Dollar firmer, Euro vulnerable, Yen wary

multitude of market moving events last week led to severe gyrations in risk appetite but with no clear direction for currencies. Indeed, currency markets were whipsawed as the news flow shifted back and forth. Major events such as the European Central Bank (ECB) and US Federal Reserve meetings, and US jobs data provided plenty of volatility points for markets. This week’s US data slate is less littered with first tier data, with trade data and Michigan confidence, the highlights of the week. Against this background the USD will take direction from events in the eurozone and in our view will likely trade with a firmer bias given that eurozone tensions will not ease quickly.

The EUR was relatively resilient despite a referendum (later cancelled) that could have spelled the beginning of the end of Greece’s membership in the eurozone. Nonetheless, the currency still dropped over the week. This week will be no different as markets sift through various pieces of news regarding Greece and the EU rescue plan. Although the Greek Prime Minister survived a confidence vote the EUR will remain vulnerable to a lack of detail about the EU rescue plan including but not limited to how the mechanism for leveraging the EFSF bailout fund. The longer the delay in providing such details the bigger the risk to the EUR. Data releases will be unhelpful for the EUR, with hard data such as German industrial production confirming a slowdown in activity.

Japan’s FX intervention at the beginning of last week has all but been forgotten among the plethora of other market moving news. Expectations that it would be followed up by more intervention proved incorrect as the Japanese authorities refrained from more action. Perhaps the onset of the G20 meeting stayed their hand but markets will be wary of more intervention this week. However, as the strengthening current account data in Japan will likely reveal this week, Japan’s strong external position continues to feed the underlying upward pressure on the JPY for the time being.

Interestingly FX markets appear to be reacting to growth orientated central bank policy rather than yield as reflected in the fact that EUR and GBP both strengthened despite additional quantitative easing from Bank of England at its last meeting and a rate cut from the ECB last week. This week however, inaction from the BoE will provide little direction to GBP while a likely drop in industrial production will raise fears that the economy continues to be in need of more remedial action from the central bank. GBP continues to be favoured but after having made up a lot of ground versus EUR it could lose some steam this week.

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Beyond Expectations

Egypt worries continue to reverberate across markets, yet there appears to be growing resilience or at least some perspective being placed on problems there. Encouraging economic data, particularly in the US has helped to shield markets to some extent, with equity market rallying and US bond yields rising last week. The main impact of Egypt and worries about Middle East contagion continues to be felt on oil prices.

Even the mixed US January jobs report has failed to dent market sentiment; the smaller than expected 36k increase in payrolls was largely attributed to severe weather. A further surprising drop in the unemployment rate to 9.0% due mainly to a significant drop in the labor force was also well received by the market.

There will be less market moving releases on tap this week and the data are unlikely to dent recovery hopes. Michigan confidence is set to record an improvement in February whilst the December trade deficit is set to widen to around $41.0 billion. There are also plenty of Federal Reserve speakers this week including a testimony by Chairman Bernanke.

One central bank that has softened its hawkish rhetoric is the European Central Bank (ECB), with President Trichet dampening speculation of an early rate hike last week and alleviating some of the pressure on eurozone interest rate markets. Consequently the EUR fell as the interest rate differential with the USD became somewhat less attractive. The EUR was also undermined by the opposition from some member states to French and German ideas for greater fiscal policy coordination, an aim apparently not shared across euro members.

Data in Europe will be largely second tier. The EUR will look increasingly vulnerable to a further drop this week especially given the increase in net positioning over the past week to (1st February) according to the CFTC IMM data. The potential for position squaring looms large as positioning is now well above the three-month average. Stops are seen just below EUR/USD 1.3540.

In the UK the Bank of England policy meeting will take centre stage but there is unlikely to be any change in policy settings. Clues to policy thinking will be available in the monetary policy committee meeting minutes in two weeks times but it seems unlikely that any more members have joined the two voting for a hike at the last meeting.

Recent data have been a little more encouraging helping to wash off the disappointment of the surprise drop in Q4 GDP. The UK industrial production report is likely to be similarly firm on Thursday, with the annual pace accelerating. GBP/USD may however, struggle to make much headway against the background of a firmer USD and the weigh of long positioning, with GBP/USD 1.6279 seen as strong resistance.

