On Monday, the return of risk appetite was manifest throughout all markets and by far the overriding driver of all markets: commodities and equities rallied sharply, government bonds sold off and credit spreads narrowed. In the currency market, the usual peck order was respected, with the commodity currencies outperforming all other currencies, the euro gaining against the dollar and the dollar doing the same vis-à-vis the yen.
EUR/USD started the day under downside pressure as follow up selling of the greenback in Asia occurred in a quiet market. However, equities turned higher already in Asian trade and so EUR/USD found a bottom at 1.3424 a new ST low. However, it took EUR/USD until well in the US session to break above the 1.3495 previous closing level. The euro sell-off on Friday apparently had sapped traders’ confidence in the euro. However, US equities continued to rally, eking out gains of about 3%, the biggest daily gain in several weeks, albeit in moderate volumes. So EUR/USD gradually caught a better bid, ending the session at 1.3561, a 66 tick’s gain compared to Friday’s 1.3495 closing level.
In EMU, the March trade figures showed a second monthly rise in exports (and imports), suggesting that the steep decline in trade has been slowed or stopped, while in the US, the NAHB survey (sentiment homebuilders) showed a further (relative) improvement in sentiment of homebuilders, albeit from rock-bottom levels. While these indicators support the view that the worst of the worst is over in the global economy and thus might have bolstered risk appetite, they weren’t very influential in explaining the market moves. Some strong corporate results (Lowe, homeimprovement retailer) and an upgrade of analyst recommendations on financials (BoA) together an ongoing drop of Libor rates and supporting comments of Geithner were of more importance. However, beside the overall sentiment technical factors shouldn’t be downplayed too. Last week’s correction in US and global equities convinced apparently investors at the start of the week to re-enter the market on fear that they might miss the next rally. The ability of the S&P to avoid a drop below the technical important 875 level on Friday might have played a role too. While it is early days and volumes traded weren’t spectacular yesterday, equities might now go for a test higher with 930/943 and 990 (8 May high/January high/downtrendline from top) a very important resistance area that if broken would suggest the bear market is over. It will certainly play a central role in currency markets too.
Today, the eco calendar is still relatively thin, even if yesterday’s price action shows that this doesn’t preclude interesting price action. In EMU, the German ZEW economic sentiment index is expected to have increased further. While the markets sometimes ignored the release, last month it did play a role in markets. In the US, the Housing starts & permits for April are expected to be slightly up following a steep decline in March. Following a positive NAHB survey, it is tempting to put the risks on the upside of consensus, but the lower permits in March may point to a disappointment in April’s starts. The speeches of Fed Stern and ECB Tumpel-Gugerell and Kranjec are probably neutral for EUR/USD. So it might again be equities that set the tone for trading. There might be some profit taking in equities, but overall we think that EUR/USD will remain range-bound Nevertheless a break above key resistance at 1.3738, not our favourite scenario short term, may accelerate the ascent of EUR/USD. The ST outlook remains euro positive as long as the pair stays above 1.3404 (broken 200 day moving average). The longer-term outlook remains euro positive as long as above the 1.2886 level (April low).
Global context. Over the previous months, currency markets were driven by various factors, but the swings in risk appetite/risk aversion were the dominant ones. Bad news was often dollar supportive. The euro received a better bid when investors turned more risk-minded. This pattern was a few times interrupted by Central Bank initiated swings that were only temporary in nature though. At the end of April, the euro even performed a nice rebound, supported by better than expected EMU sentiment indicators and ongoing equity strength. Longer-term, the execution of the quantitative easing policy in the US remains a risk factor for the US bond markets and for the US dollar. EUR/USD sentiment is affected by several conflicting influences, but recent euro gains are encouraging. The more gradual ECB approach on quantitative easing compared to the BoE and the Fed is a LT supportive factor for the single currency. However, technical considerations made us think that the EUR/USD couple needed some consolidation/correction following recent gains and on Friday we were served well. The gains yesterday don’t change the broad picture.
