USD steadies, but EUR remains firm
The US dollar spent a second week consolidating after the recent sell-off and there are some indications the recent dollar downtrend may be coming to a close. USD weakness has been driven by market expectations of a second round of Fed asset purchases (QE2), which has also seen US Treasury yields pushed down. Markets look to have priced in QE2 of around $1.0-1.5 trillion, which is increasingly looking extreme in light of recent Fed officials' comments. Rather than a 'shock and awe' approach (announcing $1 trillion+ of asset purchases over a defined period), the Fed now seems more inclined to take an incremental approach, possibly opting for an open-ended buying program on the order of $100 bio per month. If the Fed does take this route, it suggests potentially significant re-pricing of market expectations is needed and this could be the catalyst for a USD rebound. Indeed, 10 year US Treasury yields have already bottomed and are finishing out the week nearly 25 bps above recent lows.
We'll likely need to have the Nov. 3 FOMC decision in hand before the dollar can see more than the current modest consolidation/correction, and until then we still see risk of another new low for the buck. In EUR/USD the 1.4050/1.4100 zone is the trigger to a renewed push higher targeting the 1.4350/4400 area initially. Next week sees month-end, and USD selling is likely to be evident given gains in US stock markets. On the upside for the USD, we would note the sharp sell-off in gold and the turns higher in the USD against GBP and CHF, our preferred leading indicators of overall USD direction. We also see a potential head and shoulders top forming in EUR/USD and we think a drop below the 1.3650/3700 area could see a more substantial USD rebound.
USD weakness has been mirrored by EUR strength, and while the buck recovered somewhat against other currencies, the EUR pushed on to new highs against most other major currencies. As the ECB continues its march to withdraw extraordinary measures, German government bond yields have continued to push higher and are now at highs last seen back in April (when EUR/USD was also around 1.37-40). We have no indications yet of a peak in German rates and widening interest rate spreads suggest markets are pricing in an early 2011 ECB rate hike. These rate moves suggest the EUR will remain strong in the weeks ahead, but we will be watching closely for a turn lower in German bund yields. Our longer-term view remains that the Eurozone will slow markedly in the months ahead, likely forestalling any ECB tightening and sending rates lower again.
G20 Meetings this Weekend
The G20 meetings in Seoul this weekend is an opportunity for major and emerging economies alike to voice their opinions and concerns regarding the global economy. Over the past few months, investors in search of a higher yield often found emerging markets as their choice; which created a huge flow of money out of the U.S. Dollar and into the emerging currencies. This broad weakness in the dollar, as well as the topic of further Quantitative Easing (QE2), has spurred many of these governments to try to halt their currency’s appreciation through a variety of means: direct intervention, higher taxes on foreign investment, capital controls and talks of protectionism. These measures have created ample tension between global leaders of late, which makes these meetings in Korea of even greater importance.
It is difficult to fathom a significant policy agreement coming from the G20 this weekend, especially when one considers that Brazil – one of the countries creating the most controversy of late – will not have anyone in attendance this weekend. However, we anticipate ministers will look to center their talk around topics like “competitive devaluation”, “excessive market volatility” and “disorderly movements in exchange rates”, which is just more of the same rhetoric we continue to hear week in and week out. Ultimately this will likely be a non-event, but should something unanticipated materialize, it has real potential to shake up the FX market next week.
Is Germany a headache waiting to happen for the ECB?
Another day, another economic indicator highlighting the strength of Germany’s recovery. On Friday it was the IFO survey, which measures business confidence in 7,000 firms in the manufacturing, construction and retail sectors that exceeded analyst expectations. The headline index rose to highs last seen in 2007, prior to the recession. What was more encouraging was the sub-component of the index that measures future expectations for business activity; this was significantly higher than September’s reading. There are also signs that Germany’s recovery is becoming more broad-based and less reliant on exports. The PMI services sector survey reversed recent losses in October, which suggests that domestic consumption may pick up. Retail sales have been lagging in the German economic recovery, but a pick-up in service sector sentiment may be reflected in stronger data as we near the end of the year.
Germany’s strong bounce back from the recession highlights the two-speed recovery in the Eurozone. The German economy expanded by a 2.2 per cent quarterly rate in the second quarter of this year, equivalent to a 4.1 per cent annual rate. This compares with Ireland and Greece, whose economies actually contracted in the second quarter. Germany is growing like an emerging market, while peripheral economies with huge debt burdens will be under pressure for many quarters to come.
This is generating a headache for the European Central Bank. If a currency union should only be as strong as its weakest member then rates should be in deeply negative territory and monetary stimulus should be extended to boost the flagging peripheral economies. But that risks stoking inflationary pressure in Germany, which, along with strong growth, also has a tight labour market fuelled by the unemployment rate, which has fallen to its lowest level for more than 20 years.
The euro has shrugged off recent problems in the periphery, such as Ireland’s debt crisis in September, and instead has been riding on the coat tails of rising German bond yields. But the market may not be taking account of headwinds for the German economy next year. The German government is embarking on a fiscal austerity plan of its own to try and reduce its large government debt burden, which stands at 73.4 per cent of GDP. Spending and public sector jobs are expected to be cut, which could de-rail a recovery in domestic demand. Thus, the ECB may need to keep monetary policy looser than German bond yields suggest, to try and prop up the Eurozone’s largest economy as austerity measures start to bite. So although the ECB remains committed to returning monetary conditions back to normal and avoiding further policy stimulus, depending on how well all of the Eurozone economies perform next year, it may be the latecomer to the quantitative easing party.
The market shifts its focus to more QE in the UK
Chancellor George Osborne may have claimed that Britain took a step back from the brink during his Spending Review on Wednesday, but the markets seem to think the UK has taken a step towards more quantitative easing. As the market digests GBP80bn of spending cuts, 500,000 public sector job losses, a 3- way split on the monetary policy committee and anaemic growth in the money supply, 2-yr Gilt yields have tumbled. The market is increasingly expecting the Bank of England to embark on a second round of quantitative easing as early as their next meeting on 4 November.
This has weighed on the pound, which dropped by nearly 2 per cent on a trade-weighted basis over the week. A weekly close below 1.5750 is a bearish signal for GBP/USD, but perhaps only in the short-term. There are signs that the market may be getting ahead of itself. It’s worth looking at the minutes from the MPC’s October meeting, released on Wednesday, that noted: “The analysis and projections prepared for the November Inflation Report would give the Committee an opportunity to re-evaluate more thoroughly the outlook for activity, the margin of spare capacity and inflation in light of all the news.” This suggests that the MPC may want to see the Inflation Report prior to making any decisions on more QE.
Since the Report is not released until 10 November - after the MPC meeting - there is a chance the market could be disappointed if the Committee decides to hold fire on 4 Nov and not make any policy changes until its meeting on 9 December.
Of course, if they already think that economic conditions are weak enough for more stimulus then why would they wait, but we think that sterling could be choppy as we lead up to the first week of November. In the very short-term we think the GBP/USD is at risk of a reversal, especially if we see a weekly close below 1.5750, which is a bearish divergence signal. Key levels of support lie at 1.5450 – 100-hr simple moving average (SMA), and then 1.5330/40, the 200-day SMA. If GBP/USD does not hold at these levels then we could see it fall back to 1.50. Sterling may also be the main loser as long as last week’s dollar strength remains and investors reduce their short greenback positions as we get closer to the 2/3 November FOMC meeting.
