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Sunrise Market Commentary: Currencies

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FX: Chinese central bank continues to advocate a super−sovereign reserve currency

Mon, Jun 29 2009, 07:19 GMT
by KBC Market Research Desk

KBC Bank

On Friday, EUR/USD trended higher for most of the session. In Asia, the pair received support from a strong stock market performance. European stocks failed to maintain the positive momentum from the Asian markets and this capped the EUR/USD upmove. However, later in the session, the Bank of China reiterated recent calls for a new reserve currency that is delinked from the economies of the issuers. This new pleading caused some additional losses in most dollar cross rates and EUR/USD tested offers in the 1.41 area at the start of the US trading session. Later in the session, US stock markets showed an indecisive trading pattern and this stemmed the losses of the US currency. EUR/USD closed the session at 1.4056, compared to 1.3988 on Thursday.

During the weekend, there was a BIS meeting in Bazel. On the sidelines of that meeting, the debate on the role of the dollar as reserve currency continued. Some policy makers from emerging market countries again advocated to examine the possibility of a more diversified system of currency reserves. China and Brazil said they are working on an agreement to increase the use of their local currencies for mutual trade purposes. At least for now, the reaction of the USD on those headlines was limited.

Today the European eco calendar contains confidence indicators from the European Commission. These data are interesting, but after the publication of the PMI’s and the IFO, we don’t expect them to have a lasting impact on trading. On top of that, markets are gradually looking for evidence from hard data rather than from sentiment indicators to confirm the hopes that the worst of this downturn might be behind us. In the US, only some smaller regional business confidence indicators are on the agenda. So, the data probably will only have a limited impact on currency trading. The swings on the stock markets and technical considerations will again be the most important factors for trading.

Global context. During the month of May, EUR/USD performed quite a strong rally. The euro profited from improved global risk appetite. On top of that, investors were cautious on the dollar as there was still quite some uncertainty about next steps in the Fed policy and about the fiscal situation in the US. The EUR/USD ascent stalled after the better than expected US payrolls report early June. It temporary looked as if markets would shift their attention to the pace of the recovery in the US and its potential impact on the Fed policy. However, until now, other hard data mostly were not strong enough to support this thesis. Last week’s FOMC meeting didn’t bring any insights on new/additional policy steps either. So, until now, there are no indications that the Fed policy will turn more dollar supportive anytime soon. On top of that, the debate on the role of the USD as reserve currency sometimes also caused some temporary dollar nervousness.

Recently, the ECB side of the story was not really that important for price action on the currency markets in general and for EUR/USD in particular. However, last week, we noted signals from Mr. Weber that the ECB measures don’t filter through enough into bank lending. This debate is still in its very early stages but it deserves the attention, also from a currency market point of view. The ECB potentially moving further in the direction of new unconventional measures might, at some point, become a negative factor for the euro, too. In this respect, we take a close look at EMU lending data to be published on Tuesday and at the ECB press conference on Thursday.

For now, EUR/USD traders mostly continue to watch investor sentiment (as mirrored in stocks and in commodities) as the most important guide for EUR/USD trading. Over the previous two weeks, we had a neutral bias for EUR/USD. For now, we hold on to that view.

Looking at the technical charts, the medium term outlook remains euro constructive as long as the EUR/USD pair stays above 1.3739 (Previous reaction high). After the payrolls, quite a forceful correction occurred, but a test of this key level didn’t occur and the EUR/USD currency pair settled in a sideways trading pattern between 1.3739 and 1.4338. The pair returning above MTMA and above the previous shortterm highs (1.4013/33) made the short-term picture again neutral. A break above the 1.4178 reaction high would open the way for a retest of the range to at 1.4338. We expect this level to be difficult to break short-term. A break above the 1.45 area, would suggest the risk for a more profound loss of confidence in the US dollar and could even lead to dollar panic. This is not our favorite scenario. In a day-to-day perspective we slightly prefer a sell-on-up-ticks approach.

On Friday, the USD/JPY pair joined the global USD decline. In Asian the pair was supported by a decent stock market performance. However, in Europe global investors turned more cautious. This triggered yen buying at the start of trading in Europe. Later in the session, the comments for the Chinese central bank on an alternative reserve currency caused an additional wave of dollar selling. The pair settled in the low 95 area going into the weekend. USD/JPY closed the session at 95.18, compared to 95.95 on Thursday evening.

Overnight, Japanese industrial production statistics were published. Production rebounded 5.9% on a monthly basis. However, the figure was weaker than expected and the Y/Y figure is still deeply in negative territory (-29.5%). May retail trade stabilized (on a monthly basis) in May. The data suggest an inventory-driven rebound, but the key question remains whether final demand will pick-up in order to support this rebound going forward. Asian stock markets are mostly lower this morning (except for the Chinese stock markets).

Global context. Since March, USD/JPY developed a sideways trading pattern between 101.40 and 93.86/54 (May low/March low). The ‘traditional link’ between USD/JPY and the performance of global stock markets/risk appetite was no longer as tight is it used to be some time ago. Nevertheless, at times of rising market stress, this market theme still plays its role. At the end of May, USD/JPY came relatively close to the key 93.54 range bottom, but a real test/break didn’t occur and USD/JPY returned higher in the medium term trading range. The subsequent rebound ran into resistance ahead of the first resistance area (the early May highs). In a longer term perspective, this remains a range trading story. We expect the range bottom (MT reaction lows at 93.85/93.55) to hold. In a day-to-day perspective, watching the stock markets remains the name of the game.

On Friday, the EUR/GBP pair again drifted slightly lower in technically inspired trading. There were no important UK eco data. Friday’s trading pattern confirms the feeling that the pair entered some kind of consolidation pattern. However, after all, sterling holds up rather well and at least for now there are no signals of a protracted sterling correction yet. EUR/GBP closed the session at 08507, compared to 0.8546 on Thursday.

This morning, the UK Hometrack housing price measure showed that UK home prices were stable for the second month in a row. Later today, the UK lending data deserve some attention. However, usually these data are no big movers for the currency market.

During the month of May, sterling performed a remarkable rebound against the euro (and the dollar). Improving eco data were a good reason for investors to turn sterling positive. The break below the EUR/GBP level of 0.8637 was a clear signal that something had changed in investor sentiment towards the UK currency. This move forced us to leave our longstanding buy-on-dips approach in the EUR/GBP pair. We turned to a neutral approach vis-à-vis the UK currency. Nevertheless, there is still a lot of uncertainty on the BoE policy going forward (additional buying of assets?). On top of that, recent comments from BoE policy members gave the impression that they felt quite comfortable with a weak pound to support the economy.

Over the previous two weeks, there were tentative signs that the sterling ascent was losing momentum. Recently, we indicated we thought that enough good news for sterling had been priced in at the current levels and advocated profit taking on EUR/GBP shorts. We hold on to this tactics, even if we have to admit that the sterling showed rather resilient until now. Regaining the 0.8605 area (last week high) would call off the ST alert in EUR/GBP and would be an indication that the EUR/GBP rebound could have some further to go.

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Published on  Mon, Jun 29 2009, 07:25 GMT