There are plenty of releases in Australia this week to focus including the January employment data, consumer confidence, and a testimony by RBA governor Stevens in front of the House of Representatives on Friday. The data slate started off somewhat poorly this week, with December retail sales coming in softer than expected, up 0.2% MoM. AUD/USD is likely to be another currency that may struggle to sustain gains this week but much will depend on data over coming days. Resistance is seen around 1.0255.

On a final note, the weekend’s sporting events highlight how it’s not just economic data or moves in currencies that don’t always go as expected. After a solid run in the Ashes cricket England slumped to a 6-1 series loss to Australia in the one-day series, putting the Ashes win into distant memory. A similarly solid performance by Man United was dented with their unbeaten record broken by bottom of the table Wolves.

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Risk on mood prevails

The end of the year looks as though it will finish in a firmly risk on mood. Equity volatility in the form of the VIX index at its lowest since July 2007. FX volatility remains relatively low. A lack of market participants and thinning volumes may explain this but perhaps after a tumultuous year, there is a certain degree of lethargy into year end.

Whether 2011 kicks off in similar mood is debatable given the many and varied worries remaining unresolved, not the least of which is the peripheral sovereign debt concerns in the eurozone. It is no surprise that the one currency still under pressure is the EUR and even talk that China offered to buy Portuguese sovereign bonds has done little to arrest its decline.

Reports of officials bids may give some support to EUR/USD just below 1.31 but the various downgrades to ratings and outlooks from ratings agencies over the past week has soured sentiment for the currency. The latest move came from Fitch ratings agency which placed Greece’s major banks on negative ratings watch following the move to place the country’s ratings on review for a possible downgrade.

The USD proved resilient to weaker than forecast data including a smaller than forecast 5.6% gain in existing home sales in November. The FHFA house price index recorded a surprise gain of 0.7% in October, which mitigated some of the damage. The revised estimate of US Q3 GDP revealed a smaller than expected revision higher to 2.6% QoQ annualized from a previous reading of 2.5%. Moreover, the core PCE was very soft at 0.5% QoQ, supporting the view that the Fed has plenty of room to keep policy very accommodative.

Despite the soft core PCE reading Philadelphia Fed President Plosser who will vote on the FOMC next year indicated that if the economy continues to strengthen he will look for the Fed to cut back on completing the $600 billion quantitative easing (QE) program. Although the tax deal passed by Congress will likely reduce the need for QE3, persistently high unemployment and soft core inflation will likely see the full $600 billion program completed. Today marks the heaviest day for US data this week, with attention turning to November durable goods orders, personal income and spending, jobless claims, final reading of Michigan confidence and November new home sales.

Overall the busy US data slate will likely maintain an encouraging pattern, with healthy gains in income and spending, a rebound in new home sales and the final reading of Michigan confidence likely to hold its gains in December. Meanwhile jobless claims are forecast to match the 420k reading last week, which should see the 4-week average around the 425k mark. This will be around the lowest since August 2008, signifying ongoing improvement in payrolls. The data should maintain the upward pressure on US bond yields, which in turn will keep the USD supported.

Please note that this will be the last post on Econometer.org this year. Seasons greatings and best wishes for the new year to all Econometer readers.

All eyes on G20

Although we move from feast to famine this week in terms of data there are still a few events that are noteworthy. In the US the September trade balance (Wed) will be of interest with a narrowing expected. Net exports negatively impacted GDP in Q3 but this is likely to reverse in Q4. Michigan confidence at the end of week is also likely to reveal better news with a rebound expected in October in the wake of firming equities, whilst the October budget statement is likely to reveal a sharp narrowing compared to October last year. Several Fed speakers over the week will be also be in focus as markets try to gauge the level of support within the FOMC for the QE2 announced last week.

There are a few data releases of interest in the eurozone including the preliminary estimate of Q3 GDP. Worryingly the divergence across the eurozone between healthier northern Europe and weaker performing in Southern Europe is becoming increasingly stark, a big headache for the Eurozone Central Bank with its one size fits all policy. Elsewhere, in the UK the Bank of England Quarterly Inflation Report will be scrutinized to determine whether recently firmer data and sticky inflation has pushed the BoE away from following the Fed into QE2. Japan’s volatile machinery orders data marks the highlight of its calendar, with a sharp drop expected in September following two strong months.