Key data and events to watch next week
The US economic calendar kicks off on Monday with the September Chicago Fed National Activity Index, existing home sales and the October Dallas Fed Manufacturing Activity Index. Fed Chairman Ben Bernanke and Fed Members William Dudley, James Bullard, and Thomas Hoenig are due to speak on Monday also. Tuesday sees the S&P/Case Shiller Home Price index for August, October Conference Board Consumer Confidence and Richmond Fed Manufacturing Index. The Fed’s Dudley is set to speak on Tuesday and Wednesday. Durable goods orders and new home sales for September are also due out on Wednesday followed by Thursday’s weekly jobless claims. Friday wraps the week up with 3Q advance GDP and the Personal Employment Cost Index as well as the Chicago PMI and University of Michigan Confidence survey results.
The Euro zone starts the week off with EZ industrial new orders for August on Monday. Tuesday’s data includes the German GfK Consumer Confidence Survey for November, German September import prices, as well as French October consumer confidence. Due out on Wednesday is France’s September consumer confidence, Germany’s October CPI figures, and a speech from ECB member Carlos Costa. Thursday sees French September producer prices, German unemployment data for October, and Euro zone October confidence indicators. Friday rounds the week out with the EZ CPI estimate for October.
The UK economic data begins with Monday’s BBA Loans for House Purchase in September, the Asset Purchase Facility Quarterly Report for Q3 and speeches by the BOE’s Paul Tucker and Governor Mervyn King. Tuesday includes the release of 3Q advance GDP, August Index of Services, and a speech by the BOE’s Adam Posen while Thursday sees October Nationwide House Prices and GfK Consumer Confidence Survey results. The data comes to a close on Friday with September mortgage approvals, net consumer credit and net lending secured on dwellings.
Japan’s calendar kicks off with September merchandise trade balance figures on Monday. On deck for Wednesday is October Small Business Confidence and set for release on Thursday is September retail trade data and the Bank of Japan target rate. Friday finishes the week with September jobless data, Tokyo and National CPI, September housing starts, and September preliminary industrial production.
In Canada, the week begins on Wednesday with the August Teranet/National Bank HPI and finishes on Friday with August GDP, September industrial product price index and raw materials price index.
The calendar down under starts on Monday with Australia’s 3Q PPI and a speech by RBA Governor Glenn Stevens. Set for release on Tuesday is 3Q NAB Business Confidence and Wednesday includes Australia 3Q CPI data and New Zealand’s NBNZ Activity Outlook and Business Confidence for October. The RBNZ will announce its official cash rate on Thursday and Australia will see the August Conference Board Leading Index. Friday rounds the week with NZ building permits and trade balance data for September as well as Australia’s September HIA new home sales and private sector credit.
Be on the lookout for important China data as well. Sometime between Monday and Friday will see the release of September Leading Index and set for release on Friday is the MNI Business Conditions Survey.
Strategy of the week
Buying EUR/JPY on pullbacks
A developing trend of easier monetary policy across a consortium of central banks sent equities screaming higher Tuesday. The BoJ was the first to act as it took part in another round of QE with the announcement of an asset purchase plan of about $60bn in conjunction with the unexpected decision to drop its interest rate to virtually zero. Markets also seem to be pricing in Fed QE2 as a certainty rather than a possibility evidenced by the drudging the greenback has taken recently. It seems now that a concerted effort from various central banks towards easier monetary policy has now become a reality. One major central bank that hasn’t hinted at additional easing has been the ECB which is a partial factor in the steep ascent of the single currency. The parabolic move higher in EURUSD seems a bit overdone and significant resistance lurks directly above current levels (50% retracement for the descent from the July 2008 all time highs into 1.3955/60). However, the current trend of euro strength is unmistakable and we would like to exploit any euro pullbacks, specifically against the yen as global liquidity measures may see yen crosses rally on a re-emergence of risk appetite.
EUR/JPY is approaching significant technical supply into 116.25, trendline resistance from the 170.00 record highs. Additionally, hourly charts evidence potential exhaustion as the pair nears channel tops around 116.00. However, we believe that any possible reversal may provide an opportunity to buy dips for a continuation of the recent uptrend. There are a couple factors contributing to the longer term bullish bias. Firstly, EUR/JPY continues to remain in a rising channel which is additionally supported by the 200-hr SMA. Until both the channel support and moving average are breached, the uptrend remains intact. Also, the bullish price/Macd divergence suggests the 119.25 61/8% retracement for the 4/5 to 9/20 decline is in view. The strategy will look to buy half a position of EUR/JPY on a pullback into 114.50 channel support and the remaining on further weakness into 113.25 for an average rate of 113.87. The stop loss will be below the June to July 2010 horizontal pivot around 112.60, for a total risk of about 125 pips. The take profit objective is for 50% at long term trendline resistance into 116.00 and the remaining half into the 119.25 key 0.618 fibo level. We would bring our stops to break even on a move above 116.00.
Support
• 114.50 Rising channel support, short term pivot
• 114.00 Daily Tenkan line, Hourly Rising Channel Support, 200-hr SMA
• 113.25 June – July 2010 Horizontal pivot resistance turned support
Resistance
• 116.25 Trendline Resistance from 2008 170.00 highs
• 117.95 200-day SMA
• 119.25 61.8% retracement (4/5 – 9/20 decline)
Tuesday, October 26, 2010
Monday, October 18, 2010
Weekly Overview and strategy Oct 17
QE speculation leads to broad-based USD weakness
The markets have been fixated on the potential of further Fed easing measures in the form of a second round of asset purchases or ‘QE2’. This past week gave a lot of clues into the Fed’s thinking with the release of the September 21 FOMC meeting minutes and Fed Chairman Ben Bernanke’s speech at Friday’s Boston Fed conference. The meeting minutes showed that ‘many’ on FOMC noted too-slow growth and too-low inflation as arguments in favour of additional asset purchases. Only ‘some’ members said that the economic benefits of purchases may be small. The key point that the market focused on here was that FOMC members said accommodation may be ‘appropriate before long’. Bernanke, in a speech on Friday took an accommodative stance and highlighted too-low inflation as a case for further action.
Investors have priced in a significant amount of QE as economic data has deteriorated and Fed officials have stepped up the rhetoric. The fact is that the weakness we have seen in the USD in the past several weeks has been due to mostly to speculation; the Fed has not acted yet. While most traders are expecting another round of QE, the extent of asset purchases is unknown. As such there is risk that the markets have been too aggressive in pricing in ‘QE2’ and may be disappointed if the Fed does not deliver what the market is expecting. On the other hand, there is the possibility that market participants may not have priced in enough (though the former is the more likely scenario). Uncertainty will remain until the Fed announces their decision.
Asian central bank action also added fuel to USD weakness with the unexpected decision by Monetary Authority of Signapore to widen the band in which its dollar trades to allow for faster currency appreciation. This increased speculation that other Asian central banks may follow and added to the decline in USD. Major technical levels were reached this past week on a softer USD. Swissy (USD/CHF) reached new record lows near 0.9460/70, gold (XAU/USD) climbed to record highs near 1387, the Loonie (USD/CAD) and the Aussie (AUD/USD) both reached parity as commodities gained and the dollar tumbled. Short term Treasury yields also reached record levels with 2-yr yields falling as low as near 33 bps. USD/JPY which is highly correlated with the Treasury yields fell to 15-year lows dipping below 81.00 to around 80.90.
