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FX Technical Strategy

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Fed fund futures price a 58% chance of a 25bps rate hike by end of Q1 2010

Thu, Sep 17 2009, 09:14 GMT
by Kenneth Broux

Lloyds TSB Financial Markets

Macro Outlook

A stalling in equity and bond market rallies may shake up some of the principal drivers for currency markets. The market is likely to shift its focus to the US Q3 earnings season and the potential for the G20 to begin discussions regarding the unwind of emergency stimulus and liquidity programmes. Our main pointers over the week ahead are the Fed meeting and the BoE MPC minutes. Mindful of the less downbeat but discounted economic backdrop and of the ongoing frailties in the US labour and housing markets, the FOMC must decide whether to let the Treasury purchase programme lapse at $300bn. The BoE MPC minutes may give us some insight about the probability of the Bank increasing QE above £175bn, though much of the suspense was taken away when governor King testified to the Treasury Select Committee that considerations are ‘ongoing’ for a reduction in remuneration rates on bank reserves. Negative US/G10 libor spreads have increased the attraction of funding exposure in commodities and other pro-risk assets through the USD.

• USD

  Bearish sentiment towards the USD remains unusually high but we suspect short positions could be reduced over the coming week ahead of the Fed FOMC meeting on September 23/24. A decision by the FOMC not to extend Treasury purchases beyond $300bn could give the USD a fillip and set up the currency for a relief rally off the summer lows. Downside risks for the USD are associated with US Treasury supply, though overseas bidding and low tails point to solid demand, and rising commodity prices (principally through gold). Housing starts and building permits for August are due on Friday and could bolster expectations of strong Q3 GDP. Fed fund futures price a 58% chance of a 25bps rate hike by end of Q1 2010.

• EUR

  Momentum vs the USD is most bullish since June and risk reversals favouring EUR calls have been translated in EUR/USD hitting a 2009 high above 1.4650. EUR/GBP broke 0.8845 and 0.89 resistance in quick succession and this could line up a move up to 0.90 as the EU/UK 2y spread approaches 50bps. The German general election at the end of the month and a levelling off in some leading indicators as we approach the end of Q3 could take the shine off the EUR. The 1.6pt increase in the German ZEW index marked the smallest rise since March and could be echoed in the EU-16 PMI’s and German IFO. A smaller CDU/CSU majority at the September 27 election could equally spark profit taking. The ECB will hold its second one-year unlimited Long-Term Refinancing Operation (LTRO) at the end of the month. With the Bank charging no penalty above the 1% refi rate, we expect strong overall bidding for funds.

  

• GBP

  Governor King’s testimony to the Treasury Select Committee removed some suspense ahead of next week’s MPC minutes and dragged 2y gilts yields to a new cycle low of 0.74%. King’s comments that the Bank could consider cutting remuneration rates from 0.50% on bank reserves to spur lending may have shifted the emphasis to negative UK/US rate spreads and could discourage further upside in GBP/USD. Weak average earnings, retail sales and public finances stats this week are likely to keep GBP on the defensive with a move in GBP/USD to 1.64 support possibly triggering a retracement towards the late August/early September lows around 1.6115. Weekly IMM positioning data has been quite erratic recently in signalling short-term GBP direction.

  

• CHF

  We await the SNB announcement at its quarterly monetary policy meeting on Thursday and would be surprised to see the SNB make (meaningful) changes to the June assessment on inflation and GDP prospects. We take the view that the SNB is still determined to intervene to weaken the CHF primarily through EUR/CHF. The cross has been fairly range bound since the start of the month, fluctuating around 1.5150. We look for CHF shorts to be reinstated if the SNB reiterates that it stands ready to ‘take firm action to prevent an appreciation of the CHF vs the EUR’.

• JPY

  USD/JPY is still grinding lower against most predictions, finding support in positive overseas investment flows into Japanese securities and negative US/Japanese libor spreads. The comments by new finance minister Fuji are also supporting offers in USD/JPY below 91.0. According to Mr Fuji, a weak JPY is not in Japan’s interest and FX intervention (to weaken the currency) is not on his radar. Unless the G20 reacts to the USD weakness next week, it is hard to argue against an extension of the bearish trend. A test of 90.0 could spark short covering and squeeze the pair towards the January low of 87.13. We expect the BoJ to make no changes in its economic assessment at this week’s monetary policy meeting. The Nikkei is holding up above 10,000, but we reiterate our concerns for exporters and hence possible underperformance vs other G10 benchmarks.

• CAD

  Verbal intervention on behalf of the Bank of Canada is likely to keep the CAD lagging other commodity currencies like the AUD and NOK. The CAD has underperformed the AUD and NZD by about 2% so far this month. We look for a near-term pullback in USD/CAD to the August low of 1.0633. Beyond that, and barring BoC or G20 statements, a decline towards trendline support around 1.0529 cannot be ruled out. August CPI data on Thursday is forecast to show a rise in headline CPI to -0.7% from -0.9% in July. July retail sales are due next week Tuesday.

  

• SEK

  The SEK continues to trade remarkably well as a result of its association with pro-risk positioning. The resilience of equities, upbeat comments by the Riksbank on the position of Swedish banks with regard to imbalances in the Baltic states and an upward revision to Q2 GDP to +0.2% q/q underpinned the move in USD/SEK below 7.0. EUR/SEK shrugged off the widening in the EU/SW 2y spread to 42bps. A break of 10.15 technical support and bullish SEK momentum could nudge EUR/SEK closer to the August low of 10.0366. August unemployment data is due on Thursday. The OMX is lagging the Dax and FTSE so far this month, gaining just 3.8% vs 6% and 6.6%, respectively.

  

• NOK

  We still favour NOK over SEK on the prospect of widening interest rate differentials but are forced to go with the bearish trend for NOK/SEK at present following failure to breach trendline resistance at 1.1990 and the subsequent pullback below 1.18. Norwegian CPI surprised to the downside for August, registering surprise falls to 1.9% y/y (headline) and 2.3% (underlying). Foreign trade data for August are forecast to show a decline in the surplus to NOK24.9bn. We look for a bounce in NOK/SEK into next week as dealers trim NOK/SEK shorts ahead of Norges Bank’s interest rate meeting on September 23 (forecast unchanged deposit rate at 1.25%). Support runs at 1.1750. USD/NOK sits right on 50% Fibo retracement (5.8617) from the 7.3109 high. USD aversion risks pulling USD/NOK below 5.85 ahead of next week’s Fed FOMC meeting.

• AUD

  ‘In due course’ are the words the RBA used in the September minutes to describe the (likely) timing of a change in monetary policy. This supports our view that the RBA will raise the cash rate target from 3% by year-end. The rally in AUD/USD stepped up a gear overnight on broad-based USD aversion. We reiterate our near-term 0.88 target. August employment data disappointed with a 30,800 drop in full-time jobs (4th consecutive decline), but the unemployment rate stayed unchanged at 5.8% for a 2nd successive month. New vehicle sales for August are due next Monday. Dec-10 bank bill futures have rallied 30 ticks over the last week, paring back expectations of aggressive rate hikes.

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Published on  Thu, Sep 17 2009, 11:16 GMT