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FX Technical Strategy

Market Outlook

Tue, Jan 26 2010, 11:43 GMT
by Kenneth Broux

Lloyds TSB Financial Markets  |  View company's profile

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A rebound in volatility follows this week’s breakdown in risk appetite and ongoing sovereign credit concerns, and testifies to the deeper running uncertainties that cloud the outlook for major currencies. The threat of a pullback in equities and commodities to December lows and the first signs of a levelling off in leading economic indicators should keep demand elevated for the USD through safe haven plays, though enthusiasm to go underweight risk may be tempered by the Fed’s January 27 statement on interest rates and MBS purchases and an impressive first read of US Q4 GDP. For GBP, an impressive two-week rally looks in danger of running out of steam as sterling bulls await the first read on UK Q4 GDP before making their next move. The breakdown of confidence in the EUR is unlikely to be resolved soon and the success of Greece’s syndicated fund raising efforts next week could be an important test of short-term performance.

USD

• The DXY has set its sights on 80.0 courtesy of a breakdown in risk appetite an withdrawal of emerging market flows. The 3.7% drop in EUR/USD - the currency pair accounts for 57.6% of the dollar index - boosted the DXY up to rally to 78.8, the highest since last September. A break of 79.0 would clear the way for a rally up to 80.0, the 38.2% Fibo resistance.
  
  
  

• We don’t expect the Fed to make changes at the January 26/27 FOMC meeting to monetary policy or MBS purchase targets. Profit taking on USD crosses is clearly a risk if the statement reiterates that rates are likely to stay low for an ‘extended period’, and this could recharge the pro-risk approach through relative cheapness of USD vs G10 funding.

• However, the breakdown in pro-risk sentiment is set to dominate trends for now an argues for buying USD dips. The prospect of a strong US Q4 GDP number (4% plus) and a anaemic Q4 performance in the euro zone/UK should help USD bulls to strengthen their grip, and negate the more defensive set-up associated with the weak US labour market and Fed’s ZIRP. Strong demand at next week’s US Treasury 2y, 5y, and 7y auctions should help to cement positive USD momentum.

EUR

• Spiralling peripheral euro zone/bund and CDS spreads continue to wreak havoc on EUR crosses and have led to a fundamental reassessment of the near-term outlook. The negative Itraxx Euro sovereign vs corporate spread is likely to deter overseas EUR flows.

• The EU and ECB have reiterated their opposition to direct intervention in Greece. A relaxation of collateral procedures has also been ruled out, meaning that Greece’s success in raising funds is paramount in restoring confidence. Talk of ‘outside help ‘ ((IMF) has been played down by the Greek PM but cannot be ruled out if the decline in the January euro zone PMIs heralds the start of a protracted drop in confidence.

• The correlation of EUR/USD with the S&P has collapsed from over 0.93 at the start of January to 0.26. A comparable drop in late 2008/ early 2009 was translated into a 7.4% retreat in EUR/USD. At today’s price, this would correspond to a fall in EUR/USD to 1.39. Key technical support runs at 1.3812. Stalling appetite in emerging Asia and positioning for a PBoC rate hike following strong Chinese Q4 GDP and December CPI data argue in favour of selling EUR/USD rallies. Resistance runs at 1.4294.
  
  
  

• EUR/USD 1mth risk reversals have dropped from -0.7 to -1.41 (-1.54 the low this week). The December 19 low is -1.59 and could be a natural draw, with levels around -1.75 targeted below.

• Weak monthly EC confidence surveys next week would cause economic gloom to return and dampen optimism about growth prospects in the first half of 2010. CPI is forecast to have accelerated to 1.2% in December from 0.9% in November, whilst M3 money supply growth is forecast to have dropped in to -0.5% from -0.2%.

GBP

• Profit taking in GBP crosses followed the shock UK inflation numbers and has seen GBP/USD retreat below the 20d MA (1.6140), but GBP retain most of its weekly gains vs the NZD, CAD and SEK. We look for GBP to stay well supported in the run-up to the February MPC meeting, though caution against intermediate downside pressure next week on a lagging Q4 GDP performance of the UK vs the US.
  
  
  

• For GBP/USD, a rally from the January 7 low (1.5897) reached a top of 1.6458 following the December CPI report (2.9% vs 1.9%). A Q4 GDP outcome superior to 0.5% q/q is probably required next week Tuesday to protect the pair from a move below 1.60. A weak GDP number ie close to zero would probably see the BoE favour an increase in QE from the present £200bn target and would favour exiting long GBP/USD positions with 1.5897 targeted. 1mth risk reversals reversed after hitting a -0.85 high.

• For EUR/GBP, a completion of the retracement from the October 15 high of 0.9412 entered a final stage as the cross sinks below 0.88. A pullback below 0.86 and extension towards the low of last July around 0.85 is on the cards as confidence deserts the single currency, though could be preceded by a brief spike up to 0.8950. A widening in UK/ EU 2y yields spread through 10bp provides cover for EUR/GBP below 0.88. EUR/GBP 1mth risk reversals hit a 6-month low of 0.25.

• The preliminary Q4 GDP release towers over next week’s release calendar and is pencilled in to show a 0.4% q/q rise. A disappointing 0.3% rise reported by the NIESR presents downside risk to the ONS number, especially if followed by US GDP topping 4% annualised.