The UK’s deficit plan under the microscope
It’s the UK’s turn to take centre stage next week. The minutes of the Bank of England Monetary Policy meeting will be released on Wednesday at 0930BST, on the same day as the government announces the detail of its spending cuts (due at 1230BST) to reign in the UK’s unwieldy budget deficit, which currently stands at 11.5% of GDP.
The market has been waiting for the coalition government’s Comprehensive Spending Review (CSR) since the emergency budget back in June when Chancellor George Osborne announced GBP 80bn of cuts between 2010/11 and 2014/15, the equivalent of 6% of GDP over 5 years. Since then, we know what departments will be spared the axe: the National Health Service and overseas aid. Leaked reports also suggest that cuts of up to 25% across the other departments will be implemented, which may precipitate the culling of 500K public sector jobs.
Investors seem to have given the UK the benefit of the doubt, and it has avoided a Greek/Irish style assault on its bond market. UK 10-year Gilt yields have been steadily falling since April. Sterling has fared less well, on a trade weighted basis it has fallen more than 4% since August. However, considering the size of the UK’s fiscal adjustment in the coming years this doesn’t seem too harsh and GBP/USD has actually appreciated 9% since September.
Wednesday’s report will give the market the detail it’s been waiting for since June. Although the market will be looking for a firm commitment that the UK will reduce its debt overhang, this needs to be balanced against the effect of harsh austerity cuts on consumer confidence. The facts about the scale of the fiscal retrenchment, combined with a VAT hike planned for 1 January, may cause consumer confidence to plummet, acting as a serious drag on growth. Therefore, the CSR may prove to be a double-edged sword for UK assets.
We believe that investors will use sterling as a way to express their faith, or lack thereof, in the outlook for the UK economy, rather than the FTSE 100. This is because the FTSE is heavily weighted toward the mining and financial sectors and has a large number of international companies. Sterling is thus a better proxy for the outlook for UK growth.
What will investors are watching for? If the government cuts the budgets of departments vital to the UK’s long term growth, such as education, science and R&D, this may spook investors. This, in turn, may cause a grind lower in the pound over the long-term. This would likely also boost expectations for further QE from the BOE, boosting Gilts.
MPC minutes crucial for sterling in the short-term
In the short-term, we believe that the MPC minutes from October’s meeting will be the main driver of sterling. Earlier this week, former Deputy Governor Sir John Gieve said that the MPC should raise rates and refrain from further QE. However, it’s the current members that the market will focus on this week. There is a possibility of a three-way split in the committee with Andrew Sentance maintaining his hawkish stance and Adam Posen calling for further QE, which is a rare occurrence for the MPC.
The markets will be looking to see if any of the other members have come off the fence and joined Posen. If this happens, then the market may take this as a sign the BOE will extend QE, which would be negative for sterling. However, we think it is likely that the MPC discussed the persistent stickiness of inflation as a barrier to further monetary stimulus. While we don’t think that any members will have voted for an extension of QE at this meeting, they may well do in the near future. But the absence of a commitment to more QE from the MPC may disappoint the market, putting downward pressure on gilts and boosting sterling in the short-term.
We think the long-term outlook for sterling is weak and view rallies in GBP/USD back to the 1.6100 area as potential short opportunities with the potential to move lower toward the 1.5850 area. A move above 1.6200 would negate this view.
Europe’s peripheral concerns put to bed for now
Rhetoric coming out of Europe continues to verge on the hawkish side. Axel Weber, head of the German Bundesbank, said that the ECB should stop buying the bonds of Europe’s peripheral economies. Indeed, last week the ECB bought just EUR9m of government bonds, which follows large purchases of Irish, Greek and Portuguese government debt in recent weeks. This gave the market some confidence in the peripherals, and spreads between their bonds versus the benchmark German bund yield dropped last week. It‘s hard to say if the markets think these economies are now out of the woods, or if they are cheered by the fact that the ECB is still willing to intervene when necessary.
Greek bond yields have made an impressive recovery, and credit-default swaps haven fallen from 900 bps, to 683 bps, reversing the rise from May to September. This suggests that the market is getting more confident about Greece’s fiscal consolidation plans. Economic data has also started to improve. Industrial production in August rose by 5.6%, suggesting that the economic contraction in Q3 will not be as bad as Q2, when the economy shrank by a larger than forecast 1.8%.
BoC likely to hold steady on rates, growth concerns
The BoC interest rate announcement is scheduled to be released on Tuesday October 19 at 0900EDT and economists expect the rate to remain steady at 1.00%. We think it is important to note that the BoC has already raised rates 75 bps this year from their extremely accommodative “crisis” lows of 0.25%. This policy tightening diverges from the Feds (where QE2 speculation abounds) and has seen the Canadian dollar strengthen – it reached parity this past week – due to the widening interest rate differentials between the two countries. In the short term, the stronger Loonie should keep a lid on Canada’s export growth with the Unites States.
The next day, on Wednesday October 20 at 1030EDT, the BoC quarterly Monetary Policy Report (MPR) will be released and is followed by Governor Mark Carney’s press conference at 1115EDT. The bank revised their 2010 growth outlook lower from 3.5% in April to 3.2% QoQ in their last report in July. Unfortunately, the most recent GDP data (July MoM) declined for the first time since August 2009, by -0.1%. This suggests the October MPC report will also have to downgrade their 2010 end of year figures, as well as the 2011 estimates. In July the Bank expected their economy to return to full capacity by the end of 2011 – This figure will now likely be pushed back to the beginning of 2012. Meanwhile, the underlying dynamics of inflation should remain relatively subdued for the foreseeable future, and re-affirms our view that a wait-and-see approach is best for the BoC at this juncture.
Key data and events to watch next week
U.S. data kicks off on Monday with August Net Long-term TIC Flows, September Industrial Production, September Capacity Utilization, and the October NAHB Housing Market Index. Wednesday follows with September Housing Starts, September Building Permits, and October ABC Consumer Confidence. Thursday sees MBA Mortgage Applications and the Fed’s Beige Book. Thursday wraps up with weekly Jobless Claims, September Leading Indicators, and the October Philly Fed Index. In terms of economic events, the Fed’s Lockhart will be speaking on the economy in Georgia on Monday. Thursday will see Bullard holding a press briefing on monetary policy and Hoenig speaking in Albuquerque on the U.S. economic outlook.
The Euro zone calendar begins with the Euro-area finance ministers meeting on Euro reforms beginning Monday. Tuesday begins a moderately light data slate with August Current Account, August Construction Output, and the October ZEW Survey of Economic Sentiment. Thursday closes out with October Composite, Manufacturing, and Services PMI alongside October Euro-zone Consumer Confidence. German data begins with the October ZEW Survey of Economic Sentiment and Current Situation on Tuesday. Wednesday sees September Producer Prices and is followed up with October Manufacturing and Services PMI on Thursday. The German Finance Ministry will also be publishing the September Monthly Report on Thursday. Friday ends the data session with October IFO Business Climate, Current Assessment , and Expectations.
