Chinese data casts a shadow over markets

The better than expected reading for January US jobs growth (175k versus 149k consensus) helped to buoy asset markets at the end of the week, with major US equity indices posting gains. The uptick in the US unemployment rate to 6.7% was also not perceived badly as it will put less pressure on the Fed to change its forward guidance. The jobs data helped to overcome concerns over ongoing tensions between the West and Russia over Ukraine.

Consequently the USD strengthened as US yields rose, with the 10 year Treasury yield almost touching 2.82%. The most sensitive currency pair to higher US yields is USD/JPY and further upside traction is likely. The main exception to the USD rebound was the EUR, which continued to benefit from the ECB’s lack of policy easing or dovish commentary at its policy meeting last week.

Chinese data released over the weekend will prove to be less constructive for asset markets at the turn of this week, however, with a surprise trade deficit registered over February and slowing inflation to a 13 month low. Exports dropped by whopping 18.1% in February while imports rose more strongly than expected at 10.1% yielding a trade deficit of USD 22.99 billion.

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A more constructive start to the week

Following a period of heightened volatility markets ended last week on a more positive note. Despite another soft reading for US non farm payrolls in January which revealed jobs growth of 142k following a gain of 74k in the previous month, markets took some comfort from a drop in the unemployment rate to 6.6% which for a change was not related to a drop in the participation rate. The participation rate rose to 63.0% in January.

Against this backdrop Fed Chairman Yellen will be giving her first testimony to Congress this week and while there is likely to be little change to the Fed’s policy outlook there will need to be some reassessment of the Fed’s forward guidance, especially given the surprisingly quick drop in the unemployment rate. The USD index slipped last week but we expect a slightly firmer tone to ensue over coming days in line with higher US yields.

Markets will kick off the week much as they left off last week, with a calmer and more constructive tone likely. Aside from Yellen’s speeches, US data will be soft on the whole, with January retail sales likely to post a small decline, while industrial production will record a gain and Michigan sentiment will fall, with consumer confidence weighed down by weaker equity markets.

Caution continues

The cautious tone in risk assets was maintained at the turn of this week as equity markets slipped further overnight in the US and recorded mixed performances in Asia. While the rise in risk aversion is unlikely to reflect a major change in market sentiment, it does highlight that risk assets will not repeat the one sided moves recorded in Q4 last year over coming months. US equity valuations for example look far richer compared to historical valuations while earnings expectations are softer, suggesting that equity momentum may not be as robust.

Ahead of the key data and events this week including European Central Bank and Bank of England policy decisions and the US employment report, caution is likely to prevail. Highlights today include flash December Eurozone CPI inflation data, which is likely to show inflation pressures remaining subdued, German December employment data and the US November trade balance.

Disappointing US non manufacturing confidence data released yesterday (53.0 for the ISM non manufacturing survey against expectations of 54.7) has taken the wind out of the USD’s sails although most major currencies look set to gyrate in relatively tight ranges over the near term. JPY will find some support from a generally softer risk tone that has filtered through markets and may struggle to retake the 105 level.

Meanwhile EUR/USD has failed to hold onto recent gains, with sentiment turning less positive as indicated by the latest CFTC IMM data on speculative positioning. Likely soft Eurozone inflation data to be released today will likely undermine the currency further. However, given that it is unlikely that the ECB will sound any more dovish at this Thursday’s policy meeting the downside for the EUR is set to be limited, with technical support around 1.3525.

Consolidating ahead of payrolls

Ahead of the belated release of the US September jobs report markets are set to remain range bound, with most assets consolidating recent moves. For instance, the VIX “fear gauge” edged higher following steep declines while US Treasury yields gained a few basis points helping the USD index to push slightly higher. Equity investors will have one eye on earnings reports hoping that the recent run of positive Q3 US earnings surprises continues.

The consensus for US September non farm payrolls is 180k, with a low of 100k and high of 256k according to Bloomberg and unemployment rate likely to remain 7.3%. The data will have important implications for Fed tapering expectations, with the outcome likely to help support expectations that the Fed will not begin tapering until early next year.

Like other asset classes little movement is expected in FX markets ahead of the release of the US jobs report. A payrolls outcome around the consensus will have little market impact but it appears that the consensus is skewed towards a weaker outcome, suggesting a bigger FX reaction should there be an above consensus outcome (around 200k+).

Both the EUR and JPY are struggling to make further headway against the USD. There is nothing of note on the data front from the Eurozone or Japan today suggesting that attention will be mainly centred on US data. Stabilisation in US bond yields leaves the USD in better form against both currencies and given that a lot of bad news is now priced into the USD its downside looks more limited although much will depend on today’s jobs data.