CAD

• The 6bp compression in CA/US 2y rate differentials to 36bps and drop in crude oil to $75 provide cover for the USD/CAD bounce through 1.05. With the FOMC set to repeat its ZIRP next week and lower equities supporting steeper yield curves, we look for CA/US rate differentials to reassert a more positive CAD influence (negative USD/CAD).

• The Bank of Canada left its assessment of the economy and inflation unchanged this week and reiterated that the target overnight rate is expected to remain at 0.25% until the end of Q2. The Bank also warned against persistent strength of the CAD and the downside risk this poses for inflation.

• Retail sales data for November are forecast to show a 0.2% drop vs a 0.8% gain in October. IPPI and RMPI data for December are also due, along with the latest monthly read for GDP (forecast +0.3 m/m). IMM positioning stats show CAD bullish-ness near extremes vs the USD though we suspect some unwinding will have taken place this week.

JPY

• Flight-to quality currency flows squeezed USD/JPY through key technical support in the 0.9030-50 area. The unchanged FOMC stance next week may briefly encourage pro-risk theme to resume and argues for a reversal towards 92.0. However, we are heeding the bearish warning signs from global stocks (plus the likelihood of a PBoC rate hike) and look for USD/JPY to remain capped in the near term. Support is situated at 89.0 and 88.40.

• A seasonal flurry in demand for JPY equities is observed since the start of January, with purchases by non-residents of Japanese stocks reaching a 4-week high and net equity flows hitting the highest level since July 2008. Japanese investors have been net sellers of overseas bonds for the last 2 weeks and net buyers of overseas stocks for 8 weeks on the trot.

• For EUR/JPY, downward pressure remains intact below 130 with the pair losing ground and sinking below 128.78 and 126.82 technical support levels, assisted by broad based EUR weakness. A pullback to 125.59, the 50% Fibo retracement looks likely.

• We expect the BoJ to leave the target rate on hold next week at 0.10%. The BoJ will also release its monthly report on the economy. December trade stats are forecast to show a jump in the trade surplus to Y607bn vs Y371bn and could buttress JPY strength.

AUD

• The AUD approaches a critical juncture over the next two weeks. The release of Q4 inflation data on January 27 will provide the RBA with the final input before it decides on interest rates the February 3. A 25bps hike to 4% is priced in but a stronger CPI release could tip the balance towards a more aggressive 50bps move to 4.25%. The consensus is for the RBA CVPI trimmed mean to stay at 3.2% vs Q3 and for the weighted mean to fall to 3.5% vs 3.8%.

• We like AUD/USD higher as a short-term play based on the Fed’s dovish stance but are not blind to downside risk associated with equities and bearish spill-over to pro-risk currencies, gold below $1,100 a narrowing in AUD/US 2y yield spreads (351bp) and flattening of the 3-mth future bill curve. The S&P/ASX index has underperformed the S&P 500 since January 1 (-0.9% vs +0.1%).
  
  
  

• Key support for AUD/USD runs along the 0.8950 trendline, whilst upside targets are pinned along the January 14 high of 0.9335. A move through 0.89 clears the way for a retracement towards the December 23 low of 0.8731. Talk of a big tax levy on Australian miners resurfaced last week, souring pro-AUD sentiment. This could be an excuse to sell AUD rallies if inflation stats surprise to the downside.

• Weekly IMM data shows speculative positions are overweight AUD longs along with the CAD vs the USD. For GBP/AUD, failure at 1.80 and subsequent drop below the 50d MA (1.7892) favours a return towards the 1.75 area, with the fall in gold below $1,100 and weak UK GDP data potentially compounding bearish influence.

NOK & SEK

• USD/NOK perked up over 5.80, motoring through trendline resistance to a 5.8299 high. The sequence of falling highs since last September does not bode well for NOK bulls and argues for a pullback towards the January lows in the 5.60 area. Key support rests at 5.7159, the 50d MA. A breakdown in March Brent below $80 has gathered momentum and now looks poised to extend towards the December low situated at $72.7.

• GBP/NOK hit the upper end of the 4-month trading range but fading momentum in the 9.4350 area and subsequent reversal below 9.36 support bearish calls for a move back towards 9.20, with a move sub 9.20 targeted if UK Q4 GDP disappoints. Key resistance is situated at 9.50. Norwegian December retail sales and unemployement data are due next week.

• USD/SEK: the bullish technical formation of higher highs over the last 4 trading sessions favours a near-term rally up to the December peak of 7.3626. The SEK has been among the laggards in the G10 since the start of the year, shedding 4.4% vs the JPY, 1.8% vs the AUD and 1.1% vs the USD. We target a move up to 7.50 over 3 months.
  

• GBP/SEK: the bouce off 11.29 trendline support on January 11 has seen the cross accelerate to a 11.7428 high. Failure to to reach trendline resistance at 11.82 does not bode well for near-term price action and favours shorting the cross with a 11.35 target. Swedish December retail sales and unemployment data are due next week. The first Riksbank meeting of 2010 is not until February 11.
  
  
  

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Published on  Tue, Jan 26 2010, 12:07 GMT

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