U.K. economic data begins Sunday with October Rightmove House Prices and continues on Tuesday with October CBI Business Optimism. Tuesday also sees BOE Governor Mervyn King delivering a speech in Dudley, England. Wednesday follows with the release of the Bank of England Minutes and the much anticipated Spending Review. Thursday wraps up the data slate with September Major Banks Mortgage Approvals and September Retail Sales.
The calendar in Japans starts off with August Tertiary Industry Index on Sunday and September Nationwide Department Sales on Monday. Wednesday sees August Coincident Index and September Convenience Store Sales followed by the August All Industry Activity Index on Thursday. Friday ends the data session with September Supermarket Sales.
Canada’s calendar begins with August International Securities Transactions on Monday. The Bank of Canada Rate Decision is scheduled for Tuesday followed by the BOC Monetary Policy Report on Wednesday. Wednesday also sees August Wholesale Sales followed by September Leading Indicators on Thursday. Friday wraps up with September CPI, September Bank of Canada Core CPI, and August Retail Sales.
Australia’s data slate begins with September New Motor Vehicle Sales on Sunday and the Reserve Bank’s Board October Minutes on Monday. Tuesday sees August Westpac Leading Index and October DEWR Skilled Vacancies. Thursday closes out with Q3 Import and Export Price Indices. New Zealand’s calendar begins with September Performance Services Index and Q3 Consumer Prices on Sunday. Wednesday closes out with September Credit Card Spending and the October ANZ Consumer Confidence Index.
All China data is scheduled for release on Wednesday which sees Q3 Real GDP, September Producer Price Index, September Purchasing Power Index, September Retail Sales, September Industrial Production, and September Fixed Assets Investment Urban Cumulative. Also be on the lookout for the G-20 Ministerial meeting on October 21-23 in Kyungju, Korea.
Strategy
Buying EUR/JPY on pullbacks
A developing trend of easier monetary policy across a consortium of central banks sent equities screaming higher Tuesday. The BoJ was the first to act as it took part in another round of QE with the announcement of an asset purchase plan of about $60bn in conjunction with the unexpected decision to drop its interest rate to virtually zero. Markets also seem to be pricing in Fed QE2 as a certainty rather than a possibility evidenced by the drudging the greenback has taken recently. It seems now that a concerted effort from various central banks towards easier monetary policy has now become a reality. One major central bank that hasn’t hinted at additional easing has been the ECB which is a partial factor in the steep ascent of the single currency. The parabolic move higher in EURUSD seems a bit overdone and significant resistance lurks directly above current levels (50% retracement for the descent from the July 2008 all time highs into 1.3955/60). However, the current trend of euro strength is unmistakable and we would like to exploit any euro pullbacks, specifically against the yen as global liquidity measures may see yen crosses rally on a re-emergence of risk appetite.
EUR/JPY is approaching significant technical supply into 116.25, trendline resistance from the 170.00 record highs. Additionally, hourly charts evidence potential exhaustion as the pair nears channel tops around 116.00. However, we believe that any possible reversal may provide an opportunity to buy dips for a continuation of the recent uptrend. There are a couple factors contributing to the longer term bullish bias. Firstly, EUR/JPY continues to remain in a rising channel which is additionally supported by the 200-hr SMA. Until both the channel support and moving average are breached, the uptrend remains intact. Also, the bullish price/Macd divergence suggests the 119.25 61/8% retracement for the 4/5 to 9/20 decline is in view. The strategy will look to buy half a position of EUR/JPY on a pullback into 114.50 channel support and the remaining on further weakness into 113.25 for an average rate of 113.87. The stop loss will be below the June to July 2010 horizontal pivot around 112.60, for a total risk of about 125 pips. The take profit objective is for 50% at long term trendline resistance into 116.00 and the remaining half into the 119.25 key 0.618 fibo level. We would bring our stops to break even on a move above 116.00.
Support
• 114.50 Rising channel support, short term pivot
• 114.00 Daily Tenkan line, Hourly Rising Channel Support, 200-hr SMA
• 113.25 June – July 2010 Horizontal pivot resistance turned support
Resistance
• 116.25 Trendline Resistance from 2008 170.00 highs
• 117.95 200-day SMA
• 119.25 61.8% retracement (4/5 – 9/20 decline)
The markets have been fixated on the potential of further Fed easing measures in the form of a second round of asset purchases or ‘QE2’. This past week gave a lot of clues into the Fed’s thinking with the release of the September 21 FOMC meeting minutes and Fed Chairman Ben Bernanke’s speech at Friday’s Boston Fed conference. The meeting minutes showed that ‘many’ on FOMC noted too-slow growth and too-low inflation as arguments in favour of additional asset purchases. Only ‘some’ members said that the economic benefits of purchases may be small. The key point that the market focused on here was that FOMC members said accommodation may be ‘appropriate before long’. Bernanke, in a speech on Friday took an accommodative stance and highlighted too-low inflation as a case for further action.
Investors have priced in a significant amount of QE as economic data has deteriorated and Fed officials have stepped up the rhetoric. The fact is that the weakness we have seen in the USD in the past several weeks has been due to mostly to speculation; the Fed has not acted yet. While most traders are expecting another round of QE, the extent of asset purchases is unknown. As such there is risk that the markets have been too aggressive in pricing in ‘QE2’ and may be disappointed if the Fed does not deliver what the market is expecting. On the other hand, there is the possibility that market participants may not have priced in enough (though the former is the more likely scenario). Uncertainty will remain until the Fed announces their decision.
Asian central bank action also added fuel to USD weakness with the unexpected decision by Monetary Authority of Signapore to widen the band in which its dollar trades to allow for faster currency appreciation. This increased speculation that other Asian central banks may follow and added to the decline in USD. Major technical levels were reached this past week on a softer USD. Swissy (USD/CHF) reached new record lows near 0.9460/70, gold (XAU/USD) climbed to record highs near 1387, the Loonie (USD/CAD) and the Aussie (AUD/USD) both reached parity as commodities gained and the dollar tumbled. Short term Treasury yields also reached record levels with 2-yr yields falling as low as near 33 bps. USD/JPY which is highly correlated with the Treasury yields fell to 15-year lows dipping below 81.00 to around 80.90.
The UK’s deficit plan under the microscope
It’s the UK’s turn to take centre stage next week. The minutes of the Bank of England Monetary Policy meeting will be released on Wednesday at 0930BST, on the same day as the government announces the detail of its spending cuts (due at 1230BST) to reign in the UK’s unwieldy budget deficit, which currently stands at 11.5% of GDP.
The market has been waiting for the coalition government’s Comprehensive Spending Review (CSR) since the emergency budget back in June when Chancellor George Osborne announced GBP 80bn of cuts between 2010/11 and 2014/15, the equivalent of 6% of GDP over 5 years. Since then, we know what departments will be spared the axe: the National Health Service and overseas aid. Leaked reports also suggest that cuts of up to 25% across the other departments will be implemented, which may precipitate the culling of 500K public sector jobs.
Investors seem to have given the UK the benefit of the doubt, and it has avoided a Greek/Irish style assault on its bond market. UK 10-year Gilt yields have been steadily falling since April. Sterling has fared less well, on a trade weighted basis it has fallen more than 4% since August. However, considering the size of the UK’s fiscal adjustment in the coming years this doesn’t seem too harsh and GBP/USD has actually appreciated 9% since September.