The main event of the week is the G20 leaders meeting in Seoul at the tail end of the week. Rhetoric going into the meeting suggests little support for the US plan to limit current account surpluses to 4% of GDP and even US officials appear to have cooled on the idea. Moreover the G20 meeting will probably elicit further reaction to the Fed’s QE2 announcement. Reaction was highly critical initially but seems to have softened lately. Currencies will nonetheless, remain the major topic of discussion although expectations of a global agreement are likely to be disappointed.

The Fed’s QE2 announcement helped provide a prop to risk assets and weighed on the USD last week despite the amount of asset purchases being within expectations. The USD will remain a sell on rallies this week and once again the best way to play USD weakness is likely via the higher yielding commodity currencies, especially AUD and NZD. Scandinavian currencies also offer a good way to capitalize on USD weakness.

The EUR may also struggle this week given worries about peripheral Europe and widening in peripheral bond spreads. Ireland’s budget cuts announced last week have so far failed to shore up confidence whilst political uncertainties are also rising. Greece’s regional elections revealed that the ruling socialist party narrowly retained control allowing the government to continue with reforms suggesting a modicum of support for its debt. Nonetheless, with Irish and Portuguese sovereign worries continuing, the EUR will continue to lag. Notably the CFTC IMM data revealed that speculative EUR sentiment deteriorated in the latest week to its lowest in over a month. EUR/USD is likely to target 1.3864 after dropping swiftly below the 1.4000 level.

Perhaps best way to play EUR vulnerability is versus the AUD, with a further decline through 1.3800 likely to pave the way for a drop below the 13 September low around 1.3660. AUD/JPY may also be another cross worth exploring especially as Japan’s new fund begins buying JGBs today, which could limit JPY upside. A test of AUD/JPY 83.65 is on the cards shortly. If Australia’s October employment report on Thursday reveals another strong reading it will likely give the currency further support into the end of the week.

Week Ahead

The market mood can be characterised as uncertain and somewhat downbeat, as reflected by the downdraft in US equity markets which posted their second weekly loss last week. Conversely, there has been a bullish run in government bonds, with the notable exception of peripheral debt. Over the last week markets had to contend with more data disappointment, in the wake of soft Japanese Q2 GDP, and a plunge in the August Philly Fed into negative territory, its first contraction since July 2009. Additionally a jump in jobless claims, which hit 500k highlighted the slow improvement in US job market conditions currently underway.

Despite all of this, the USD proved resilient and instead of the usual sell-off in the wake of soft data it benefited instead from increased risk aversion. The USD is set to retain some of this resilience though range-trading is likely to dominate over much of the weak. Reflecting the USD’s firmer stance, speculative positioning in the form of the CFTC IMM data revealed a reduction in aggregate USD short positioning in the latest week and although positioning is well below the three-month average, the improvement over the latest week and current magnitude of short positioning, highlights the potential and scope for further short-covering.

Negative data surprises have forced many to downgrade their forecasts for growth and policy implications, especially in the US. Markets will look for further clarity on the economic outlook this week but it is not clear that anything conclusive will be delivered. At the end of the week Q2 GDP will be revised sharply lower and whilst the data is backward looking it will reveal the weaker momentum of growth going into the second half of the year.

US Housing data will be mixed, with existing home sales set to drop in July as the impact of the expiration of home buyers tax credits continues to sink in whilst new home sales will likely increase but only marginally and will remain well below the April levels. Overall the picture of housing market activity remains bleak and this week’s data will do little to shake this off. On a more positive note July durable goods orders and August Michigan confidence will rise, the latter only marginally though. There will be plenty of attention on Fed Chairman Bernanke’s speech at the Jackson Hole Fed conference at the end of the week, especially given speculation of more quantitative easing in the pipeline.

