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Sunrise Market Commentary: Currencies

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Dollar gains ground on euro as equities resumed correction on Friday

Mon, Nov 2 2009, 08:34 GMT
by KBC Market Research Desk

KBC Bank

On Friday, EUR/USD came again under pressure, especially when US equities started to crumble. As usual, stocks were the key driver for trading in the EUR/USD currency pair. European stock markets failed to extend the gains in the US after Thursday’s Q3 US GDP figure. This capped the rebound in EUR/USD, but the losses for the single currency remained rather limited, with the pair holding above the 1.48 mark going into the US trading session. Later on, the Chicago PMI came out much better than expected and the Michigan consumer confidence was revised slightly higher, too. However, this was not enough for equities to resume Thursday’s rebound. On the contrary, investors were disappointed that the eco data couldn’t bring more buyers to the market and equities faced quite a forceful selling wave under the adagio “what cannot go up (on good news), must come down”. Investors were maybe a bit ‘cautious’ going into this week’s heavy calendar, full of important eco data and with all major central bankers deciding on monetary policy. Whatever the reason, unsurprisingly the equity sell-off hit EUR/USD, too. The pair dropped below the 1.48 mark and closed the session at 1.4718, a loss of slightly more than one big figure compared to Thursday’s closing level. The pair even closed slightly below the uptrendline, in the 1.47 area (1.4721 today).

Overnight, there was some negative headline news with the chapter 11 filing of CIT. However, the CIT story cannot qualify as a new, unforeseen development that would open the door for another dismal phase in the financial crisis. We think the financial system is more robust now and can cope with the CIT failing. Of course, prima facie, it is dollar positive via an increase of risk aversion and eventually falling equities. So will it be the trigger for dollar strength? Difficult call. However, the market currently seems to favour our interpretation. US equity futures are up, Asian stocks are down, but less than one could have expected following Wall Street’s freefall on Friday. EUR/USD very early today tested the recent low at 1.4680, but swiftly rebounded at trade currently at 1.4768. Trading is still thin and direction may easily change. However, we see no reason yet to become dollar positive, even if one should stay openminded, especially in case a technical signal pops up (see below).

Today, the eco calendar contains the final European PMI and the US ISM manufacturing surveys. Especially the latter is interesting/important. The market expects a slightly higher ISM and the Chicago PMI, released on Friday, certainly offers hope on an upward surprise. However, other regional surveys pointed towards a (slight) weakening of momentum. Whatever the result though, as illustrated on Friday by the price action after the Chicago PMI, the reaction of the stock markets (thus also of EUR/USD) can turn out rather surprising. Later this week, attention focuses on the policy meetings of Fed, ECB and BoE. As we don’t expect the Fed (or the ECB) to change its ultra-loose policy stance, the dollar may again come under some downward pressure later on. This would qualify the current dollar strengthening as a correction. Of course, for that to happen, EUR/USD should preferably stay above the uptrend line or at the most stay above the previous low 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 ammunition 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 scale down its stimulating monetary policy. Last week, the ongoing building up of USD short positions in step with the stock market rally triggered a correction. However, this correction phase might have entered its final phase.

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 continued 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. We maintain a buy on dips approach with current levels and the 1.4480 level obvious entry points.

On Friday, the USD/JPY resumed its fall that was temporarily stopped on Thursday when equities surged. On Friday, risk aversion was again the key theme and falling equities favoured the yen that strengthened when Wall Street hit the skids in the US trading session. Earlier in the morning, the BOJ policy decision received quite some attention. The bank gave a mixed signal by ending the buying of corporate bonds and commercial paper in December, but it maintained a key funding program until March. We considered this a slightly ‘hawkish’ stance, but without much importance for the Fx market. The mostly sideways price action seemed to have confirmed that view. Later on it was all equities that reigned on the forex markets. So, once again, it looks that the yen is still the currency that behaves most like the safe haven/carry currency in case of more pronounced moves on global markets.

The news about CIT asking for chapter 11 protection from its creditors initially drove Asian equity markets lower, but the tide turned quite rapidly and while intra-day gains are still modest it seems that equities might have a more constructive session probably also in Europe. This is reflected in USD/JPY that spiked lower in early dealings (to 89.20), but has currently erased all losses trading near Thursday’s closing level of 90.09. A similar turn for the better (risk) sentiment) is visible in the Aussie dollar that reversed early losses against the US dollar and trades actually up on the expectation that the RBA will raise rates when it meets tomorrow.

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 Friday, the rebound of sterling continued to lose momentum against the euro following a violent correction in the previous days. There were no UK data and the EMU dataflow wasn’t exciting either. So technical trading kicked in. At first the euro spiked higher but as there was no follow through buying, the market concluded that there was no room for short covering yet in spite of the heavy euro losses in the previous days. After the upside in the pair held, traders tried the downside sending sterling to a EUR/GBP 0.8930 low. However, this attempt had no more success than the earlier move higher and the recent low of 0.8912 was not even tested, leaving EUR/GBP 0.8944, only marginally below Thursday’s close at 0.8958

This morning, the Hometrack housing prices showed the positive development in the housing sector continued in October, but no big deal for markets. Later on the manufacturing PMI release will be closely watched. The market goes for the 50 breakeven level in October, up from 49.5 previously. The risk might be on the upside of consensus, but more important than having the figure right, we are interesting with the reaction of the market in case of a deviation from consensus. Indeed, the sterling rebound is losing momentum and the pair need a fast and sustained move up above the 0.90 level to alleviate downward pressures. The BoE meeting is the key event of the week. We expect the MPC to decide an extension of its QE policy, which would support our sterling negative view that stands currently under heavy pressure. However, it seems that most in the market embrace such an extension, which would suggest that it isn’t the Holy Grail for the euro bulls like us. Therefore, we stay aside hoping for clearer signals about the future direction of the pair.

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 nevertheless attracted the attention. Some observers correctly noted that in contrast to September 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 optimistic on the economy. We were not sure whether such an interpretation of the Minutes was correct and have to wait for this week’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 overextend short positions is not completely worked out. For now we keep a wait and see approach to see how the test of this key support 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, the correction might go quite a bit further. The 0.8845 area is the next high profile support.

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Published on  Mon, Nov 2 2009, 08:39 GMT