Wednesday’s report will give the market the detail it’s been waiting for since June. Although the market will be looking for a firm commitment that the UK will reduce its debt overhang, this needs to be balanced against the effect of harsh austerity cuts on consumer confidence. The facts about the scale of the fiscal retrenchment, combined with a VAT hike planned for 1 January, may cause consumer confidence to plummet, acting as a serious drag on growth. Therefore, the CSR may prove to be a double-edged sword for UK assets.
We believe that investors will use sterling as a way to express their faith, or lack thereof, in the outlook for the UK economy, rather than the FTSE 100. This is because the FTSE is heavily weighted toward the mining and financial sectors and has a large number of international companies. Sterling is thus a better proxy for the outlook for UK growth.
What will investors are watching for? If the government cuts the budgets of departments vital to the UK’s long term growth, such as education, science and R&D, this may spook investors. This, in turn, may cause a grind lower in the pound over the long-term. This would likely also boost expectations for further QE from the BOE, boosting Gilts.
MPC minutes crucial for sterling in the short-term
In the short-term, we believe that the MPC minutes from October’s meeting will be the main driver of sterling. Earlier this week, former Deputy Governor Sir John Gieve said that the MPC should raise rates and refrain from further QE. However, it’s the current members that the market will focus on this week. There is a possibility of a three-way split in the committee with Andrew Sentance maintaining his hawkish stance and Adam Posen calling for further QE, which is a rare occurrence for the MPC.
The markets will be looking to see if any of the other members have come off the fence and joined Posen. If this happens, then the market may take this as a sign the BOE will extend QE, which would be negative for sterling. However, we think it is likely that the MPC discussed the persistent stickiness of inflation as a barrier to further monetary stimulus. While we don’t think that any members will have voted for an extension of QE at this meeting, they may well do in the near future. But the absence of a commitment to more QE from the MPC may disappoint the market, putting downward pressure on gilts and boosting sterling in the short-term.
We think the long-term outlook for sterling is weak and view rallies in GBP/USD back to the 1.6100 area as potential short opportunities with the potential to move lower toward the 1.5850 area. A move above 1.6200 would negate this view.
Europe’s peripheral concerns put to bed for now
Rhetoric coming out of Europe continues to verge on the hawkish side. Axel Weber, head of the German Bundesbank, said that the ECB should stop buying the bonds of Europe’s peripheral economies. Indeed, last week the ECB bought just EUR9m of government bonds, which follows large purchases of Irish, Greek and Portuguese government debt in recent weeks. This gave the market some confidence in the peripherals, and spreads between their bonds versus the benchmark German bund yield dropped last week. It‘s hard to say if the markets think these economies are now out of the woods, or if they are cheered by the fact that the ECB is still willing to intervene when necessary.
Greek bond yields have made an impressive recovery, and credit-default swaps haven fallen from 900 bps, to 683 bps, reversing the rise from May to September. This suggests that the market is getting more confident about Greece’s fiscal consolidation plans. Economic data has also started to improve. Industrial production in August rose by 5.6%, suggesting that the economic contraction in Q3 will not be as bad as Q2, when the economy shrank by a larger than forecast 1.8%.
BoC likely to hold steady on rates, growth concerns
The BoC interest rate announcement is scheduled to be released on Tuesday October 19 at 0900EDT and economists expect the rate to remain steady at 1.00%. We think it is important to note that the BoC has already raised rates 75 bps this year from their extremely accommodative “crisis” lows of 0.25%. This policy tightening diverges from the Feds (where QE2 speculation abounds) and has seen the Canadian dollar strengthen – it reached parity this past week – due to the widening interest rate differentials between the two countries. In the short term, the stronger Loonie should keep a lid on Canada’s export growth with the Unites States.
The next day, on Wednesday October 20 at 1030EDT, the BoC quarterly Monetary Policy Report (MPR) will be released and is followed by Governor Mark Carney’s press conference at 1115EDT. The bank revised their 2010 growth outlook lower from 3.5% in April to 3.2% QoQ in their last report in July. Unfortunately, the most recent GDP data (July MoM) declined for the first time since August 2009, by -0.1%. This suggests the October MPC report will also have to downgrade their 2010 end of year figures, as well as the 2011 estimates. In July the Bank expected their economy to return to full capacity by the end of 2011 – This figure will now likely be pushed back to the beginning of 2012. Meanwhile, the underlying dynamics of inflation should remain relatively subdued for the foreseeable future, and re-affirms our view that a wait-and-see approach is best for the BoC at this juncture.
Key data and events to watch next week
U.S. data kicks off on Monday with August Net Long-term TIC Flows, September Industrial Production, September Capacity Utilization, and the October NAHB Housing Market Index. Wednesday follows with September Housing Starts, September Building Permits, and October ABC Consumer Confidence. Thursday sees MBA Mortgage Applications and the Fed’s Beige Book. Thursday wraps up with weekly Jobless Claims, September Leading Indicators, and the October Philly Fed Index. In terms of economic events, the Fed’s Lockhart will be speaking on the economy in Georgia on Monday. Thursday will see Bullard holding a press briefing on monetary policy and Hoenig speaking in Albuquerque on the U.S. economic outlook.
The Euro zone calendar begins with the Euro-area finance ministers meeting on Euro reforms beginning Monday. Tuesday begins a moderately light data slate with August Current Account, August Construction Output, and the October ZEW Survey of Economic Sentiment. Thursday closes out with October Composite, Manufacturing, and Services PMI alongside October Euro-zone Consumer Confidence. German data begins with the October ZEW Survey of Economic Sentiment and Current Situation on Tuesday. Wednesday sees September Producer Prices and is followed up with October Manufacturing and Services PMI on Thursday. The German Finance Ministry will also be publishing the September Monthly Report on Thursday. Friday ends the data session with October IFO Business Climate, Current Assessment , and Expectations.
U.K. economic data begins Sunday with October Rightmove House Prices and continues on Tuesday with October CBI Business Optimism. Tuesday also sees BOE Governor Mervyn King delivering a speech in Dudley, England. Wednesday follows with the release of the Bank of England Minutes and the much anticipated Spending Review. Thursday wraps up the data slate with September Major Banks Mortgage Approvals and September Retail Sales.
The calendar in Japans starts off with August Tertiary Industry Index on Sunday and September Nationwide Department Sales on Monday. Wednesday sees August Coincident Index and September Convenience Store Sales followed by the August All Industry Activity Index on Thursday. Friday ends the data session with September Supermarket Sales.
Canada’s calendar begins with August International Securities Transactions on Monday. The Bank of Canada Rate Decision is scheduled for Tuesday followed by the BOC Monetary Policy Report on Wednesday. Wednesday also sees August Wholesale Sales followed by September Leading Indicators on Thursday. Friday wraps up with September CPI, September Bank of Canada Core CPI, and August Retail Sales.
Australia’s data slate begins with September New Motor Vehicle Sales on Sunday and the Reserve Bank’s Board October Minutes on Monday. Tuesday sees August Westpac Leading Index and October DEWR Skilled Vacancies. Thursday closes out with Q3 Import and Export Price Indices. New Zealand’s calendar begins with September Performance Services Index and Q3 Consumer Prices on Sunday. Wednesday closes out with September Credit Card Spending and the October ANZ Consumer Confidence Index.
