All Eyes On Europe

EUR looks range bound ahead of key events including the European Central Bank (ECB) meeting, European Union Summit and release of bank stress test results. A senior German official poured cold water over expectations of a concrete outcome from the EU Summit, dampening EUR sentiment as a result.

There will be plenty of attention on the ECB to determine whether they will give a little more ground and provide further assistance to the Eurozone periphery. While a refi policy rate cut is highly likely as well as additional liquidity measures I do not expect any move in the direction of more aggressive action to support peripheral bonds in terms of becoming “lender of the last resort’.

If however, the ECB hints at intensifying its securities market purchases of Eurozone bonds this will likely bode well for the EUR. Indeed, reports overnight suggest that the ECB will announce a set of measures to stimulate bank lending including easing collateral requirements for banks.

More weak UK data in the form a bigger than consensus drop in manufacturing and industrial production in October add to the soft BRC retail sales and house price data, in putting pressure on the Bank of England (BoE) to increase its quantitative easing at today’s policy meeting. While the BoE is set to keep policy unchanged it is only a matter of time before additional asset purchases are announced.

Despite the weaker IP data GBP has held up relatively well against the USD although downside risks appear to be intensifying. If I am correct in the view of no change by the BoE today we expect little change in GBP although there could be a risk of a push higher in EUR/GBP if the ECB delivers some positive news, with resistance seen around 0.8665.

The RBNZ unsurprisingly left policy rates unchanged at 2.5%, sounded less hawkish than the previous meeting and also lowered growth forecasts. The NZD was left unmoved by the rate decision and looks well supported at current levels perhaps due to relief that the statement was not more dovish. The kiwi has been an underperformer over the year but unlike the AUD it has not been particularly influenced by gyrations in risk aversion.

Interest rate futures differentials have seen a renewed widening versus the US over recent weeks. This is significant given that the NZ-US interest rate differentials have a very strong correlation with the performance of NZD/USD. If this widening is sustained it will point to upside potential for the Kiwi.

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Japanese yen spikes higher

Events in Japan continue to dominate market action in this respect the situation is highly fluid. Markets will continue to gyrate on various pieces of news concerning the nuclear situation in Japan. As a result, risk aversion remains highly elevated and safe haven assets including US Treasuries, German bunds and the CHF are the main beneficiaries. In contrast, risk assets including global equity markets and risk currencies have come under growing pressure.

Prior to Japan’s earthquake risk aversion was already elevated amidst renewed eurozone peripheral bond tensions but the aftermath of the earthquake has seen our risk barometer rise to its highest level since the end of August last year. Any decline in risk aversion will depend on the nuclear situation coming under some form of control but until then the general “risk off” market tone will continue. Similarly currency and equity volatility will also remain relatively high.

Risk had been losing its influence on currencies over recent months but the spike in risk aversion over recent weeks has seen short-term correlations increase. The most highly impacted (highest correlations over the past month) currencies from higher risk aversion USD/JPY, USD/CHF, NZD/USD, NOK/SEK, EUR/CHF, EUR/HUF, EUR/PLN, USD/KRW. Over a three-month period all of the correlations are much lower and insignificant for the most part. JPY and CHF will likely remain the key beneficiaries in the current environment.

USD/JPY hit a low of 76.25 amidst volatile trading conditions but Japanese authorities noted that rumours of Japanese life and non life insurance companies repatriating funds back to Japan are “groundless”. USD/JPY bounced from its lows but there appears to be no sign of intervention although there may have been Bank of Japan rate checking, which helped to provoke some fears about imminent intervention. There is a high risk of FX intervention as long as USD/JPY remains below the 80.00 level.

Greek Aid Boosts Euro

Greece is never far from the headlines and the big news over the weekend was once again centred on this small (in terms of economy size) eurozone Country, with the agreement by Eurozone members to provide up to EUR 30 billion in loans to Greece. This will be supplemented by additional contributions from the IMF to the tune of around EUR 15 billion. The rate of around 5% for the three-year fixed loan is well below that yielding on Greek debt but above the International Monetary Fund (IMF) standard lending rate. In other words, the terms of the loan are far more favourable than they would currently face in the market.

