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Daily Fx Strategy

Why Optimism Remains Premature?

Mon, Apr 21 2008, 15:03 GMT
by Ashraf Laidi

CMC Markets

Dollar and sterling are the main losers as the yen and euro dominate in today’s quiet trade, reflecting a renewed retreat in risk appetite. Last week’s growing optimism is running into resistance as the major US equity indices fail to breach above the key technical levels of 1,390 and 12,900 in the S&P500 and the Dow respectively. Commentators and pundits alike have erroneously stated that last week’s highs in US equity indices broke important technical levels. The Dow has not only failed to breach above a key trend line resistance of 12,920, prevailing since the October highs but also failed to breach the 50% retracement from the same high to the January lows. Similarly, the S&P500’s major resistance stands at the 1,410 trend line resistance acting since the October 10 highs. We remind our readers that these recurring failures are no coincidence but instead a technical failure that is largely in synch with prolonged economic uncertainty.

The notion that the worst of the credit crisis is behind us and that US equity indices have reached bottom was given a firm boost late week when markets remarkably shrugged a worst than expected earnings and further writedowns from Citigroup. IBM and Google’s earnings helped to improve overall sentiment and reinvigorate risk appetite at the expense of the Japanese yen. But sentiment is drifting lower after the 77% decline in Bank of America earnings. Last week’s strong earnings were largely a reflection of relatively robust foreign demand and of the weak US dollar. In the event that equities continue to rally simply on the notion that the “worst is behind us”, they will risk diverging with the stark macroeconomic reality that is highlighted by soaring energy costs and rising unemployment. The near bankruptcy of Bear Stearns has become a benchmark of market risk and fear, desensitizing market participants from what is likely to be a slow and long deterioration in US labor markets and an increasingly retrenched US consumer. This week’s release of retail sales is expected to show a 0.3% decrease in March following a 1.0% increase, while ex auto sales are seen up 0.1% from -1.1%. The week will also give way to further corporate earnings reports. Next week will see Fed decision, US payrolls and the first revision of US Q1 GDP and whether it would have shown a contraction.

Next Jobs Report to Elucidate Economic View

We remind readers of the following facts in US labor markets. In the 2000-02 recession, there were as many as 15 consecutive months of negative payrolls between March 2001 and May 2002 producing a monthly average of 148K. In the 1990-91 recession , the longest streak of losing payrolls was 11 consecutive months --between July 1990 and May 1991-- producing an average of 147K. In the current slowdown (not yet officially declared a recession), we’re only in the third straight monthly decline in payrolls, with the monthly average standing at 59K . Thus, to be consistent with previous recessions, payrolls will likely register negative readings for the rest of the year into Q1 2009. This also means that the unemployment’s recent rise to 5.1% is here to stay and the rate is most likely to climb to as high as 5.9-6.0% by year end.

Yen Regains Strength as Optimism Fades

The aforementioned fundamental and technical rationale of the unfolding gauge of market and economic risk is imbedded into increasingly inconclusive gains in the yen crosses. We expect USDJPY to retest last week’s 104.64 highs and falter at the 105 level before charting a renewed pullback towards the 102.20s. Escalating weakness in Japanese fundamentals such as the downgrade of economic conditions by the BoJ and Cabinet are serving to slow the yen’s climb, and offering the G7 comfort as far as currency movements are concerned. Given the spread of layoffs in the auto and finance sectors, we cannot foresee the US April labor report to show a net creation of jobs nor a decline nor a drop in the unemployment rate below 5.0%. But before getting to the jobs obstacle, markets will have to face a test in next week’s FOMC decision in the event a 25-bp rate cut is delivered. We do not expect markets to maintain the same optimism and resilience they have shown recently. The economic repercussions of rising layoffs, falling purchasing power and prolonged loss of home equity maybe in the 4 th or 5 th inning, but are far from the end. 105 yen is likely to act as the next barrier, but 101.50-102 will more likely prevail by mid May.

Sterling’s High Profile Failure

Just as US equity indices failed to break their respective technical requirements for prolonged gains, sterling has failed to chart a convincing breach of the $2.00 mark. We mentioned in Friday’s FX charts strategy that “the high profile rally to $1.9980 from $1.9600 earlier this week was as high profile as the failure to break above the key $2.00 resistance, suggesting that the technical picture remains largely in synch with the fundamental landscape”. Indeed, GBPUSD today topped put at $2.00 before falling to $1.9835. The expectations of at least 75-bps in interest rate cuts from the Bank of England should keep cable below $2.00 and recall the $1.95 by month end.

Published on  Mon, Apr 21 2008, 15:06 GMT

Archive

• CPI Softens Dollar Rebound, to Boost Risk Appetite
  Published On Wed, May 14 2008, 13:32 GMT
• Dollar Cheers Sales, Ignores Autos
  Published On Tue, May 13 2008, 13:41 GMT
• Sterling Deepens Gloom, Yen Gains on Risk Appetite
  Published On Fri, May 9 2008, 14:57 GMT
• USD Unable to Follow up, GBP Down Across the Board
  Published On Mon, May 5 2008, 14:58 GMT
• Why Optimism Remains Premature?
  Published On Mon, Apr 21 2008, 15:03 GMT

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