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FX Technical Strategy

Market Outlook

Mon, Mar 8 2010, 11:10 GMT
by Kenneth Broux

Lloyds TSB Financial Markets  |  View company's profile

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Better than feared US employment data for February accompanied by new liquidity measures in Japan to combat deflationary pressures has reestablished a bid for pro-risk strategies, with a return of JPY led carry trades being touted. A bullish technical set-up for risk assets and commodities, characterized by a move through 5,600 for the FTSE100 and crude oil through $81pb, favours long AUD, CAD, SEK vs JPY strategies over the week ahead. GBP and EUR on the other hand continue to suffer from a growing short investor base and look set to fall further behind the curve vs the high yield an commodity currencies where tightening monetary policies are pursued and where less dovish inflation skews shave become mainstream. Intra-G10 currency variations of correlation with risk assets, interest rate differentials and the SNB meeting will garner close attention next week. For GBP, a shock surge in the February services PMI has diminished the likelihood of a double dip in Q1, though the strength of economic recovery remains highly uncertain. Three MPC members take to the speaker circuit next week, meaning that discussions over the probability of additional QE are set to dictate GBP flows.

USD

• Investor sentiment turned neutral vis-a-vis the dollar index as we move into March, pinning the DXY between 80.0 and 81.0. With equity indices challenging key technical resistance levels, conditions remain in place for high yielding and commodity currencies to rally vs the USD. However, with the CAD accounting for only 9.1% of the DXY, momentum for a rally up to the May 90 high 83.22 remains intact. 

• We believe that the BoJ and Japanese MoF initiatives accompanied by investor scepticism to bid up the EUR, despite a successful Greek 10y bond sale, will help the dollar index to first consolidate and then resume its upward trend. Our long DXY view is formulated through USD/JPY combined with short EUR/USD and GBP/USD strategies. 

• Better than expected US non-farm payrolls data for February boosted US yields, causing rate differentials to improve in favour of the USD. With risk appetite buoyed on the back of the data and supportive of carry trades, we favour long USD vs JPY within the G10, targeting a move up to 92.0. 

• A low-key week for US data features February retail sales and weekly claims. A 2nd successive gain for retail sales ex-cars (f/cast +0.3% m/m) would boost optimism for Q1 GDP, though this could be offset by bigger drag from net trade (Jan trade deficit f/cast -$41bn) The Treasury will sell $40bn 3y, $21bn 10y and $30bn 30yr paper. The Fed is sidelined on Fed funds.

  
  

EUR

• We are doubtful whether positive short-term developments in Greece (supplementary 4.8bn eur in budget savings plus 10y bond sale) have put a floor under EUR/USD. Though conditions for EUR/JPY look more inviting for a relief rally on BoJ/MoF measures, we remain defensive on EUR/USD, targeting 1.3250 near-term. Our bearish view is based on ongoing Q2 refunding concerns for Hellenic sovereign debt and more fragmented FOMC commentary on asset sales and Fed fund policy. With the Greek economy prone to a further setback from indirect tax hikes and anemic demand, we think a further discount in the EUR is warranted. 

• EUR/USD is caught in a 1.3436-1.3839 trading range since early February. Though event risk from the euro zone next week appears low, we believe upside is capped by speculation of a yuan revaluation and further PBoC credit tightening. Moreover, a compression in the 2y bund/treasury spread to 14bp (-17bp since January 29) is set to constrain EUR/USD bulls. Onemonth risk reversals have flatlined at -1.48, hinting at reduced appetite to extend EUR puts. 

• We look for euro zone data to stay overshadowed by swing in EU peripheral spreads and discussions over Greece’s refunding targets in Q2. Strong German new orders data for January (+4.3% m/m, domestic/ capital goods led), suggests Q1 GDP should improve from a flat Q4 performance. However, as the ECB indicated, the likelihood of a change in monetary policy is still remote. German industrial output for January looks set to top the 1% m/m consensus estimate on Monday.

