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Sunrise Market Commentary: Currencies

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Dollar gains in erratic end of quarter trading conditions

Wed, Jul 1 2009, 07:09 GMT
by KBC Market Research Desk

KBC Bank

On Tuesday, EUR/USD showed some strange swings. The link between the price action and the economic data was not that easy to make. Technical considerations and (end of quarter?) order driven activity probably played an important role. In Asia and early in Europe, the pair moved up and down in a 1.4080/1.4150 trading range. The euro set an intraday low after weaker than expected Euro-zone lending data, but returned to the 1.4150 area early in US trading. However, a real test of the important 1.4178 area didn’t occur and this apparently was good reason to scale back EUR/USD long positions. Remarkably, later the dollar gained ground both on positive and negative news from the US. A first USD buying wave occurred after a (slightly) better than expected CS house price report. The next phase of the EUR/USD declined was triggered by correction on the stock markets, after a weaker than expected US consumer confidence release. To find some logic in this move, price action on the bond markets might bring some part of the explanation as the USD received interest rate support (US yields rose faster than their European counterparts). It would be an interesting development if this pattern would be continued, but at this stage we remain very cautious on this call. Whatever the explanation, EUR/USD corrected rather sharply from the intraday highs, tested bids in the 1.40 area and closed the session at 1.4033, compared to 1.4083 on Monday evening.

Today, in Europe the final manufacturing PMI will be published. In the US the calendar is more interesting with the ADP labour market report, the ISM manufacturing, the pending home sales, the construction data and the vehicle sales scheduled for release. With respect to the ADP report, it won’t be easy for markets to draw firm conclusions as this report didn’t capture the unexpected improvement in last month’s payrolls. The manufacturing ISM is expected to improve further but the key question is whether the rise will be strong enough to really convince markets that a sustained economic rebound might be expected further out this year. On top of that, looking at yesterday’s price action, one might raise the question whether the dollar needs good or bad news. At least for now we hold on to the view that the stock market reaction will continue be the most important driver for EUR/USD 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 also caused some temporary dollar nervousness. Regarding the European side of the story, we recently took notice of the fact that some ECB members had become more concerned that the ECB measures didn’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. We take a close look whether the ECB will elaborate on this item at the press conference on Thursday. In a short-term perspective, 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 take place 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 short-term 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. So, we slightly prefer a sell-on-upticks approach. 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.

On Tuesday, USD/JPY more or less tracked the moves in other USD cross rates. So, the correlation with the stock markets was again very loose. The dollar recouped its early losses despite a rather steep decline on the stock markets, later in US trading. Higher US bond yields might have played a role. We suppose that end of quarter position squaring and technical considerations played also an important role in this move. USD/JPY closed session at 96.36 compared to 96.06 on Monday. Nevertheless, given the global market context, the dollar showed a decent performance overall.

This morning, the BOJ Tankan survey was published. The ‘headline’ large manufacturing index improved from -58 to -48, but this was still below the consensus forecast (-43). Most other sub-indices also improved less than expected. Japan (large) companies also expected an accelerating decline in capital spending in 2009. The reaction to the report on the currency market was fairly limited. However, there was chatter of investment fund buying of foreign assets at the start of the new quarter and this caused some moderated USD/JPY gains this morning.

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 still played a role, but is no longer as tight is it used to be some time ago. 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 and the 95.00/94.88 area provides some intermediate support short term. In this context, a cautious buyon- dips approach might be considered.

On Tuesday, trading in sterling showed two completely different faces. Early in the session sterling posted a strong performance as the UK currency profited from better than expected US housing data. EUR/GBP dropped to the 0.8440 area after the release. However, the key 0.8400 support area stayed out of reach. Sentiment turned completely after worse than expected (final) Q1 GDP numbers and a materially higher than expected current account deficit. We were a bit surprised to see such sharp correction on these (somewhat outdated) Q1 data. Nevertheless, sterling completely reversed the early gains and EUR/GBP tested offers in the 0.8535 area. A speech from BoE’s Tucker on banking regulation had no visible impact on sterling trading. Later in the session, the pair settled in a tight range slightly above the 0.85 big figure. Overnight, sterling lost further ground against the euro.

Later today, the PMI manufacturing survey will be published. The consensus expects an improvement from 45.4 to 46.4. Recently, sterling reacted rather well to good/better than expected UK eco data. We don’t have a strong opinion on the outcome of the release, but have the impression that any sustained sterling gains have become a bit more difficult even in case of relatively good UK eco data.

Global context. 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 force. 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 sterling showed rather resilient until now. Regaining the 0.8598/0.8605 area (Reaction highs) 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. For now the pair is locked in a 0.8400/0.8600 sideways trading range.

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Published on  Wed, Jul 1 2009, 07:18 GMT