On Monday, USD/JPY at first tested the downside, but as equities turned higher later in the day the pair took off too. It seems that the 6 day fall in the pair associated with weaker equities is over for now. That down-move threatened to break key support level that would have opened the road to far stronger yen levels. For the moment, it seems that our view of range-trading, recently under pressure, is still justified. Return of risk appetite is of course the obvious reason, but there is more behind it (see below). SO after USD/JPY set a new ST low at 94.55 in yesterday’s overnight session, the pair started to inch higher, ultimately closing the session at 96.30, a daily gain of slightly more than 1 yen. Overnight, the pair held on to a sideways trading range.
Moody’s downgraded the Japanese external debt rating to Aa2, while it lifted its domestic debt rating to Aa2 from Aa3, effectively bringing both ratings at the same level. As Japan has no meaningful external debt and a huge pile of reserves of nearly $1T, its downgrading of the external debt rating is a bit odd, but not significant unless from a PR point of view. In terms of sentiment, it is negative though. Similarly, for the first time in quite a while, Japanese officials started jawboning about the yen strength. Vice Finance Minister Sugimoto said that excessive moves in currencies may hurt the Japanese economy. The Japanese are of course worried about the yen strength as the economy is in a still deeper recession than other major economies. Japanese Q1 GDP will be published tomorrow. To stress his warning, he added that they’ll continue to monitor currency markets. Such comments may of course influence traders that want to buy yens for dollars.
Global context. Over the previous months, the yen lost part of its safe haven status as markets grew more concerned on the Japanese economic performance. Nevertheless, an improvement in global investor sentiment in March supported a second USD/JPY up-leg and the pair tested the key 100.55/102.20 resistance area. Sustained gains beyond this area proved to be difficult and a technical correction sent USD/JPY to a 95.63 reaction low at the end of April. A renewed dollar rally failed to breach the previous highs and caused dollar selling this week that took the USD/JPY pair to a 94.55 level overnight. The key support level was extensively tested recently with a new ST low at 94.55, but reaction occurred bringing the pair again in the range. A bullish engulfing pattern on the charts suggests that the pair might again move higher in the range.
On Monday EUR/GBP and EUR/USD went their separate ways. While the dollar lost against the euro on increased risk appetite, sterling extended its two day rally. The pair closed at 0.8835 versus the previous close at 0.88928. We didn’t see the specific driver behind the strengthening of sterling yesterday morning. Later on trading developed in a sideways way.
The EMU calendar contains the German ZEW while in the UK, the CPI is scheduled for release. In other countries we saw recently quite some surprises on the upside, especially for the core CPI. This was true for the UK last month. Higher inflation is sometimes a support for the currency as it may incite the Central Bank to be tighter/less accommodative in its policy. Of course, we are currently in a special situation, making us less confident about the market’s reaction to an eventual upward surprise. We put forward range trading in the 0.8765 to 0.9156 range at the start of the week and stick to this. However, the technical picture is interesting as the pair is nearing again an important support area. A break below our range (0.8765) would paint a double top formation on the charts and open the way for an eventual test of the 0.8663 level, which is really key and if broken changes the longer term outlook in favour of sterling. Such a break cannot be ignored.
Global medium term context. After a forceful rebound in March, EUR/GBP was captured in an ongoing downtrend. At some point, it even looked as if the pair was heading for a test of the key 0.8637 area. However, mid April, the sterling rebound ran out of steam (Reaction low in the 0.8787 area). The UK budget announcement and the weaker than expected Q1 GDP, again brought the fragile situation of the UK economy in the spotlights. However, the subsequent EUR/GBP rebound didn’t show strong momentum and the pair again tested the 0.8787 previous low. In a longerterm perspective, we have been advocating for quite some time that a sustained rebound of sterling was premature. In this respect, we take some comfort from recent price action after the ECB and BoE interest rate decision and the failure to drop below key support. The combination of a rather aggressive QE approach by the BoE and a much more cautious approach by the ECB should continue to give the euro downside protection against sterling, at least in a short-term perspective. We hold on to our cautious buy-on-dips approach. Short-term the pair develops in a sideways trading pattern between 0.8765 and 0.9156 in which we don’t expect a change short term.
