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Sunrise Market Commentary: Currencies

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Yen profit the most of renewed turmoil

Fri, Nov 27 2009, 08:58 GMT
by KBC Market Research Desk

KBC Bank

On Thursday, trading was very nervous. The US Thanksgiving holiday only added to global market uncertainty. Headlines on Dubai World, the Dubai state holding that tries to reach a delay in its debt payments of Government caused quite a lot of stress in all markets. However, for us, the impact of this story on currency trading in general and on EUR/USD in particular was not that clear. The dollar stayed close to the year lows in Asia, but regained gradually ground during the European trading session. Initially, the EUR/USD losses were rather contained if put against the 3%+ losses on most European stock markets. However, during the afternoon session, the pair ceded further ground. It is a bit difficult to see whether this move should be considered as a dollar rebound or intrinsic euro weakness. On Wednesday and Thursday morning, some kind of disconnect appeared between EUR/USD trading and the theme of risk aversion/risk appetite. Autonomous dollar weakness due to the recent soft Fed talk apparently had become the name of the game. However, the EUR/USD decline in step with the stock market sell-off later in the session suggests that this paradigm has still a role to play. We don’t make too much out of it yet, but the negative headlines about the budgetary situation and risks in Greece (and its impact on government funding and intra-EMU government bond spreads, see bond part) might have been a euro negative factor too. The sharp decline in EUR/JPY supports the thesis of underlying euro weakness, the price action in EUR/GBP to some extent points in the opposite direction. So, the jury is still on which framework the currency market will adopt to trade to current complex environment. Nevertheless, Risk was again a factor and in thinned market conditions this also caused quite a sharp decline in EUR/USD. The pair struggled somewhat higher in the final few hours of (thin) trading. EUR/USD closed the session at 1.5020, compared to 1.5134 on Wednesday eve. Overnight, the down-move in EUR/USD resumed sending the pair towards the 1.4920 area ahead of the European open.

Today, the US market calendar is empty, as most trading desks will be very thinly staffed. In Europe, the EC economic sentiment indictors are on the agenda. However, the impact on this kind of news on markets will most probably be very limited. The key question will be whether the panic/risk aversion as it became apparent in Europe yesterday will stay in place when the US rejoins the price action. We don’t exclude that the Dubai story was a fine trigger to cause some profit taking on long standing trends in various markets. Tentatively, we feel that it is not the start of a new dangerous phase in the financial markets. The fuss will come down eventually, but probably not for some more volatile sessions. The wall of liquidity should shield us from another catastrophe of major importance. On top of that, how important is this risk theme still for EUR/USD. Will the dollar enjoy for long an eventual prolongation of risk aversion behaviour, as it did in September/ October of last year? We don’t think so, but probably we need more normal market conditions (today is still a day of reduced activity in the US) to make a longer term assessment.

Global context. Already for quite some time, the swings in risk appetite/risk aversion are the main driver for price action on the currency markets. Improving investor sentiment towards risk is still considered a good reason to sell the US dollar. On top of that, 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. Recently, several key Fed members, including Bernanke, obviously refrained from giving such a signal. The opposite was the case. The swings in risk appetite/risk aversion might accelerate/slow the decline of the dollar against the euro. However, the theme of risk appetite/aversion at some point will stop playing its role as a guide for currency trading in general and EUR/USD in particular. Recently, we indicated that this point was coming closer and that the decline of the dollar could become a factor of global uncertainty. Yesterday’s price action didn’t confirm this thesis, but we continue to monitor the situation. In any case, yesterday’s move is not enough to leave our USD negative bias. Much more is needed for that.

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 gradual way. Nevertheless, the corrections, if any, were very limited, too. The pair tested several times the longstanding uptrend line since March, but a break didn’t occur. So, the ST picture remains euro constructive, even as the momentum of the uptrend was waning. Tuesday’s break above the previous was a new USD warning signal but after yesterday’s correction, the pair is again within the 1.4626/1.5064 trading range. We keep sidelined for now.

On Thursday, after the sell-off on Wednesday and yesterday morning, USD/JPY basically held a tight sideways trading pattern rather close to the new reaction low around 86.50/80. Japanese policy makers gave only some soft warnings (watching the market, but no immediate plan to intervene). Nevertheless, this approach was still enough to slow the decline of the dollar against the yen. Markets apparently felt that its approach could change very quickly, for example in case of a swift break toward the 85 mark. So, USD/JPY closed the session at 86.59 compared to 87.35 on Wednesday. However, overnight trading became tricky. Japanese equities opened weakly and USD/JPY plunged fast from 86.40 level to 84.83, in an apparently stop loss driven panicking market. The risk aversion trade and the unwinding of carry trades are clearly back in town. Finance Minister Fujii raised the prospect of a G-7 joint statement and suggested the Japanese government could response to extreme moves. While it reminded markets that interventions were always a possibility, the remarks weren’t yet seen as a signal interventions were imminent. Whatever the case, USD/JPY swiftly turned course towards the 86/86.50 area. However, Asian equities are sliding further down and pressure on the USD/JPY may continue.

This morning, a lot of Japanese eco data were scheduled for release. At the margin they were better-than-expected. The jobless rate fell unexpectedly to 5.1% from 5.3% previously and compared to expectations for a rise to 5.4%. However, the jobsto- applicants ratio was little changed and in line with expectations. The various measures of Tokyo CPI (November) fell less than in October and less than expected. Retail trade was in line with expectations but large retailers’ sales fell more than anticipated. However, these data didn’t affect the market that was jawboning about the global theme of the health of the financial system following the problems surrounding Dubai debt.

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, price action in USD/JPY to some extent 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 as the pair came closer to the 88.00/87.10 range bottom and we were looking for re-entry opportunities in the 92/93 area, an area reached end October. At that point, we advocated re-installing USD/JPY short positions for return action lower in the trading range. We hold on to our bias. Recently, indicated that a break of the key 0.8800/0.8710 support area might be a difficult. So we took profit on USD/JPY shorts at this key support level. Yesterday, the pair dropped below this key support level, making the picture even more negative for USD/JPY. The risks are clearly to the downside. However, from a tactical point of view we don’t feel the need to challenge the possibility of USD/JPY interventions from the BOJ. We still look to reinstall USD/JPY shorts in case of a more pronounced uptick (which might occur in case of interventions).

On Thursday, the news headlines on Dubai hammered sterling as the UK banking sector has a big exposure to this region. So, cable was hit hard and sterling also lost quite some ground against the euro at the start of trading in Europe. EUR/GBP touched intraday highs in the 0.9125/30 area at that time. However, later in the session, the euro faced quite some strong headwinds, too and sterling managed to regain some ground against the single currency. EUR/GBP returned below the 0.9100 mark later in the session. However, the pair still closed the session higher compared to the closing level on Wednesday evening. (0.9090 versus 0.9060). Overnight, in thin Asian sterling trade, EUR/GBP moved again to the 0.9130 area, but currently trades little changed from closing levels.

Today, the UK calendar is empty and US trading desks will be thinly staffed. The EMU eco data are interesting, but shouldn’t draw attention. It will be Dubai, equities and risk aversion that will drive the sterling market.

Global context: Since early August, sterling sentiment deteriorated again as the BoE raised the asset purchase program to £175B. On top of that, BoE’s King kept a dovish tone, indicating 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 and October meetings, the BoE took no additional policy steps. However, the debate on additional QE steps was still ongoing. Nevertheless, a sterling short-squeeze kicked in since mid October, even as speculation on additional QE continued. The November BoE decision to raise the amount of asset purchases (surprisingly) didn’t bring any harm for sterling and reinforced the feeling that the sterling correction might have further to go. From a fundamental long term point of view, we don’t see any reason to turn sterling positive in a context where the BoE is lagging the ECB in scaling down (a much more aggressive) monetary stimulation. However, in a shortterm perspective, we couldn’t ignore the sterling constructive mood/technical picture. This pair dropping below the 0.8900 area was an additional warning signal. However, sentiment changed again after the publication of the Minutes of the November policy meeting as the BoE discussed the possibility of cutting the discount EUR/GBP regained the 0.8900 area and is now well above the MTMA (today at 0.8855). So, the downside alert in EUR/GBP has been called off. A first test of the 0.9060/78 resistance area was rejected earlier this week, but the pair finally cleared this barrier yesterday. If sustained, this would make the ST picture again positive for EUR/GBP. We maintain a buy-on-dips approach for EUR/GBP. However, in the current volatile market environment we’re not in a hurry to rush in.

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Published on  Fri, Nov 27 2009, 09:08 GMT