Payrolls sour mood, Eurozone concerns intensify

The market mood has soured further and risk aversion has increased following disappointing August US jobs report in which the change in payrolls was zero and downward revisions to previous months has reinforced the negative mood on the US and global economy while raising expectations of more Federal Reserve action. Moreover, the report has put additional pressure on US President Obama to deliver fresh jobs measures in his speech on Thursday though Republican opposition may leave Obama with little actual leeway for further stimulus.

There is plenty of event risk over coming days, with a heavy slate central bank meetings including in Europe, UK, Japan, Australia, Canada and Sweden. The European Central Bank will offer no support to a EUR that is coming under growing pressure, with the Bank set to take a more neutral tone to policy compared its previously hawkish stance. In the UK, GBP could also trade cautiously given recent comments by Bank of England Monetary Policy Committee members about potential for more UK quantitative easing.

The EUR has been unable to capitalise on the bad economic news in the US as news there has been even worse. The negative news includes the weekend defeat of German Chancellor Merkel’s centre-right bloc in regional elections, which comes ahead of a vote in Germany’s constitutional court on changes to the EFSF bailout fund.

The withdrawal of the Troika (ECB, IMF and EU) from Greece has also put renewed emphasis on the country at a time when protests are escalating. If all of this is not enough there is growing concern about Italy’s apparent backtracking on austerity measures, with the Italian parliament set to discuss measures this week. Separately Germany, Holland and Finland will hold a meeting tomorrow on the Greek collateral issue. On top of all of this is the growing evidence of deteriorating growth in the euro area.

Data releases are unlikely to garner a great deal of attention amidst the events noted above, with mainly service sector purchasing managers indices on tap and at least threw will look somewhat better than their manufacturing counterparts. In the US the Beige Book and trade data will be in focus but all eyes will be on Obama’s speech later in the week. The USD has maintained a firm tone despite the jobs report but its resilience may be better explained by eurozone negativity rather than US positivity. Even so, the USD is looking less uglier than the EUR in the current environment.


The Week Ahead

Equity markets and risk trades have generally performed well over the last couple of weeks, with for example the S&P 500 around 7.5% higher since its late August low, whilst equity and currency volatility have been generally low, the latter despite some hefty FX intervention by the Japanese authorities which did provoke a spike in USD/JPY volatility last week.

Risk appetite took a knock at the end of last week in the wake of worries that Ireland may seek EU / IMF assistance although this was denied by Irish officials. A similar worry inflicted Portugal, and as a result peripheral bond spreads were hit. Sovereign worries in Europe have not faded quickly and bond auctions in Greece, Spain and Portugal will garner plenty of attention this week. Renewed worries ahead of the auctions suggest that the market reception could be difficult.

Attention will swiftly turn to the outcome of the Fed FOMC meeting tomorrow and in particular at any shift in Fed stance towards additional quantitative easing following the decision at the August FOMC meeting to maintain the size of the Fed’s balance sheet. Given the recent improvement in US economic data the Fed is set to assess incoming data before deciding if further measures are needed.

Housing data in the US will also garner plenty of attention, with several releases scheduled this week. Increases in August housing starts, building permits, existing and new home sales are also expected. Whilst this may give the impression of housing market improvement, for the most part the gains will follow sharp declines previously, with overall housing market activity remaining weak following the expiry of the government tax credit.

Weakness in house prices taken together with a drop in equity markets over the quarter contributed to a $1.5 trillion drop in US household net wealth in Q2. Wealth had been recovering after its decline from Q2 2007 but renewed weakness over the last quarter will not bode well for consumer spending. Household wealth is around $12.4 trillion lower than its peak at the end of Q2 2007.

Aside from the impact of renewed sovereign concerns, European data will not give the EUR much assistance this week either, with Eurozone September flash PMIs and the German IFO survey of business confidence set to weaken as business and manufacturing confidence comes off the boil. If the Fed maintains its policy stance whilst risk aversion increases over coming days the USD may find itself in a firmer position to recoup some of its losses both against the EUR and other currencies.

This will leave EUR/USD vulnerable to drop back down to around support in 1.2955 in the very short-term. As indicated by the CTFC IMM data there has been further short EUR position covering last week whilst sentiment for the USD deteriorated, suggesting increased room for short-USD covering in the event of higher risk aversion.

The impact of Sweden’s election outcome over the weekend is unlikely to do much damage to the SEK despite the fact that the coalition government failed to gain an outright majority. EUR/SEK has edged higher over recent days from its low around 9.1528 but SEK selling pressure is unlikely to intensify following the election, with EUR/SEK 9.3070 providing tough technical resistance.

