, which has helped it to remain relatively resilient. Nonetheless, GBP will find it difficult to avoid detaching from the coat tails of a weaker EUR and in this respect looks set to test strong support around GBP/USD 1.5630 over the short term.

Greece throws a spanner in the works

Having already retraced around 50% of its losses from its high around 4 April to its low on 27 October the USD index is on a firm footing and looks set to extend gains. The USD is benefitting both from the EUR’s woes and receding expectations of more US quantitative easing in the wake of less negative US data releases.

Whether the USD is able to build on its gains will depend on the outcome of the Fed FOMC meeting, accompanying statement and press conference today. While there have been some noises from Fed officials about the prospects of more QE, the Fed is likely to keep policy settings unchanged, leaving the USD on the front foot.

Greece has thrown a spanner in the works by calling a national referendum on the European deal. The fact that this referendum may not take place until January will bring about a prolonged period of uncertainty and further downside risks for the EUR against the USD and on the crosses. As a result of the increased uncertainty from the referendum, growing doubts about various aspects of last week’s agreement as well as hesitation from emerging market investors to buy into any European investment vehicle, peripheral bond spreads blew out further, and the EUR dropped.

The immediate focus will be on emergency talks today between European leaders in Cannes where Greek Prime Minister Papandreou has been summoned at a time when his grip on power appears to be slipping ahead of a government confidence vote on Friday. EUR/USD looks set to slip to support around 1.3525.

The Swiss National Bank’s floor under EUR/CHF has held up well since it was implemented in early September. How well it can be sustained going forward is questionable especially given that risk aversion is intensifying once again. A weaker than forecast reading for the Swiss October manufacturing PMI yesterday falling further below the 50 boom / bust reading to 46.9 highlights the growing economic risks and consequent pressure to prevent the CHF from strengthening further. However, now that Japan has shown its teeth in the form of FX intervention the CHF may find itself once again as the target of safe haven flows.

Technical indicators revealed that GBP was overbought and its correction lower was well overdue. However, GBP looks in better shape than the EUR even in the wake of some mixed UK data yesterday. On a positive note, UK Q3 GDP surprised on the upside in line with our expectations coming in at 0.5% QoQ. However, the forward looking PMI manufacturing index dropped more than expected in October, down to 47.4 suggesting that UK economic momentum is waning quickly.

EUR/GBP looks set to test its 12 September low around 0.8259 but GBP/USD remains vulnerable to a further pull back against a resurgent USD. Overall, GBP’s resilience despite the implementation of more quantitative easing by the Bank of England has been impressive and I expect it to continue to benefit from its semi safe haven status

High Hopes

EUR/USD has rallied over recent days from a low around 1.3146 last week. Market hopes of a eurozone solution may fall flat but the pressure on officials has ratcheted higher, and the risks of failure are now too significant to jeopardize with half measures. Weekend promises of banking sector recapitalisation by Germany and France have helped but will not be enough should such promises prove empty. Markets will likely give the benefit of the doubt to eurozone officials ahead of the delayed October 23 EU Summit and the November 3 G20 meeting.

Consequently EUR will find some support over coming days and could extend gains as risk appetite improves; having broken above 1.3600 the next big resistance level for EUR/USD is 1.3800. The fact that EUR speculative positioning is very negative (biggest short position since June 2010 according to IMM data) highlights the potential for short covering.

Possible good news in Greece, with an announcement by the Troika (ECB, EU and IMF) on talks over the next tranche of the bailout will likely provide more EUR support. One stumbling block for the EUR could come from the Slovakian vote on EFSF bailout fund enhancement, which is by no means guaranteed to pass.

The JPY remains firm benefitting from higher risk aversion, registering one of the highest correlations with risk over recent months. However, the reason why the JPY is not even stronger is that bond yield differentials (especially 2-year) with the US have widened out in favour of the USD over recent days. If the recent improvement in risk appetite continues, combined with widening yield differentials it could push USD/JPY to finally move higher and sustain a break above 77.00.

GBP/USD has made an impressive bounce over recent days from a low around 1.5272 last week despite the Bank of England’s announcement of more quantitative easing last week and credit ratings downgrades of several UK banks. This resilience is impressive but it appears that GBP is caching onto the coat tails of a firmer EUR rather than benefitting from a domestically led improvement in sentiment. Nonetheless, there is scope for further gains in GBP given that speculative positioning in the currency moved close to its all time low early last week in anticipation of BoE QE.

%d bloggers like this: