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Sunrise Market Commentary: Currencies

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FX dollar again in the defensive

Thu, Jul 2 2009, 08:06 GMT
by KBC Market Research Desk

KBC Bank

On Wednesday, the news flow was both euro positive and dollar negative and this caused EUR/USD to test (and temporary break) the first important resistance area around 1.4175. Early in the session, EUR/USD was supported by a positive start of the new quarter on the European stock markets. The US eco data painted a mixed picture, but US stock market indices joined the rally in Europe and EUR/USD came close to the 1.4175 area. A brief correction occurred, but later in the session another well-know story resurfaced as there were news headlines that China was seeking to put the debate on a new reserve currency on the agenda of next week’s G8 meeting. EUR/USD briefly spiked to the 1.4200 area, but there was again no follow through price action and the pair closed the session at 1.4142, still a gain of more than one big figure compare to the 1.4033 close on Thursday.

Overnight, Chinese officials said they had not heard about a request to debate over a global reserve currency. China indicated that it hopes the dollar to remain the global reserve currency, but at the same time it supported the idea that diversification is needed. EUR/USD drifted south on these headlines and returned to the low 1.41 area. The least one can say is that it won’t be easy for China to strike a good bal-ance in this debate, if it were to take place.

Today, the calendar is very interesting. In Europe, the EMU unemployment will be published but the market focus will be on the ECB interest rate decision and press conference. We especially look out whether and how much Mr. Trichet will elaborate on the theme of a credit squeeze in the euro zone. The ECB won’t pre-announce any new measures yet, but if the bank would come to the conclusion that its strategy to provide ample liquidity to the banking sector doesn’t filter through to the economy via favourable lending conditions, this might by a good reason to consider additional non-conventional policy steps. It is still early days, but such a move would in theory be a negative factor for the single currency. At least for now, this is not a big issue for the currency market, but we continue to monitor this issue. At the same time of the start of the press conference, the US payrolls rapport will also hit the screens. Last month’s better than expected payrolls report caused quite an interesting reaction on the interest rate markets and on the currency market. The dollar at that time gained ground against the euro as it was supported by higher St US yields. However, later last month markets didn’t walk that road anymore. After the disappointing ADP re-port, there is not really a good reason to play this card again. So, by default, one should expect the market reaction today’s data to go again via the reaction on the stock market. Ironically, this might mean that a poor payrolls report might turn out to be good news for the USD dollar.

Global context. During the month of May, EUR/USD performed quite a strong rally as 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 as-cent 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, other hard data mostly were not strong enough to support this thesis. Last week’s FOMC meeting didn’t bring any in-sights 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 dol-lar 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 (cf supra). The ECB poten-tially moving further in the direction of new unconventional measures might, at some point, become a negative factor for the euro, too. 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 construc-tive as long as the EUR/USD pair stays above 1.3739 (Previous reaction high). Last month the EUR/USD currency pair settled in a sideways trading pattern between 1.3739 and 1.4338, we the pair now moving closer to the top of this range. We ex-pect this 1.4338 range top 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 Wednesday, USD/JPY some intraday swings, but at the end of the day the changes were limited. The pair settled in the high 96-area after an early spike in Asia, but there were no follow-through gains, despite a decent stock market perform-ance in European and early in US trading. On the contrary, the pair even lost ground early in US trading (after the disappointing ADP report) and the headlines about China caused the pair to test bids in the 96.25 area. However, in this cross rate there was also no follow-through price action on this item and USD/JPY closed the session at 96.65, little changed from the 96.36 close on Tuesday. Nevertheless, given the positive sentiment on global stock markets, the USD/JPY performance should be considered as slightly disappointing.

This morning, Asian stocks trade mixed (small losses in Japan, moderate gains in China). Comforting comments from China on the reserve currency issue helped the dollar to gain a few ticks against the yen.

Global context. Since March, USD/JPY developed a sideways trading pattern be-tween 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 ex-pect 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, we maintain a cautious buy-on-dips approach.

On Wednesday, EUR/GBP extended the rebound that started after the disappointing Q1 GDP and current account data. The move started already in Asia and continued throughout the session. A better than expected PMI from the manufacturing sector only brought temporary relief for sterling. EUR/GBP closed the session at 0.8581, compared to 0.8524 on Tuesday.

Today, the calendar only contains the PMI survey from the construction sector. However, some other events have market moving potential. BoE’s Besley speaks on macro-economy and quantitative easing and the BoE releases its quarterly credit conditions survey. Any signs that additional unconventional measures might be needed could have a negative impact on the UK currency. At the start of trading this morning, the EUR/GBP pair is coming close to the key 0.8605 resistance area.

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 inves-tors 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 cur-rency. 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. Never-theless, 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 even if we have to admit that sterling showed rather resilient until now. Re-gaining 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. So, players might consider playing this break in case of sustained trad-ing above the 0.8605 barrier.

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Published on  Thu, Jul 2 2009, 08:29 GMT