All China data is scheduled for release on Wednesday which sees Q3 Real GDP, September Producer Price Index, September Purchasing Power Index, September Retail Sales, September Industrial Production, and September Fixed Assets Investment Urban Cumulative. Also be on the lookout for the G-20 Ministerial meeting on October 21-23 in Kyungju, Korea.
Strategy
Buying EUR/JPY on pullbacks
A developing trend of easier monetary policy across a consortium of central banks sent equities screaming higher Tuesday. The BoJ was the first to act as it took part in another round of QE with the announcement of an asset purchase plan of about $60bn in conjunction with the unexpected decision to drop its interest rate to virtually zero. Markets also seem to be pricing in Fed QE2 as a certainty rather than a possibility evidenced by the drudging the greenback has taken recently. It seems now that a concerted effort from various central banks towards easier monetary policy has now become a reality. One major central bank that hasn’t hinted at additional easing has been the ECB which is a partial factor in the steep ascent of the single currency. The parabolic move higher in EURUSD seems a bit overdone and significant resistance lurks directly above current levels (50% retracement for the descent from the July 2008 all time highs into 1.3955/60). However, the current trend of euro strength is unmistakable and we would like to exploit any euro pullbacks, specifically against the yen as global liquidity measures may see yen crosses rally on a re-emergence of risk appetite.
EUR/JPY is approaching significant technical supply into 116.25, trendline resistance from the 170.00 record highs. Additionally, hourly charts evidence potential exhaustion as the pair nears channel tops around 116.00. However, we believe that any possible reversal may provide an opportunity to buy dips for a continuation of the recent uptrend. There are a couple factors contributing to the longer term bullish bias. Firstly, EUR/JPY continues to remain in a rising channel which is additionally supported by the 200-hr SMA. Until both the channel support and moving average are breached, the uptrend remains intact. Also, the bullish price/Macd divergence suggests the 119.25 61/8% retracement for the 4/5 to 9/20 decline is in view. The strategy will look to buy half a position of EUR/JPY on a pullback into 114.50 channel support and the remaining on further weakness into 113.25 for an average rate of 113.87. The stop loss will be below the June to July 2010 horizontal pivot around 112.60, for a total risk of about 125 pips. The take profit objective is for 50% at long term trendline resistance into 116.00 and the remaining half into the 119.25 key 0.618 fibo level. We would bring our stops to break even on a move above 116.00.
Support
• 114.50 Rising channel support, short term pivot
• 114.00 Daily Tenkan line, Hourly Rising Channel Support, 200-hr SMA
• 113.25 June – July 2010 Horizontal pivot resistance turned support
Resistance
• 116.25 Trendline Resistance from 2008 170.00 highs
• 117.95 200-day SMA
• 119.25 61.8% retracement (4/5 – 9/20 decline)
Monday, October 11, 2010
Weekly Overview and strategy
USD under pressure as markets speculate stimulus
The greenback lost further ground this past week as economic data came in soft and speculation mounted that the Fed will provide additional stimulus. The prospect of further quantitative easing stepped up a gear on Friday after non-farm payrolls data disappointed market expectations. The US labour market lost -95K jobs in September, expectations were for a decline of -5K due to a steep loss in government jobs (-159K). +64K private payrolls were added, but this was still less than the expected +75K and the prior month’s +93K was revised higher from +67K.
NY Fed President William Dudley called for further policy stimulus in a speech last week. He said that the unemployment and inflation rates in the US are “unacceptable”. This suggests that the economic data doesn’t need to get any worse for further QE to remain on the table. So, the deterioration in the labour market last month can be viewed as more QE in November. But the market’s reaction to the QE may be more temperate going forward. Estimates suggest that the amount of quantitative easing from the Fed that is already priced into the bond market is between $700 billion and $1 trillion. That is a huge amount, and if the Fed disappoints the market then there could be an almighty unwind that would cause volatility in FX to soar.
Fed members became noticeably less dovish than William Dudley at the end of the week, possibly to temper the market’s exuberance about the possibility of further QE. St. Louis Fed President James Bullard told a financial news network on Friday that more QE in November wasn’t necessarily a given. Instead he said that the FOMC might delay QE until the December meeting. Bullard was also more bullish on the growth outlook than Dudley was. He said that the soft patch in the economy “isn’t so obvious” that the Fed has to act now. Tuesday’s release of the Minutes for the Sept. 21 FOMC Meeting should provide more insight into how policy makers view the economic outlook.
Markets may temper expectations of more QE
The drop in the dollar on the back of Friday’s labour report has eased off for now, as dollar bears get fretful that the Fed may not deliver what they want. The same thing happened with sterling this week. After the Bank of England announced that it was keeping its asset purchases target steady at GBP200 billion, sterling immediately surged. The market was pricing in a slight chance of QE after MPC member Adam Posen said he thought the economy needed more policy stimulus in a speech last week. The lesson here is to be cautious of basing the rationale for your positions on the central banker who talks too candidly. BOE Governor King, Deputy Governor Tucker and members Sentance and Fisher are all set to speak in the week ahead.
The European Central Bank maintained its stance of withdrawing policy stimulus from the European financial system at its meeting that concluded on Thursday. This is in direct contrast to other central banks, which helped boost the euro briefly above $1.40. However, immediately after the payrolls figure, the EU’s Jean-Claude Juncker said in an interview in Brussels that the “euro is too strong today”, limiting the upside in EUR/USD. This highlights the newest risk investors need to be aware of in FX: the verbal currency war being staged by global central bankers.
While the market waits with bated breath for QE from the Fed and the BOE, Japan managed to surprise the markets by announcing further policy stimulus earlier this week. It not only lowered the interest rate to 0-0.1percent, but it also announced a package worth $60bn to buy government and private sector debt. Unfortunately for the BOJ, the market can only concentrate on selling one currency at a time, and right now it is the dollar and USD/JPY continued its march lower, falling to new 15-year lows under the 82.00 figure.
The excitement is building in the FX markets right now, but trading conditions are getting trickier. We believe there is upside potential in EUR/GBP, as further QE from the BOE is expected while the ECB remains firm in maintaining its exit strategy. Also, the relative growth prospects for the core economies of Europe are, in our view, stronger than they are for the UK. Fears over the UK’s growth may build in the coming weeks prior to the 20 October, when the UK government’s Comprehensive Spending Review and the minutes of this month’s MPC meeting are published. The bias is higher while above the 200-day moving average around 0.8685 with a potential target towards 0.8850. A move below 0.8590 would negate this view.
Currency “war” or just a skirmish?
The IMF meetings this weekend present leaders with an opportunity to express their views on the global economic outlook and traders should beware of the headline risk involved. We are likely to hear plenty of commentary addressing the topic of “currency wars”. Participants will probably touch upon direct market intervention from Japan, quantitative easing measures from the FED, BOJ & BOE, fiscal austerity measures in the Euro-zone and continued pressure on China to let their currency appreciate at a faster rate. While the Chinese are faced with the greatest amount of global pressure, they are also the most likely to fiercely defend their decision and will let the Yuan appreciate at a “gradual” pace, avoiding “shock-therapy”. At this juncture we believe the recent panhandling between nations has been overblown due to political pressures. Ultimately, we believe traders shouldn’t get caught too bullish or bearish any one particular currency based on he said/she said rhetoric. We think after the elections in November this will be reflected upon as a mere skirmish between political figureheads, rather than grow into full blown financial warfare.