What To Watch This Week

Well so much for a “risk on” week. Market sentiment soured at the end of last week following The US Securities and Exchange Commission (SEC) civil action against Goldman Sachs, in which they accused the bank of fraud. The impact reverberated across markets and risk trades were pulled back as a consequence. Bulls shouldn’t be too downhearted though as the drop in risk trades followed several days of gains and part of the pullback could be attributed to profit taking.

Speculation of similar probes in Europe by financial regulators will cast a shadow over markets early this week. Nonetheless, direction will at least in part come from earnings. So far the run of earnings looks upbeat, with around 83% of the 48 S&P 500 companies reporting, beating analysts’ estimates. Overall profits are forecast to increase by around 30% from a year ago but are on track to easily beat this estimate. Bellwether names including IBM, Apple, Coca-Cola, Boeing, Microsoft, and AT&T report this week.

The meeting between Greek officials, ECB, IMF and EU has been delayed until Wednesday. There is little likelihood of Greece seeing any loan money soon as the need for parliamentary approval in some EU countries and upcoming regional elections in Germany on 9 May will put a spanner in the works. An issue of EUR 1.5bn of 3-month Greek debt tomorrow will act another test of market confidence but the recent widening in Greek debt spreads suggests a less positive reception than the previous sale.

There are also a few central bank meetings to contend with this week including Canada, Sweden, India, Philippines and Thailand. The only Bank likely to hike interest rates out of this bunch is the RBI in India with another hike expected, following closely on the heels of the March move. Canada and Sweden are unlikely to shift policy until at last after the end of Q2 whilst protests in Bangkok, Thailand, and the knock on impact on consumer confidence, have effectively sealed the case for no rate move there.

On the data front, attention will turn to US housing market activity. Markets will be able to gauge further clues to whether recovery in the housing market has stalled. An increase in both existing (Thu) and new home sales (Fri) in March is expected, which may allay some concerns although any improvement is likely to continue to fragile against the background of tight credit and high foreclosure levels.

In Europe, aside from the ongoing Greek sage, sentiment surveys will garner most attention, with the release of the German ZEW (Tue) and IFO (Fri) surveys as well as manufacturing and service sector purchasing managers indices (PMIs) across Europe. On the whole the surveys are likely to reveal some improvement as confidence.

Risk aversion will be slightly elevated at the beginning of this week but strong earnings and improving data will help to prevent too much damage. Consequently Risk currencies will start the week under pressure but any pullback will be limited. Given that speculative positioning in risk currencies such as the AUD, NZD and CAD is well above their three-month average according to the latest Commitment of Traders’ IMM data there will be some scope for profit taking. EUR speculative sentiment has seen some improvement but EUR/USD remains vulnerable to a further pull back to technical support around 1.3302 this week.

Tarnishing The Euro

I am just finishing up a client trip in Japan and waiting to take a flight back to Hong Kong. The time ahead of the flight has allowed some reflection on my meetings here. One thing that has been particularly evident is the strong interest in all events European. Some I have spoken to have wondered out loud whether this the beginning of the end of the European project.  At the least it is evident that fiscal/debt problems in Greece and elsewhere in Europe have tarnished the image of the EUR.

Markets continue to gyrate on any news about Greece and the potential for support from the Europe Union and/or IMF. The divergent views between European countries about how to deal with the problem has intensified, suggesting that reaching an agreement will not be easy. Some countries including the UK and Sweden have suggested enrolling the help of the IMF but this has been resisted by other European countries. Germany and France are trying to rally support ahead of today’s crucial meeting of European officials.

The EUR reacted positively to news that some form of support package is being considered but nothing concrete has appeared yet, leaving markets on edge. The EUR has been heavily sold over recent weeks; speculative market positioning reached a record low in the latest week’s CFTC Commitment of Traders’ IMM report. The fact that EUR positioning has become so negative suggests that the EUR could rebound sharply in the event that some support package for Greece is announced.

Any package will not come without strings attached, however, as European officials will want to avoid any moral hazard. A couple of options hinted at by German officials include fresh loans or some form of plan to purchase Greek debt. Either way, any solution to Greece’s problems will not be quick and will likely result in a sharp contraction in economic activity as the government cuts spending especially as Greece does not have the option of the old remedy of devaluing its currency. Meanwhile, strikes and social tensions in the country could escalate further. A solution for Greece will only constitutes around 2.5% of eurozone GDP will also not prevent focus from continuing to shift to Portugal, Spain and other countries with fiscal problems despite comments by Moody’s ratings agency to differentiate between the countries.