After weeks of haggling the decision to detail the amount and terms of a loan for Greece will help reassure markets and likely result in a narrowing in Greek spreads over the near term. Further details will be finalised early in the week including conditions imposed on Greece as well as the exact amount of the IMF contribution but the real test of confidence will be the reception to Greece’s EUR 1.2 billion sale of 3 and 6-month paper at the beginning of the week.

Markets were already embarking on a short covering exercise in EUR/USD early last week according to the latest CFTC IMM report which showed a reduction in net EUR short speculative positions. As a result of the weekend’s agreement the EUR looks set to consolidate its gains into the beginning of this week. Further out, there are still plenty of risks ahead and sellers are likely to emerge around EUR/USD resistance at 1.3696.


Data releases this week will be conducive to maintaining further support for risk appetite whilst shoring up recovery expectations. In particular US March retail sales are set to jump on the back of strong autos spending (consensus 1.2% monthly gain). March industrial production is also likely to record a healthy reading (consensus 0.7% month-on-month), whilst gains in both manufacturing (Empire manufacturing and Philadelphia Fed) and consumer confidence (Michigan confidence) for April are likely.

There will also be plenty of attention on Chinese data this week with a plethora of releases over coming days including FX reserves, GDP, loans data, inflation, retail sales and industrial production. In short, the data will continue to reveal a robust economic performance, which will be good for risk appetite and Asian currencies, but will also add to the pressure to revalue the Chinese currency, CNY, soon.

The USD impact will depend on whether the market reacts to firmer risk appetite or signs of stronger US growth. I suspect the former will apply for now, likely keeping the USD on the back foot early in the week. The main beneficiaries include risk currencies such as AUD, NZD and CAD as well as most Asian currencies. AUD/USD is set to target technical resistance around 0.9407 whilst NZD/USD will set its sights on resistance around 0.7252 over the next few days.

Selling Risk Trades On Rallies

Disappointing earnings as well as a weaker than expected outcome for data on the health of the US service sector (the ISM non-manufacturing index failed to match expectations, coming in at 50.5 in January versus consensus of 51.0) has weighed on markets, undoing the boost received from the generally positive manufacturing purchasing managers (PMIs) indices earlier in the week. It was not all bad news however, as earnings from Cisco Systems beat expectations Meanwhile US ADP jobs data fell less than expected, dropping 22k whilst data for December was upwardly revised. These are consistent with a flat outcome for January non-farm payrolls.

Various concerns are still weighing on confidence. Sovereign ratings/fiscal concerns remain high amongst these and although much has been made of the narrowing in Greek debt spreads, attention now seems to be turning towards Portugal. Greece is also far from being out of the woods, and whilst the European Commission accepted Greece’s economic plans the country would be placed under much greater scrutiny by the EC.

The US has not escaped either, with Moody’s warning that the US AAA credit rating would come under pressure unless more stringent actions were taken to reduce the country’s burgeoning budget deficit. The move follows the US administration’s forecast of a $1.565 billion budget deficit for 2010, the highest as a proportion of GDP since the second world war, with the overall debt to GDP ratio also forecast to rise further.

The current environment remains negative for risk trades and the pullback in high beta currencies has been particularly sharp over recent weeks. Sentiment for the NZD was dealt a further blow from a surprisingly weak Q4 jobs report in New Zealand. Unemployment rose to a decade high of 7.3% over the quarter whilst employment growth contracted by 0.1%. The pull back in wage pressures will also be noted by interest rate markets, as it takes some of the pressure off the RBNZ to raise rates anytime soon.

Data in Australia will not help sentiment for the AUD too. Australian retail sales dropped by 0.7% in December, a worse than expected outcome. The data will only serve to reinforce market expectations that the RBA will no hike interest rates as quickly as previously expected. Nonetheless, I would caution reading too much into the data, with real retail sales volumes rising by a solid 1.1% over Q4 whilst other data showed a strong 2.2% jump in building approvals.

The overall strategy against this background is to sell risk trades on rallies. There are still too many concerns to point to a sustained improve in risk appetite. Moreover, the market is still long in many major risk currencies. Asian currencies have so far proven more resilient to the recent rise in risk aversion however, a reflection of the fact that a lot of concerns are emanating from the US and Europe. However, Asian currencies will continue to remain susceptible to events in China, especially to any further measures to tighten policy.

Further USD strength against this background is likely, which could see EUR/USD testing support around 1.3748, AUD/USD support around 0.8735, and NZD/USD support around 0.6916.

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