Key data and events next week
U.S. data kicks off on Tuesday with the September FOMC Meeting Minutes followed by October ABC Consumer Confidence. Wednesday sees October MBA Mortgage Applications and September Import Price Index. Thursday follows with August Trade Balance, September Producer Price Index, and weekly Jobless Claims. A heavy load of data on Friday wraps up the week with September Consumer Price Index, September Retail Sales, October Empire Manufacturing and August Business Inventories. Friday’s data also includes the University of Michigan Confidence survey and Bernanke’s speech at the Boston Fed Conference.
The Euro zone starts off on Tuesday with Germany’s September final CPI. Wednesday sees August EZ Industrial Production. The data session continues Thursday with the ECB’s October Monthly Report and wraps up Friday with September CPI and August Trade Balance. Germany sees September CPI on Tuesday and wraps up with September Wholesale Price Index on Thursday.
U.K. economic data begins on Sunday with speeches by BOE Governor Mervyn King and the BOE’s Paul Tucker. Monday sees August RICS House Price Balance. A busy Tuesday sees September CPI, August DCLG UK House Prices, September Retail Price Index, August Trade Balance, and September RPI. Wednesday sees a speech by the BOE’s Andrew Sentance, September Claimant Count Change, September Jobless Claims Change and the August ILO Unemployment Rate. Thursday closes out the week with September Nationwide Consumer Confidence.
The calendar in Japan starts off with September Consumer Confidence, Japan Money Stock M2 & M3, and August Machine Orders. Wednesday sees September Domestic CGPI and Thursday follows with September Machine Tool Orders. Friday wraps up the Japanese data session with August Industrial Production.
Canada’s economic data begins with August New Housing Price Index on Wednesday followed up with August International Merchandise Trade on Thursday. Friday wraps up the light data session with August Manufacturing Sales and New Motor Vehicle Sales.
Australia’s data session kicks off with August Home Loans on Sunday followed by September NAB Business Conditions on Monday. Tuesday sees the October Westpac Consumer Confidence survey. Wednesday wraps up the week with October Consumer Inflation Expectation. New Zealand’s calendar begins Tuesday with September Food Prices and continues Wednesday with September REINZ House Sales, August Retail Sales, and September Business PMI.
Significant data out of China sees September Trade Balance and 3Q Business Climate Index due out on Wednesday. The Conference Board China August Leading Economic Index is due out on Friday. Sometime between Monday and Friday China will release its September Foreign Exchange Reserves and China Property Prices. Also be on the lookout for the October 8-10 IMF and World Bank Meetings in which currencies are likely to be key topic on the agenda.
Weekly Strategy
Buying EUR/JPY on pullbacks
A developing trend of easier monetary policy across a consortium of central banks sent equities screaming higher Tuesday. The BoJ was the first to act as it took part in another round of QE with the announcement of an asset purchase plan of about $60bn in conjunction with the unexpected decision to drop its interest rate to virtually zero. Markets also seem to be pricing in Fed QE2 as a certainty rather than a possibility evidenced by the drudging the greenback has taken recently. It seems now that a concerted effort from various central banks towards easier monetary policy has now become a reality. One major central bank that hasn’t hinted at additional easing has been the ECB which is a partial factor in the steep ascent of the single currency. The parabolic move higher in EURUSD seems a bit overdone and significant resistance lurks directly above current levels (50% retracement for the descent from the July 2008 all time highs into 1.3955/60). However, the current trend of euro strength is unmistakable and we would like to exploit any euro pullbacks, specifically against the yen as global liquidity measures may see yen crosses rally on a re-emergence of risk appetite.
EUR/JPY is approaching significant technical supply into 116.25, trendline resistance from the 170.00 record highs. Additionally, hourly charts evidence potential exhaustion as the pair nears channel tops around 116.00. However, we believe that any possible reversal may provide an opportunity to buy dips for a continuation of the recent uptrend. There are a couple factors contributing to the longer term bullish bias. Firstly, EUR/JPY continues to remain in a rising channel which is additionally supported by the 200-hr SMA. Until both the channel support and moving average are breached, the uptrend remains intact. Also, the bullish price/Macd divergence suggests the 119.25 61/8% retracement for the 4/5 to 9/20 decline is in view. The strategy will look to buy half a position of EUR/JPY on a pullback into 114.50 channel support and the remaining on further weakness into 113.25 for an average rate of 113.87. The stop loss will be below the June to July 2010 horizontal pivot around 112.60, for a total risk of about 125 pips. The take profit objective is for 50% at long term trendline resistance into 116.00 and the remaining half into the 119.25 key 0.618 fibo level. We would bring our stops to break even on a move above 116.00.
Support
• 114.50 Rising channel support, short term pivot
• 114.00 Daily Tenkan line, Hourly Rising Channel Support, 200-hr SMA
• 113.25 June – July 2010 Horizontal pivot resistance turned support
Resistance
• 116.25 Trendline Resistance from 2008 170.00 highs
• 117.95 200-day SMA
• 119.25 61.8% retracement (4/5 – 9/20 decline)
The greenback lost further ground this past week as economic data came in soft and speculation mounted that the Fed will provide additional stimulus. The prospect of further quantitative easing stepped up a gear on Friday after non-farm payrolls data disappointed market expectations. The US labour market lost -95K jobs in September, expectations were for a decline of -5K due to a steep loss in government jobs (-159K). +64K private payrolls were added, but this was still less than the expected +75K and the prior month’s +93K was revised higher from +67K.
NY Fed President William Dudley called for further policy stimulus in a speech last week. He said that the unemployment and inflation rates in the US are “unacceptable”. This suggests that the economic data doesn’t need to get any worse for further QE to remain on the table. So, the deterioration in the labour market last month can be viewed as more QE in November. But the market’s reaction to the QE may be more temperate going forward. Estimates suggest that the amount of quantitative easing from the Fed that is already priced into the bond market is between $700 billion and $1 trillion. That is a huge amount, and if the Fed disappoints the market then there could be an almighty unwind that would cause volatility in FX to soar.
Fed members became noticeably less dovish than William Dudley at the end of the week, possibly to temper the market’s exuberance about the possibility of further QE. St. Louis Fed President James Bullard told a financial news network on Friday that more QE in November wasn’t necessarily a given. Instead he said that the FOMC might delay QE until the December meeting. Bullard was also more bullish on the growth outlook than Dudley was. He said that the soft patch in the economy “isn’t so obvious” that the Fed has to act now. Tuesday’s release of the Minutes for the Sept. 21 FOMC Meeting should provide more insight into how policy makers view the economic outlook.
Markets may temper expectations of more QE
The drop in the dollar on the back of Friday’s labour report has eased off for now, as dollar bears get fretful that the Fed may not deliver what they want. The same thing happened with sterling this week. After the Bank of England announced that it was keeping its asset purchases target steady at GBP200 billion, sterling immediately surged. The market was pricing in a slight chance of QE after MPC member Adam Posen said he thought the economy needed more policy stimulus in a speech last week. The lesson here is to be cautious of basing the rationale for your positions on the central banker who talks too candidly. BOE Governor King, Deputy Governor Tucker and members Sentance and Fisher are all set to speak in the week ahead.
