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Sunrise Market Commentary: Currencies

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Euro continues to struggle

Thu, Feb 5 2009, 08:28 GMT
by KBC Market Research Desk

KBC Bank

On Wednesday, EUR/USD trading showed again quite some volatility. On Tuesday, the pair rebounded rather sharply. Yesterday morning we already indicated that we didn’t give too much weight to the explanation that the improvement in global sentiment (and thus also the gain in EUR/USD) was due to the better than expected pending home sales. The market is always right, the EUR/USD rise on Tuesday was nevertheless ‘suspect’. Yesterday, EUR/USD came under downward pressure from the start of trading in Europe, despite a good performance of the Asian and the European stock markets. So, the ‘good news is good for the euro’ paradigm didn’t work yesterday. Later in the session, the Fitch rating downgrade of Russia added to the euro negative sentiment. EUR/USD gave up all the Tuesday afternoon gains and came close/retested the Tuesday lows in the 1.2800/15-area. From that point, the pair settled into a sideways trading pattern. The better than expected US ISM nonmanufacturing and the positive open of the US stock markets also gave EUR/USD downside protection. However, the least one can say is that the euro performance was again far from convincing. Uncertainty ahead of the ECB meeting probably played a role. EUR/USD closed the session at 1.2849, compared to 1.3040 on Tuesday.

Today, in the US, the jobless claims and the factory orders are on the agenda. However, the market focus will be on the ECB interest rate decision and press conference. The ECB is widely expected to leave rates unchanged as Mr. Triceht indicated at the January press conference that the next rendezvous on rates was March. However, the press conference will be interesting. Will the ECB president ‘pre-announce’ a March rate cut? Even more important, will he give any insight in the potential unconventional measures that the bank is preparing, in case they would be necessary further out in the cycle. It’s probably too early for an open debate on this item. However, the market feeling is that the ECB at some point will also be obliged to move to some kind of quantitative easing. This might be a (slightly) negative factor for the euro.

Since the start of the year, the currency market gave more weight to negative news from the euro zone. The deterioration of the European government finances, pressure on the Member states’ credit ratings and the widening of intra-government spreads weighed on the single currency. The dollar has regained the advantage of doubt over the euro, especially in times of rising global market pressure. Since last week, the EUR/USD decline shifted into a lower gear and earlier this week the euro even gave the impression that there could be room for a technical rebound. Longer-term, we’re not convinced that the dollar should perform a sustained rally against the euro from the current levels. However, recently the market clearly had a euro skeptic attitude, keeping a close eye on the intra euro government bond spreads. Global risk appetite (or the absence of it) is also an important driver for the euro. The intra-EU problems are far from solved and the global investor risk appetite remains fragile. From the US side, the Fed buying Treasuries to keep long-term yields low (next step in the quantitative easing) might become a dollar negative factor over time. However, none of these EUR/USD supportive factors is fulfilled at the current juncture. So, even as EUR/USD shows some tentative signs of bottoming out, the current indecisive trading pattern might continue for some time. We don’t front-run on a major EUR/USD up-leg yet. Disappointment on the ECB message (for whatever reason) even might entail some downside risks in a day-today perspective.

From a technical point of view, the correction from mid December brought EUR/USD back in the previous sideways range (capped by the 1.3300 area). The pair extensively tested the 1.2765 support area (previous low) with a reaction low/fast break at 1.2706. The test was rejected but the subsequent rebound was (again) disappointing. A sustained drop below the 1.2765/00 area still contains the risk for return action to the1.2330 area (2008 low). A sustained rebound beyond the 1.3070 area (Boll midline) and even more above the 1.3330/85 area (MT reaction highs) is needed to improve the ST EUR/USD picture.

On Wednesday, USD/JPY extended its lackluster sideways trading. An early downswing was reversed during the US trading hours (positive stock market open) but the pair closed the session at 89.43 (compared to 89.44 on Tuesday and 89.45 Monday!). This looks like some kind of currency peg.

This morning, Asian stocks trade mixed. The Nikkei closed the session with a loss of 1.11%. Chinese/Hong Kong stock markets are little changed or even trade in positive territory.

Looking at the charts, USD/JPY set a reaction low in the 87.15 area on December 17. Since then, the pair entered calmer waters. The long-term trend in the pair remains negative, but downtrend slowed below 0.9000 (among others as Japanese officials probably will voice concerns on the ascent of the yen if USD/JPY comes closer to the 0.8710/15 reaction low). We remain yen positive longer term but don’t add/reinstall yen long exposure at the current level. We keep a wait and see approach and look for a more pronounced up-tick to reinstall/add USD/JPY short exposure. Short-term the pair is locked (or even paralysed) in a rather tight 87.10/91.30 consolidation pattern.

On Wednesday, EUR/GBP almost perfectly tracked the EUR/USD decline, especially during the morning session in Europe. At that time cable traded sideways while EUR/USD was sold, reversing the gains from late on Tuesday, hammering EUR/GBP. The UK Services PMI came out better than expected at 42.5 from 40.2, but remarkably, this data release left no traces on the EUR/GBP charts (even as EUR/GBP was captured in a downtrend at that time). So, one might assume that the price action in EUR/GBP (and in other sterling cross rates) was again very much order driven. EUR/GBP closed the session at 0.8881, compared to 0.9016 on Tuesday.

Today, all eyes will be on the BoE interest rate decision. The Bank is widely expected to cut its base rate be 50 basis points to 1.00%. Last month there was some debate within BoE whether an additional rate cut was already necessary in January. However, the bank concluded that it was not opportune to challenge the market expectations. This might also be the case today. It will again be interesting to see whether bank gives already any insight in potential next steps, beyond the conventional BoE policy tools. However, for more details one will probably have to wait for the Minutes. Today, sterling even trades slightly stronger against the euro compared to the level at the time of last month’s BoE decision.

On the technical charts, the break above a series of high profile resistance levels in November/December has made the long term technical picture positive for EUR/GBP. At the start of 2009, EUR/GBP made a forceful correction. EUR/GBP tried to resume the longstanding uptrend, but the pair ran into resistance in the 0.95 area. This lower high on the charts pulled the trigger for another forceful correction and the pair extensively tested the key 0.8840 neckline (on Friday and on Monday). From a fundamental point of view, we remain sterling skeptic (a deficit country in an environment that moves towards quantitative easing, ongoing uncertainty on the key banking sector, no clear signs of improvement in the housing market…). However, as was the case for EUR/USD, euro negative factors apparently are considered at least evenly important by the markets. The rejected test of the key neckline (0.8840-area) called off the ST downward alert in this pair. However, the jury is still out. For now, we stay neutral on EUR/GBP. Sustained return action above the 0.9130 area (previous neckline) would improve the ST picture for EUR/GBP. Sustained price action below the 0.8840/00 area would seriously question our longstanding EUR/GBP positive bias (consider stop-loss).

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Published on  Thu, Feb 5 2009, 08:39 GMT