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Sunrise Market Commentary: Currencies

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Currencies show little reaction to strong equities and important ECB and BoE meetings

Fri, Nov 6 2009, 08:27 GMT
by KBC Market Research Desk

KBC Bank

On Thursday, the currency market got quite a lot of key drivers like the ECB and BoE meetings, the stunning US productivity data and an ebullient equity run. However, when traders went home, little had changed in the major crosses. EUR/USD closed at 1.4872, very marginally up from the 1.4862 close on Wednesdays. This should be considered as disappointing from the euro point of view. Indeed, surging equities or increased risk appetite in recent months was a euro positive, while also the ECB press conference should be considered euro positive. ECB Trichet clearly pre-announced a gradual exit from emergency liquidity measures, starting with a non re-newal of the 12 month funding auctions. Trichet didn’t want to elaborate much fur-ther, but referred to the December meeting as being an important “rendez-vous”. This means that the ECB is probably the first of the major central banks to start a tightening of policy, even if it is more a redraw of part of the extra-ordinary monetary accommodation needed in the past year because of the crisis than already a genuine tightening.

Why didn’t the euro gain more ground on the dollar? Various factors may be in play. The euro rallied strongly on Wednesday and a breather was maybe needed. Sec-ondly, while equities gained substantially helped by stunning productivity figures, it was no across the board reflationary trade that swept through all markets. Commodi-ties dropped modesty, gold was little changed and the ITRAXX crossover rose slightly. Thirdly, Mr. Trichet re-iterated yesterday that excessive volatility in the cur-rency market was undesired and stressed the importance of the strong dollar. While in a certain way, these remarks are empty of meaning, they clearly signal the ECB’s reticence to see the euro becoming stronger. Thirdly, currency investors might have been cautious too as the US payrolls are published today and recently equities showed quite a lot of uncertainty and volatility. Also, despite the good run, the S&P hasn’t yet re-broken the uptrendline, which is needed to bolster sentiment and give equities a firmer footing. Therefore, the payrolls may be crucial for equities and cur-rencies alike today. A disappointing payrolls figure might still lead to renewed selling of equities, which would be a headwind for the euro. A strong payrolls, on the con-trary, might lead to risk appetite and help the euro higher, but beware as the rally highs aren’t too far away. Technically, the trend in EUR/USD is still bullish oriented, at least as long as the trendline remains intact (1.4771) with key support at 1.4480.

Global context: recently, the swings in risk appetite/risk aversion were the drivers on the currency markets. Improving investor sentiment towards risk is still considered a good reason to sell the US dollar. On top of that, in this low yield environment, the dollar has become (or is at least perceived to have become) the preferred currency to fund carry-trade deals. Lingering uncertainty on the huge US financing needs, some international debate on the status of the dollar and the Fed’s intention to run an expansionary monetary policy for a prolonged period of time offer additional ammuni-tion for carry traders to use the dollar rather than other currencies. This has put the dollar in a vulnerable position. We stay dollar skeptical as long as we don’t get a clear signal that the Fed is coming closer to reversing its very stimulating monetary policy. Yesterday’s FOMC meeting confirmed that the dollar negative Fed stance will remain in place for longer. Our view recently that the EUR/USD downward correction was nearly over is still on track with the pair regaining the uptrend channel a positive. However, a test test for the pair looms today with the US payrolls report. Is the rela-tionship between equities and EUR/USD becoming looser?

Looking at the (technical) charts, the break of EUR/USD above the range top at 1.4438/48 and above the 1.4719 (Dec high) improved the picture, but the move con-tinued to develop in a rather gradual way. Nevertheless, the corrections, if any, were very limited, too. As we had reached our long-standing technical target of 1.5021 (2nd target double bottom of 1.3739), we turned more cautious on the ST upside potential in the pair and advised partial profit taking on standing EUR/USD long positions. EUR/USD currently trades again above the upterendline (1.4754) which is a positive. Confirmation is needed and a weekly close above would go a long way in making us more comfortable with new euro long positions. In case of a strong payrolls report and higher equities, there is nothing in the way of a re-test of the highs (1.5063). If such move wouldn’t happen in these circumstances, euro bulls should start worrying and protecting long positions.

On Wednesday, USD/JPY trading was again dull. The pair has lost momentum and hovers directionless in a sideways range. The pair opened at 90.72 and closed at 90.71. Intraday, USD/JPY trading showed two moves. In Asian and early European trading, the pair fell from 90.72 to 89.89 before turning course and in a gradual way erasing the losses. The obvious driver was equities that fell till 10h CET and recov-ered afterwards.

Today, the US payrolls report will retain all attention. For the USD/JPY pair, equities seem still the driving force. So a strong report, if it pushes equities higher, should benefit the dollar. In the opposite case, the yen should win. However, we expect it to happen in the well established trading range. We have a slight preference for a stronger payrolls report, but are a bit suspicious about the upside for equities.

