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FX Technical Strategy

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GBP/CAD target of 1.75 was hit this week

Wed, Nov 18 2009, 11:46 GMT
by Kenneth Broux

Lloyds TSB Financial Markets

Market Outlook:

A rebound in risk appetite from a late October wobble has set the stage for the remainder of Q4. An eight-point drop in the VIX along with the G20’s omission of currency commentary in the 7th November statement along with a clutch of strong Chinese economic data cleared the way for a resumption of pro-risk strategies, squeezing the USD index below 75.0 - our medium term target. Over the coming week, we favour long JPY and short EUR strategies ahead of US President Obama’s visit to China and market speculation of yuan appreciation. Weak US economic data over the week ahead, including November consumer confidence and October retail sales, could challenge bearish USD scenarios. With the Fed standing by its commitment to keep interest rates low for a long period, we think the threat of follow-through USD buying is still remote. For GBP, with the November MPC decision and BoE Quarterly Inflation Report out of the way, we count on stronger October CPI and retail sales data, and the MPC minutes to trim this week’s BoE induced losses.

• USD

  Selling USD rallies is the preferred medium-term view as volatility falls and risky assets resume their upward run. The 4th November FOMC statement reiterated that interest rates are likely to stay low for a long period and with no immediate narrowing in prospect for G10/US rate differentials, USD gains are likely to be short-lived.

  Risks of a short squeeze and USD bounce are associated with flight-toquality and verbal G10 central bank intervention to slow USD depreciation (though G20 finmin meeting steered cleared of commenting on currencies). US/China summit rhetoric may support the USD.

  Michigan consumer confidence for November is due on Friday and may show a second successive drop following a weaker IBD/TIPP survey. A busy data schedule next week also features October CPI, retail sales, industrial output and TIC flows (China/Japan still buying Treasuries?).

  This week, the USD index fell below the 21 October low of 74.94, piercing support at 74.90. Our next objective is for a decline towards long-term trendline support situated just below 74.0.

• EUR

  Our core strategy is still of buying EUR/USD on dips based on the flat long-term US interest rate profile. However, US President Obama’s trip to China next week along with chart-based technical signals call for a cautious set-up. Speculation that China could decide to take another small step towards more currency flexibility favours downside for EUR crosses.

  For EUR/USD, a decline to the lower end of the four-week trading range cannot be ruled out following this week’s pullback below 1.49 from the 1.5048 high. Key support is situated in the 1.4810 area. A visit to China by ECB president Trichet and EU commissioner Juncker before year-end (to be confirmed) may also deflate EUR/USD.

  Flash EU-16 PMIs for November are due next week. A further rise increases the probability of the ECB adding a premium to the next one-year LTRO in December. We also look for ECB data to show a further rise in EU-16 portfolio flows through September. This should keep EUR/USD supported in the 1.48 area.

  For EUR/GBP, failure to consolidate gains above 0.9050 following the BoE QIR and underperformance of EUR/USD vs GBP/USD does not bode well ahead of next week’s UK data releases (see below).

• GBP

  With the November MPC and Quarterly Inflation Report behind us, we look for sterling volatility to ease off gradually after next week. First-tier data releases of CPI and retail sales plus the November MPC minutes are likely to underpin volatility and keep the curve relatively flat.

  For GBP/USD, stronger October CPI data and a unanimous MPC vote for a £25bn increase in QE could be an opportunity for GBP/USD to build a base. The pair managed to recover BoE induced losses in August and September (from lower lows). With risk appetite intact and rate differentials still favouring a weak USD, we look for a GBP/USD bounce back over 1.66. A fall below 1.65 support puts the cross on target for 1.6410 support.

  UK CPI (Tuesday) is forecast to have edged up to around 1.4% in October from 1.1% in September, marking a bottom in the inflation cycle. Higher petrol prices could result in a stronger number. October retail sales (Thursday) may surprise to the upside following disappointing September data and upbeat survey anecdotes (BRC).

• CAD
  
  A reversal in USD/CAD from the 2nd November high of 1.0870 ran out of steam in the 1.0420 area this week as CAD bulls pause for breath. Interestingly, this dovetails with the latest IMM stats which show a drop in CAD long positions to a four-week low.
  
  Positive CAN/US yield differentials and stronger economic data should keep the CAD fairly well supported over the short term, though some clouds have emerged in the commodity space. Crude oil for December delivery tested technical support at $77pb on rising US inventories. Risk of a decline to $75pb looms if support at $76.55 is breached.
  
  Our GBP/CAD target of 1.75 was hit this week. Target to the upside is situated at 1.7614 and momentum on a UK data led bounce cannot be taken lightly if oil prices extend their slide.
  
  Canadian economic data over the week ahead include October CPI, (Wednesday, annual core rate forecast to reach a three-month high of 1.7%,) and October leading indicators (Thursday, average 1.15% m/m gain over the last two months).

• JPY
  
  We favour long JPY positions ahead of the US/China summit next week, targeting a move in USD/JPY back towards the early November low around 89.20. Sell USD/JPY rally up to trendline resistance at 91.0.
  
  Japanese Q3 real GDP (Monday) is expected to show a rise of 3% annualised, up from 2.3% in Q2. Nominal GDP is forecast to stay flat at -0.5%.
  
  Heavy redemptions on overseas JGB holdings and Japanese buying of foreign fixed income paper resulted in net outflows of Y522bn. Overseas investors have reduced JGB exposure for the last five weeks. The latest Japanese positions in US treasuries will be revealed in next week’s US September TIC data.

• SCANDIS
  
  Both the NOK and SEK appreciated against the US dollar and the euro over the past week as the markets returned to a risk ‘on’ stance following the previous week’s jitters. Our strategy of selling into rallies paid off as the NOK and SEK both appreciated 5% against the dollar over the past week. There were similar moves against the euro.
  
  With the PMIs and inflation data out of the way, there is little in the way of economic data in the coming week. Over the medium-term, given the rate hike profiles of both Sweden and Norway, we would expect outperformance from these two currencies. More immediately, however, with a lack of data releases, the currencies will likely be driven by the short-term risk environment. Rate spreads have turned lower again (versus GBP, US & EUR) and with equity markets having continued their upward trend, we look for EURNOK and EURSEK to target 7.88 and 9.96 respectively.

• AUD
  
  Growth sensitive currencies have pretty much recovered from the dip experienced at the end of October. AUD bounced off its upward trend line (from the March lows) and has since continued its upward march making a new high for the year (intra-day high of 0.9370). Economic data has been positive with a sharp rise in the NAB Business conditions index in October (+12 from +3) although consumer confidence was modestly lower. Labour market data released on Thursday was also positive with employment unexpectedly increasing by 24.5k in October (consensus -10.0k).
  
  The latest sets of data would imply a further 25bps hike by the RBA at the December meeting. It does not, in our view, warrant a 50bp increase. The labour market data were strong but much of the rise came from part-time workers. As well as this, the latest Monetary Policy Report by the RBA showed revised forecasts for inflation back within the medium-term target range of 2-3% and then accelerating to the middle of this range after. This would not, in our view, warrant aggressive rate hikes.
  
  We expect AUD to continue to grind higher over the short-term and keep our target of 0.95. We also expect NZD to remain firm versus the US dollar given the larger than expected payout to dairy farmers announced in New Zealand this week. We also favour long AUD/NZD until such time that the RBNZ signal a tightening in monetary policy – unlikely in the near-term given the RBNZ’s attempts to dampen talk of rate hikes.

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Published on  Wed, Nov 18 2009, 12:10 GMT