The AUD is the outright winner in terms of gains versus the USD so far this month alongside other commodity currencies, NOK and NZD. AUD has benefitted from receding expectations of interest rate cuts, and firmer Chinese data alongside improving risk appetite. While I have been far more bullish than the consensus on AUD, it may be worth taking profits on recent gains versus USD as consolidation is likely in the short term. I see more scope for gains in AUD versus NZD over coming weeks, however.

US dollar buoyed by higher yields, Asian currencies hit

Efforts by the European Central Bank and Bank of England to disassociate themselves from Fed policy actions were overwhelmed by the US June jobs report which revealed a bigger than consensus 195k increase in payrolls and upward revisions to previous months. The data reinforced expectations that the Federal Reserve would begin tapering in September while the data also pushed US yields sharply higher (close to 23 basis points increase in US 10 year yields following the data) and fuelling further USD strength.

In fairness attempts by the ECB and BoE to introduce ‘forward guidance” may eventually garner some success but US yields will continue to dictate market direction, at least until the markets successfully transition to the reality of Fed tapering, which could take several weeks. During the interim expect transitional volatility to continue, with risk assets globally remaining under pressure.

Further detail on Fed policy will be looked for from within the minutes of the June FOMC meeting to be released on Wednesday although it is unlikely that there will be any real divergence from the message delivered by Fed Chairman Bernanke and a host of other Fed officials over recent weeks. Consequently the USD is likely to retain a broadly firm tone as it reacts to the sharp move higher in US yields at the end of last week.

The Bank of Japan will likely be emboldened in its ultra easy monetary policy stance following last week’s ECB and BoE announcements although no further policy action is likely at this week’s meeting as attention shifts to Japan’s Upper House elections on 21 July. The JPY in particular will remain susceptible to USD strength and widening yield differentials, with potential to test USD/JPY resistance around 102.45 this week.

European attention will centre on Greece and Portugal as the former will be the focus of discussions at the Eurogroup / Ecofin meetings today and tomorrow, with officials set to deliberate Greece’s bailout. Attempts in Portugal to resolve political differences between the main coalition parties appears to have garnered some success in a deal which could stave off fresh elections. None of this will help the EUR which is set to remain under pressure as it edges towards support levels at 1.2744 versus USD.

USD strength will also continue to be exhibited versus Asian currencies this week. Equity fund outflows continue to damage regional currencies lower. Since the end of May Asia has recorded around USD 15.4 billion in equity outflows. Total inflows this year have dropped to only around USD 3.6 billion. A renewed fall in the JPY will added pressure to more JPY sensitive currencies such as TWD and KRW but the overwhelming influence is higher US yields and capital outflows which will continue to have particularly negative impact on currencies with external funding needs, especially the INR and IDR.

US dollar helped by higher yields

The dichotomy between hard economic data and asset market performance continues but unlike over past weeks at least there was some justification for the rally in equity markets following the stronger than expected US April jobs report. US non farm payrolls rose by 165k while revisions added 114k to previous months and the unemployment rate dropped further to 7.5%.

The data will offer the Fed some comfort perhaps reducing the need to expand further asset purchases in the months ahead. Nonetheless, the jury is still out and following the shift in Fed language at the FOMC meeting last week, in which they opened the door to increasing quantitative easing, it may take more than one, albeit important data release to completely erase expectations of more QE.

Further Fed thoughts on the jobs data as well as the plethora of disappointing data releases over previous weeks could emerge from the Chicago Fed conference this week, with several Fed speakers including Chairman Bernanke scheduled to speak. Given that there is little else on the data front market direction will take it cue from Fed comments.

Aside from central bank meetings in the UK and Australia the data slate is similarly thin elsewhere. No change is expected from both the Band of England and Reserve Bank of Australia but the latter is a much closer call given weaker data both domestically and in China. If the RBA does not move AUD will find some further support after rallying on the back of the jump in copper prices last week although gains will be limited as markets may just push back Australian easing expectations to the next meeting.

In the Eurozone, the final services confidence indices and German industrial data will be on tap and will add more evidence of the weaker economic trajectory and likely restrain the EUR and keep Eurozone core bonds supported. EUR/USD will find little else to give it direction, with higher US yields also likely to help keep any gains in EUR/USD capped, with resistance seen around 1.3220.

Japan has little on the data front too with trade and current account data in focus. The jump in the USD/JPY following the US jobs report will mean that attention will be on whether the 100 level can finally be cracked, with the spike in US 10 year Treasury yields likely keeping the USD supported versus JPY. I suspect that this level will not be breached unless US yields rise further.

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.

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