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Sunrise Market Commentary: Currencies

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Dollar in the defensive pre−FOMC, but renewed equity weakness gives the dollar some dynamic

Thu, Nov 5 2009, 08:28 GMT
by KBC Market Research Desk

KBC Bank

On Wednesday, the main event in the currency markets was of course the FOMC meeting that concluded with the publication of the statement at 20h15 CET. However, it seemed that the market correctly anticipated the FOMC decision to keep its ultra-loose policy in place and continued to anticipate keeping rates at these exceptional low levels for an extended period of time. This is intrinsically of course dollar negative as it leaves the US with the most loose policy stance throughout the world and might incite traders to use the dollar as funding for carry trades.

Indeed, EUR/USD which bottomed already at mid session on Tuesday continued its recovery throughout yesterday’s session to trade at 1.4850 when the FOMC was released, up from opening levels around 1.4720. The up-move coincided with stronger equity trading. After the FOMC decision, the pair moved initially somewhat higher touching an intra-high at 1.4909, but equities soon after the decision turned south, which helped the dollar to recover slightly, leaving the pair at 1.4862 in the close, still good gains when compared to 1.4725 close on Tuesday. Overnight, Asian equities are trading weak, which weighs currently modestly on the euro with EUR/USD changing hands around 1.4850.

Today, the eco calendar contains the US Q3 productivity data and the inevitable weekly initial claims, while in EMU the outdated September retail sales are released. The Q3 productivity will be very strong (but that’s also the consensus) while the claims are difficult to gauge, but the trend is still downward oriented. We expect the ECB to keep its statement very close to the previous one, signaling an unchanged policy stance and Trichet to give a dull performance. He might acknowledge that the economy has improved, but in a way that is not relevant for policy and lecture the governments on the need for a fiscal exit strategy. On its exit policy, we don’t expect much new either. The December meeting should in this respect be more interesting, also because the ECB will have the new staff forecast (that should show an upward revision of growth). On the dollar, we expect no news either. Compared to the previous meeting, the trade weighted euro is nearly unchanged and Trichet knows that speaking too much about currencies when one has not the leverage to influence its course is contra-productive. In this respect the ECB meeting probably will be neutral for the EUR/USD pair. We suspect that technicals and equities will be the drivers. Positively for the euro, EUR/USD moved again above the uptrendline, but confirmation is needed (also with a weekly close above following the payrolls. Equities should in theory have profited from the FOMC decision that kept the liquidity spigot wide open. However, in the final hour of trading equities erased all gains. This is disconcerting. The chart (see introduction part bonds) shows that the upmove failed to pierce through the broken uptrendline and left a doji-like candlestick behind. While it didn’t happen on an extreme it might mean that the downward correction isn’t over yet and another selling wave could be waiting just around the corner. So, we are cautious on equities in a very short term perspective and wait for more confirmation about its future direction. While we keep our euro positive view, we are cautious on EUR/USD very short term.

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. Yesterday’s FOMC meeting confirmed that the dollar negative Fed stance will remain in place for longer. Our view yesterday that the EUR/USD downward correction was nearly over is still on track with the pair regaining the uptrend channel a positive. However, the dismal reaction of equities make us a bit wary very short term, but these worries should dissipate after the payrolls when the longer term outlook may be clearer.

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. EUR/USD currently trades again above the upterendline (1.4754) which is a positive. Confirmation is needed and a weekly close above would go a long way in making us more comfortable with new euro long positions. The MTMA at 1.4859 is currently under test.

On Wednesday, USD/JPY had a good run supported by stronger equities. An intraday peak was set at 91.32 on the release of the FOMC statement, but as equities immediately sank, the pair turned south and closed at 90.72, still moderately up from the previous close (90.72). Overnight, equities continued to fall, albeit moderately, sending the pair further down, currently trading at 90.36. These intra-day gyrations don’t change the broader picture a great deal. It seems that a sideways trading range is in formation between 88 and 92.50. The risk appetite/aversion pair is still dominating near term trading. There were no Japan specific factors at play overnight.

Today, the US eco calendar is less interesting with the Q3 productivity figures that should be outstanding and the weekly initial claims where the trend is down, but weekly surprises are a fact of life. The ECB and BoE meetings will be closely followed, but we don’t see them having a major impact on USD/JPY. Equities will remain the most important factor and here yesterday’s dismal reaction on the FOMC statement suggests that another selling wave may be around the corner, which if it happens should help the yen to some gains. However, it will remain trading within a rather tight sideways range.

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 Wednesday, EUR/GBP eked out some, albeit insignificant gains. The pair closed at 0.8977, up from 0.8958 previously. Intra-day, the price action was quite lively and interesting. Sterling started the session strongly and got another shot following a strong October PMI survey. It highlighted once more that while Q3 GDP showed a surprise contraction in growth, the UK economy is also on the mend. So, EUR/GBP dropped to 0.8919, near the post correction lows. However, no break occurred and the pair turned course in lockstep with better equities and rising EUR/USD. This failure to break below recent lows might be an indication that the downward correction might be over. The BoE decision today may be important in confirming or negating that hypothesis.

Today attention will focus on the BoE and ECB meetings more than to the UK production or the EMU retail sales data. From the ECB we don’t expect too much new info. Just like in October, the ECB may be pleased with the status quo. It is only in December that the debate inside the ECB will heat up and the ECB will have to come with decisions about the fate of its emergency liquidity measures introduced in the crisis.The meeting of the BoE may have more market impact as a decision is expected on the extension of the QE (currently worth £175B). It is probably a finely balanced decision. The dataflow has been disturbing. Indeed, the Q3 GDP report showed an unexpected prolongation of the recession in Q3 (-0.4% Q/Q) which is at odds with the timelier monthly data that pointed to a small increase of GDP. Analysts are predicting an extension of QE by a 3-to-2 margin according to a Reuters poll. Those in favour were evenly divided in their expectation for an extension by £25B and £50B. We think the decision will be either no extension or a £50B one, but the BoE may try to dampen market reactions by making clear that the decision is conditional on future developments.

The market reaction may crystallize between whether the MPC decides to stop its QE, extend it by £25B or by £50B. In the former case, sterling might strengthen and test the downside. An extension by £25B might see EUR/GBP trying to move higher, but the attempt might be short-lived, while an extension by £50B should be euro positive. However, recently we saw sterling making quite a lot of headway and while above mentioned possible reactions seem theoretically okay, we are not convinced that they will be reflected in actual trading. However, at least that will learn us much about the underlying sentiment. We also have learned that the BoE at critical junctures for sterling (when it strengthened) came out with apparently innocent (but sterling negative) comments. This makes us think that chances are more than even they will announce an extension of QE.

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 today’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 overextended 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  Thu, Nov 5 2009, 09:05 GMT