The European data slate kicks off today with the release of manufacturing and service sector PMIs. Both are likely to register small declines, albeit from high levels. Nonetheless, taken together with a likely drop in the August German IFO survey on Wednesday and weaker June industrial orders tomorrow, the data will highlight that the momentum of growth in the region is coming off the boil, with the robust GDP outcome registered in Q2 2010 highly unlikely to be repeated. Against this background EUR/USD will find it difficult to make any headway. Technically further donwnside is likely over the short-term, with a test of 1.2605 support on the cards

Japan releases its slate of month end releases including jobs data, household spending and CPI. A slight improvement in job market conditions and increased spending will be insufficient to allay growth and deflation concerns, especially with CPI remaining firmly in negative territory. The onus will remain on the authorities to try to engineer a weaker JPY, which remains stubbornly around the 85.00 level versus USD. Talk of a BoJ / MoF meeting today has been dismissed, suggesting the prospect of imminent action is small. Meanwhile, speculative JPY positioning has dropped slightly in the last week but remain close to historical highs.

Aside from various data releases this week markets will digest the outcome of Australia’s federal elections. From the point of view of markets the outcome was the worst possible, with no clear winner as both the incumbent Prime Minister of the ruling Labour Party and opposition Liberal-National Party leader Tony Abbot failed to gain an outright majority. The outcome of a hung parliament will likely keep the AUD on the back foot, with trading in the currency likely be somewhat volatile until a clear outcome is established as both candidates try to garner the support of a handful of independents. However, it is notable that apart from an initial drop the AUD has managed to hold its ground. Nonetheless, the given the fluidity of the political situation there will be few investors wanted to take long positions at current levels around 0.8900 versus USD.

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.

Euro Has That Sinking Feeling

The reaction to the US May jobs report shows that markets are particularly susceptible to negative US news at a time when growth fragilities in Europe are becoming increasingly apparent. Coupled with worries about Hungary, risk aversion has jumped.

Unsurprisingly the EUR took the brunt of pressure. Rhetoric over the weekend may help to assuage some fears but I suspect it is too late now that the cat is out of the bag. Hungary’s government maintained that it will meet this year’s budget deficit target of 3.8% of GDP. European Union officials also attempted to calm market concerns, downplaying any comparison of Hungary to Greece.

The overall EUR/USD downtrend remains intact. Renewed doubts about German participation in the EU/IMF rescue package, with the German constitutional court potentially blocking its contribution, will add to pressure as well as a UK press report titled EUR ‘will be dead in five years’ . The January 1999 EUR/USD introduction level around 1.1830 has now moved squarely into sight.

It is unlikely that data and events this week will do much to reverse the market’s bearish tone. Highlights include the ECB, BoE and RBNZ meetings in Europe, UK and New Zealand, respectively. The ECB (Thursday) is highly unlikely to shift its monetary policy stance. Given some opposition to bond purchases from within the ECB council the comments in the accompanying statement will be closely monitored. The BoE will also leave policy unchanged on the same day but the RBNZ is set to begin its hiking cycle with a 25bps move.

On the data front the US slate includes the Fed’s Beige Book, April trade data, May retail sales and June Michigan confidence. The Beige Book is likely to reveal some improvement in activity with little sign of inflation, whilst the trade deficit is set to widen further due to a higher oil import bill. Retail sales will reveal an autos led increase in the headline reading but more subdued core sales, whilst consumer confidence is set to rise for a second straight month.

There will be more attention on rhetoric from EU officials rather than eurozone data, with the Eurogroup of Finance Minister’s and Ecofin meetings garnering more interest. In Japan, politics will take centre stage, with the new cabinet line up in focus following the confirmation of Naoto Kan as Prime Minister. Comments by the new PM himself will be of interest, especially with regard to combating deflation and in particular any elaboration on his penchant for a weaker JPY.

All-in-all, the week is unlikely to see a let up in pressure on risk trades and will start much as the last week ended. Although the market’s attention is on the EUR, it should be noted that the AUD has lost even more ground so far this month although the EUR remains the biggest loser in terms of major currencies so far this year (vs USD). In the case of the AUD the move reflects a massive unwinding of long positioning (as reflected in the latest CFTC IMM data which shows that speculative AUD positioning has dropped to its lowest since March 2009).

In contrast in the case of the EUR where positioning is already very negative, the move simply reflects deteriorating fundamentals. The fact that European officials are showing little concern about the decline in the EUR (why should they given that the currency is now trading around fair value) and in some cases encouraging it, suggests that there is little to stop EUR/USD from dropping much further and parity is looming a lot closer.

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