Even if the EUR rebounds on any positive news about support for Greece any relief is likely to prove temporary and will provide better levels to sell into to play for a medium term decline in the currency. Ongoing fiscal concerns, a likely slower pace of economic recovery, divergencies in views of European officials, and the fact that the EUR is still overvalued suggests that the currency will depreciate over much of 2010, with a move to around EUR/USD 1.30 or below in prospect over coming months.

Dollar on top as central banks deliberate

There has been a veritable feast of central bank activity and decisions with most attention having been on the Fed’s decision.  In the event the FOMC meeting delivered no surprises in its decision and statement.  Basically the Fed acknowledged the recent improvement in economic activity but continued to see inflation as subdued and maintained that policy rates will remain low for an “extended period”.  The Fed also noted that most liquidity facilities were on track to expire on 1 February suggesting that they remain on track to withdraw liquidity.  

There was similarly no surprise in the Riksbank’s decision in Sweden to leave interest rates unchanged, with the Bank reiterating that it would maintain this stance through the autumn of 2010.  The SEK has been stung by outflows due to annual payments of premiums to mutual funds by the Pension Authority but the impact of this has now largely ended leaving the currency in better position.  Norway’s Norges Bank unexpectedly raised interest rates, for a second time, increasing its deposit rate by 25bps to 1.75%, with the surprise evident in the rally in NOK following the decision.   The other central bank to surprise but in the opposite direction was the Czech central bank which cut interest rates by 25bps.  

In contrast to the Norges Bank’s hawkish surprise the RBA has helped to toned down expectations for further rate hikes in Australia, with Deputy Governor Battellino suggesting that monetary policy was back in a “normal range” in contrast to the perception that policy was still very accommodative.   Weaker than expected Q3 GDP (0.2% QoQ versus forecasts of a 0.4% QoQ rise) data fed into the dovish tone of interest rate markets fuelling a further scaling back of rate hike expectations, casting doubt on a move at the February 2010 RBA meeting and pushing the AUD lower in the process.  Against this background AUD continues to look vulnerable in the short term, especially under the weight of year end profit taking and the resurgent USD.  

There was also some surprise in the amount of lending by the ECB, with the Bank lending EUR 96.9 bn in third and final tender of 1-year cash despite the cost of the loan being indexed to the refi rate over the term of the loan rather than being fixed at 1%.  There was also a sharp decline in the number of banks bidding compared to earlier 1-year auctions but at a much higher average bid.  This implies that some banks in Europe remain highly dependent on ECB funding despite the improvement in market conditions.   The EUR continues to struggle and its precipitous drop has shown little sign of reversing, with the currency set for a soft end to the year.  A break below technical support around 1.4407 opens the door to a fall to around 1.4290.   

The USD is set to retain its firmer tone in the near term though we would caution at reading its recent rally as marking a broader shift in sentiment.  The move in large part can be attributed to position adjustment into year end and is being particularly felt by those currencies that have gained the most in recent months.  Hence, the softer tone to Asian currencies and commodity currencies which appear to be bearing the brunt of the rebound in the USD.   Going into next year USD pressure is set to resume but for now the USD is set to remain on top, with the USD index on track to break above 78.000.

Earnings in focus

The majority of US Q3 earnings have beaten market expectations resulting in a boost to risk appetite and further pressure on the US dollar. At the time of writing, 61 companies have reported earnings in the S&P 500 and an impressive 79% have beaten forecasts according to Thomson Reuters. This week there are plenty of earnings on tap and although a lot of positive news appears to be priced in the overall tone to risk appetite remains positive. This implies a weaker US dollar bias given the strong negative correlation between US equities and the USD index.

Aside from the plethora of earnings there are plenty of data releases on tap this week including housing data in the US in the form of building permits and starts as well as existing home sales. The data will likely maintain the message of housing market stabilisation and recovery in the US. There will also be plenty of Fed speakers this week and markets will once again scrutinize the speeches to determine the Fed’s exit strategy.

Highlights this week also include interest rate decisions in Canada and Sweden. Both the BoC and Riksbank to leave policy unchanged and expect a further improvement in the German IFO in October though at a more gradual pace than in recent months. There will be plenty of interest in the UK MPC minutes given conflicting comments from officials about extending quantitative easing. RBA minutes will be looked at for the opposite reason, to determine how quickly the Bank will raise interest rates again.

The USD index managed a slight rebound at the end of last week but is likely to remain under pressure unless earnings disappoint over coming days. US dollar Speculative sentiment became more bearish last week according to the CFTC IMM data, with dollar bloc currencies including the AUD, NZD and CAD benefiting the most in terms of an increase in speculative appetite. GBP short positions increased to a new record but the rally towards the end of last week may have seen some of these short positions being covered. Overall any recovery in the USD this week may just provide better levels to go short.

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