Global context: USD/JPY reached a reaction high in the 97.80 area early August. Despite positive global investor sentiment, the dollar could not hold on to its gains against the yen. The link between USD/JPY and global investor risk aversion/risk appetite became less tight and sometimes it even reversed. The dollar (and not the yen) was said to have become the preferred funding currency for carry trades. So, the price action in USD/JPY more or less joined the global dollar trend (decline). The long-term trend obviously remains USD/JPY negative. We turned more cautious on USD/JPY shorts on technical considerations, looking for re-entry opportunities in the 92/93 area, an area reached last week. We advocated re-installing USD/JPY short positions for return action lower in the trading range. We hold on to our bias.

On Thursday, EUR/GBP trading was dominated by the BoE and the ECB meetings, but in the end the pair didn’t close (0.89675) very far from previous closing levels (0.89768). Following two waves of euro selling/sterling buying, the pair is stabilizing slightly below the 0.90 level. It is still uncertain whether these waves were simply a profit taking affair or some more structural re-positioning following a period of one-sided sterling selling. We cannot exclude another euro selling wave will develop that may conclude this re-positioning. Yesterday, the BoE decided to extent the QE pro-gram by an extra £25B. We were a bit surprised by both this compromise outcome (between doing nothing and going for £50B), but also by the market reaction, which differed from our expectations. Indeed, EUR/GBP spiked lower (not higher as we thought) on the decision, maybe as market expected a bigger, £50B extension. However, this doesn’t fit well with recent sterling strength that followed the weak Q3 GDP figures and triggered renewed speculation on an extension of QE. Whatever, the spike down stopped above the recent lows, meaning the move was insignificant in the broader picture. Another possibility is that investors were happy that the end of the QE expansion is now appearing on the horizon, while on the other hand it pro-voked some inflation fears as evidenced by the spike in inflation breakevens and the steepening of the curve. So maybe, markets speculate that the BoE has to become more hawkish further down the lane. However, we wouldn’t put much weight to this reasoning.

However, the turnaround intra-day came during the Trichet press conference. The president clearly hinted that the exit strategy would soon (in a few months) be im-plemented. For the first time, he said that “taking into account the improved condi-tions in financial markets, not all our liquidity measures will be needed to the same extent as in the past” and also “…the Council will make sure that the extraordinary liquidity measures taken are phased out in a timely and gradual fashion and that the liquidity provided is absorbed.” It looks to us that the ECB will be the first major Central Bank to unwind these emergency measures. The official announcement may occur at the December meeting. This should have been euro supportive. EUR/GBP jumped to the 0.8980 level, but no follow through buying occurred and the pair stalled near the opening level before even ceding a few ticks versus opening levels. This means that the euro sentiment hasn’t really recovered, that the sterling short covering hasn’t yet fully played out or that we miss something fundamental in our strategy. We will review and reassess the situation profoundly soon.

The BoE MPC kept its official bank rate at 0.5%, but decided to continue its QE pro-gram. The size of the program was expanded by £25B to £200B. Analysts were heavily divided whether the program would be extended after having reached the planned £175B of purchases and on whether it would expand it by £25B or £50B. The MPC sees medium term prospects for output and inflation determined by oppos-ing forces. On the one hand, there are the substantial easing in monetary and fiscal policy, the BoE purchases of assets and the substantial drop in sterling effective ex-change rate which supporting growth. On the other hand, there is the need of banks to repair their balance sheet which limits the availability of credit. The Committee thus sees a slow recovery that will keep a substantial margin of under-utilized re-sources. That will bear down on inflation, which will in the short term be offset by the past depreciation of sterling. Short term the MPC expects inflation to rise sharply above 2%, reflecting higher petrol prices and the reversal of last year’s VAT reduc-tion.

Today attention will be on the US payrolls. The UK PPI release will have little influ-ence on trading, even if inflation moves higher on the market’s list of market movers. The German factory orders are interesting, but probably unable to give currencies lasting guidance.

Global context: Since early August, sterling sentiment deteriorated again. The BoE decision in August to raise the asset purchase program to £175B and Governor King’s call for an even greater effort indicated that the Bank intended to maintain a loose policy for a prolonged period of time. This triggered a new sterling selling wave. At the September meeting, the BoE took no additional policy steps and this applies also to the October meeting. However, the Minutes of that meeting neverthe-less attracted the attention. Some observers correctly noted that in contrast to Sep-tember meeting, the more dovish MPC members didn’t re-state there preference for more QE, making such an expansion of the QE unlikely, especially as some MPC members including governor King in a newspaper had become slightly more optimis-tic on the economy. We were not sure whether such an interpretation of the Minutes was correct and have to wait for today’s MPC meeting to know. Nevertheless, this week’s drop below the key 0.8984 support is a technical warning signal, suggesting that the unwinding of sterling overextended short positions is not completely worked out. For now we keep a wait and see approach to see how the test of this key sup-port area will work out. However, it is obvious that our ST sterling negative bias is under pressure. If the pair doesn’t return above the 0.9000 mark soon and sustain, the correction might go quite a bit further. The 0.8845 area is the next high profile support.

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Published on  Fri, Nov 6 2009, 08:27 GMT