The European Central Bank maintained its stance of withdrawing policy stimulus from the European financial system at its meeting that concluded on Thursday. This is in direct contrast to other central banks, which helped boost the euro briefly above $1.40. However, immediately after the payrolls figure, the EU’s Jean-Claude Juncker said in an interview in Brussels that the “euro is too strong today”, limiting the upside in EUR/USD. This highlights the newest risk investors need to be aware of in FX: the verbal currency war being staged by global central bankers.
While the market waits with bated breath for QE from the Fed and the BOE, Japan managed to surprise the markets by announcing further policy stimulus earlier this week. It not only lowered the interest rate to 0-0.1percent, but it also announced a package worth $60bn to buy government and private sector debt. Unfortunately for the BOJ, the market can only concentrate on selling one currency at a time, and right now it is the dollar and USD/JPY continued its march lower, falling to new 15-year lows under the 82.00 figure.
The excitement is building in the FX markets right now, but trading conditions are getting trickier. We believe there is upside potential in EUR/GBP, as further QE from the BOE is expected while the ECB remains firm in maintaining its exit strategy. Also, the relative growth prospects for the core economies of Europe are, in our view, stronger than they are for the UK. Fears over the UK’s growth may build in the coming weeks prior to the 20 October, when the UK government’s Comprehensive Spending Review and the minutes of this month’s MPC meeting are published. The bias is higher while above the 200-day moving average around 0.8685 with a potential target towards 0.8850. A move below 0.8590 would negate this view.
Currency “war” or just a skirmish?
The IMF meetings this weekend present leaders with an opportunity to express their views on the global economic outlook and traders should beware of the headline risk involved. We are likely to hear plenty of commentary addressing the topic of “currency wars”. Participants will probably touch upon direct market intervention from Japan, quantitative easing measures from the FED, BOJ & BOE, fiscal austerity measures in the Euro-zone and continued pressure on China to let their currency appreciate at a faster rate. While the Chinese are faced with the greatest amount of global pressure, they are also the most likely to fiercely defend their decision and will let the Yuan appreciate at a “gradual” pace, avoiding “shock-therapy”. At this juncture we believe the recent panhandling between nations has been overblown due to political pressures. Ultimately, we believe traders shouldn’t get caught too bullish or bearish any one particular currency based on he said/she said rhetoric. We think after the elections in November this will be reflected upon as a mere skirmish between political figureheads, rather than grow into full blown financial warfare.
Key data and events next week
U.S. data kicks off on Tuesday with the September FOMC Meeting Minutes followed by October ABC Consumer Confidence. Wednesday sees October MBA Mortgage Applications and September Import Price Index. Thursday follows with August Trade Balance, September Producer Price Index, and weekly Jobless Claims. A heavy load of data on Friday wraps up the week with September Consumer Price Index, September Retail Sales, October Empire Manufacturing and August Business Inventories. Friday’s data also includes the University of Michigan Confidence survey and Bernanke’s speech at the Boston Fed Conference.
The Euro zone starts off on Tuesday with Germany’s September final CPI. Wednesday sees August EZ Industrial Production. The data session continues Thursday with the ECB’s October Monthly Report and wraps up Friday with September CPI and August Trade Balance. Germany sees September CPI on Tuesday and wraps up with September Wholesale Price Index on Thursday.
U.K. economic data begins on Sunday with speeches by BOE Governor Mervyn King and the BOE’s Paul Tucker. Monday sees August RICS House Price Balance. A busy Tuesday sees September CPI, August DCLG UK House Prices, September Retail Price Index, August Trade Balance, and September RPI. Wednesday sees a speech by the BOE’s Andrew Sentance, September Claimant Count Change, September Jobless Claims Change and the August ILO Unemployment Rate. Thursday closes out the week with September Nationwide Consumer Confidence.
The calendar in Japan starts off with September Consumer Confidence, Japan Money Stock M2 & M3, and August Machine Orders. Wednesday sees September Domestic CGPI and Thursday follows with September Machine Tool Orders. Friday wraps up the Japanese data session with August Industrial Production.
Canada’s economic data begins with August New Housing Price Index on Wednesday followed up with August International Merchandise Trade on Thursday. Friday wraps up the light data session with August Manufacturing Sales and New Motor Vehicle Sales.
Australia’s data session kicks off with August Home Loans on Sunday followed by September NAB Business Conditions on Monday. Tuesday sees the October Westpac Consumer Confidence survey. Wednesday wraps up the week with October Consumer Inflation Expectation. New Zealand’s calendar begins Tuesday with September Food Prices and continues Wednesday with September REINZ House Sales, August Retail Sales, and September Business PMI.
Significant data out of China sees September Trade Balance and 3Q Business Climate Index due out on Wednesday. The Conference Board China August Leading Economic Index is due out on Friday. Sometime between Monday and Friday China will release its September Foreign Exchange Reserves and China Property Prices. Also be on the lookout for the October 8-10 IMF and World Bank Meetings in which currencies are likely to be key topic on the agenda.
Weekly Strategy
Buying EUR/JPY on pullbacks
A developing trend of easier monetary policy across a consortium of central banks sent equities screaming higher Tuesday. The BoJ was the first to act as it took part in another round of QE with the announcement of an asset purchase plan of about $60bn in conjunction with the unexpected decision to drop its interest rate to virtually zero. Markets also seem to be pricing in Fed QE2 as a certainty rather than a possibility evidenced by the drudging the greenback has taken recently. It seems now that a concerted effort from various central banks towards easier monetary policy has now become a reality. One major central bank that hasn’t hinted at additional easing has been the ECB which is a partial factor in the steep ascent of the single currency. The parabolic move higher in EURUSD seems a bit overdone and significant resistance lurks directly above current levels (50% retracement for the descent from the July 2008 all time highs into 1.3955/60). However, the current trend of euro strength is unmistakable and we would like to exploit any euro pullbacks, specifically against the yen as global liquidity measures may see yen crosses rally on a re-emergence of risk appetite.
EUR/JPY is approaching significant technical supply into 116.25, trendline resistance from the 170.00 record highs. Additionally, hourly charts evidence potential exhaustion as the pair nears channel tops around 116.00. However, we believe that any possible reversal may provide an opportunity to buy dips for a continuation of the recent uptrend. There are a couple factors contributing to the longer term bullish bias. Firstly, EUR/JPY continues to remain in a rising channel which is additionally supported by the 200-hr SMA. Until both the channel support and moving average are breached, the uptrend remains intact. Also, the bullish price/Macd divergence suggests the 119.25 61/8% retracement for the 4/5 to 9/20 decline is in view. The strategy will look to buy half a position of EUR/JPY on a pullback into 114.50 channel support and the remaining on further weakness into 113.25 for an average rate of 113.87. The stop loss will be below the June to July 2010 horizontal pivot around 112.60, for a total risk of about 125 pips. The take profit objective is for 50% at long term trendline resistance into 116.00 and the remaining half into the 119.25 key 0.618 fibo level. We would bring our stops to break even on a move above 116.00.
Support
• 114.50 Rising channel support, short term pivot
• 114.00 Daily Tenkan line, Hourly Rising Channel Support, 200-hr SMA
• 113.25 June – July 2010 Horizontal pivot resistance turned support
Resistance
• 116.25 Trendline Resistance from 2008 170.00 highs
• 117.95 200-day SMA
• 119.25 61.8% retracement (4/5 – 9/20 decline)
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