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Sunrise Market Commentary: Currencies

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Currency markets await Central Bank meetings

Tue, Nov 3 2009, 08:09 GMT
by KBC Market Research Desk

KBC Bank

On Monday, EUR/USD had a quite uneventful session that ended with some modest, albeit insignificant gains for the euro which only partly erased Friday’s losses. The pair closed at 1.4775, up from Friday’s close of 1.4718. There were no decisive moves in other markets too, as most markets are eagerly awaiting the outcome of the central bank meetings that will take place this week. The global eco news was generally encouraging with further signs that the manufacturing sector is recovering quite sharply. The majority of economists remain skeptical about the sustainability of the recovery in 2010, dismissing the current boost in manufacturing output as leading only to a rebuilding of inventories. Once inventories are again sufficiently large, they’ll see the absence of final demand, especially consumption as the reason for renewed economic weakness. We are more optimistic and think that the combination of unprecedented fiscal and monetary stimulus, together with the inventory cycle and the stabilization/increase in asset prices will lead to good, albeit not super growth in 2010. Those measures and subsequent growth will start to affect the labour market, giving households enough income to support consumption to some extent.

Intra-day, EUR/USD tested the downside on the news that CIT had asked for chapter 11 protection, but the CIT decision didn’t come out of the blue and the orderly unwinding of the firm shows how far the financial healing has progressed since the panic following the Lehman bankruptcy about one year ago. So, the pair soon reversed course and very gradually moved up during the Asian and European morning session. There was a small pullback in early US dealings and ahead of the US ISM release. The latter was much better than expected and sent equities higher and in a Pavlov reaction EUR/USD jumped higher too. However, equities couldn’t hold on to its gains and when they dropped, EUR/USD slid lower too, almost to unchanged levels but some equity recovery late in the session left EUR/USD with small gains in the close. Overnight, EUR/USD remained upward oriented, but with Tokyo closed for a National holiday, flows are very thin.

Today, the eco calendar is thin and unexciting. The US factory orders might get some attention, but shouldn’t really affect the dollar. There are some ECB members speaking, but with the ECB meeting taking place on Thursday, they shouldn’t bring us new info either. The Fed meeting starts, but the statement is only scheduled for release tomorrow evening. In this context, more sideways trading looks likely.

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 reversing its very 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 (uptrendline) and the 1.4480 level obvious entry points.

On Monday, USD/JPY spiked lower at the onset of trading, as the news of CIT filing for chapter 11 protection spread. However, the spike was rapidly unwound and USD/JPY slid in a sideways range near the 90 level (previous close). In the US session, the pair jumped higher (to 90.70) as equities reacted positively on the strong US ISM manufacturing survey. However, as equities turned south again later on, the dollar gains evaporated, leaving USD/JPY at 90.21 in the close, near Friday’s closing levels. The Japanese market is closed today for Culture Day holiday keeping trading range-bound.

The Australian central bank raised rates by 25 basis points (3.5%) for the second consecutive meeting. The bank left open whether it would raise rates again at the next meeting, but re-iterated that it will phase out the stimulus in a gradual way. The decision was widely expected and some traders may have been disappointed that the RBA didn’t use firmer language. So, a buy the rumour sell the fact reaction pushed the Aussie dollar slightly lower on the decision. However, the move was insignificant from a longer time perspective.

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 Monday, EUR/GBP moved again somewhat higher following a violent correction that started on Monday last week, but showed signs of fatigue as the week drew to an end. Following such a unidirectional move there is scope for a countermovement. So EUR/GBP started the European session on stronger footing, helped by equities holding their composure. The pair traded at 0.9028, up from opening levels around 0.8950, when the UK manufacturing PMI showed an unexpectedly strong improvement in October (53.7), suggesting that while the Q3 GDP crimp was a disappointment, Q4 would turn out to be start of the recovery. Consequently, EUR/GBP turned south re-testing the 0.90 area, but the absence of follow through selling soon pushed the pair back up to the 0.9280 level. Given the steep sterling gains of recent and the upcoming BoE meeting where the MPC might decide to extent its QE, it should be no surprise that traders are cautious to push sterling to still higher levels. Of course, while the EUR/GBP gains are encouraging for euro bulls, the sentiment hasn’t been restored yet. Later in the session the euro gave even back part of its intra-day gains, closing the session at 0.9005 compared to Friday’s close at 0.8944. Overnight, the EUR/GBP traded somewhat stronger again, changing hands currently at 0.9036.

Today, the UK eco calendar only contains the construction PMI, while the EMU calendar is devoid of eco releases and the ECB members expected to speak are bound by the black period that surrounds the ECB meeting. So, the market will be driven by technicals, sentiment and eventual surprise events.

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 Thursday’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 and sustain, the correction might go quite a bit further. The 0.8845 area is the next high profile support.

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Published on  Tue, Nov 3 2009, 08:18 GMT