  
  

GBP

• Weakness in GBP/G10 crosses has temporarily abated following the plunge below 1.50 and subsequent rebound in GBP/USD above 1.51 and GBP/JPY above 136. Our near-term bearish GBP view is still conditioned by pre- Budget and pre-election positioning. Record IMM short positioning has been noted and suggests that GBP is looking increasingly stretched. Alas, takin into account historical overshoot above 100k for long GBP contracts , a further accumulation of GBP shorts is possible. 

• We have scaled back the probability of a double-dip recession in Q1 following the strong services PMI (58.4 vs 54.5), but are mindful of overestimating the quality of survey evidence in extrapolating actual GDP. With business investment and the labour market still in the doldrums, the outlook for economic recovery remains uneven. Public spending cuts mean government sector contribution is set to fall back considerably. 

• For GBP/USD, key support rests at 1.4963, the 38.2% Fibo retracement. The ascending trendline puts support below that at 1.4780. To the upside, resistance rests at 1.5356, the 50% Fibo redressment. GBP/USD has moved away from technically oversold conditions (lower Bollinger band), allowing bearish momentum to build. For EUR/GBP, exhaustion of the rally at 0.9150 was replaced by profit taking on the successful Greek 10y sale. We target a return to the 100d MA at 0.8975. The correlation with UK/EU 2y spreads has been poor at predicting recent swings. 

• Speeches by MPC members Barker, Haldane and Dale dominate the UK calendar next week and will allow us to gauge the MPC’s position on QE. Though recent commentary has been of a dovish nature, the context of a strong services PMI and optimism over a recovery in manufacturing may cool optimism over additional asset purchases. With no major data releases scheduled, MPC comments may dictate GBP flows.

  
  

JPY

• The MoF announcement of an increase in the intervention fund by Y5tln to Y145tln from April1 sparked a bout of profit taking in JPY crosses. This was compounded by a report that the BoJ will mull new measures at the March 16 monetary policy meeting to stem deflationary pressures, exhibited in part by the Q4 GDP deflator (-3%). A decision by the BoJ is not expected until the April meeting, but market positioning could cause JPY/G10 losses to deepen and IMM positioning to flip from long to short JPY. With the SP500 near two-month highs (1,035), a return to the JPY funded carry trade does not appear far off. 

• Strong buying last week of JPY securities by non-resident investors and substantial overseas bond redemption flows for domestic investors resulted in a 3rd successive week of net inflows (including money market instruments). We look for speculative IMM positions to turn short JPY, with the number of contracts climbing towards early February levels (19k).

• Instead of a step-up in risk aversion, we observed a bullish knee-jerk reaction in stocks to the US February payrolls data. Aided by the MoF/BoJ initiative, USD/JPY sailed through 90.18, the 50d MA. Follow though JPY selling is likely to occur early next week and should pave the way for a move through 90.67. Our target is for a rally to trendline resistance at 91.63, supported by widening US/JGB rate differentials (2y: 76bp, 10y: 227bp). The 200d MA is situated at 91.98. 

• For EUR/JPY, a rally through trendline resistance at 122.44 marks a reversal from the heavy selling since January. One-month risk reversals have climbed to -1.94 from the February low of -2.77. With concerns about EU sovereign funding lingering in the background, we are hesitant to jump on the EUR/ JPY bandwagon until the cross reaches 125.0. The same strategy applies for GBP/JPY where the rally from 132.03 may not signal more than a relief bounce until we reach key resistance around 139.50.

  
  

CAD

• We are keeping a close eye on the key level of 1.0207 for USD/CAD next week, the October-09 low. A shift in inflation rhetoric by the Bank of Canada and a rally in Nymex crude through $81 attracted solid CAD buying vs G10 currencies. With the Canadian employment data for February still ahead next week Friday, we look for USD/CAD to test a five-month low and rekindle speculation of parity. US/CAN 2y rate differentials broke out of the range and hit a high of 64bp, the highest since October 19. 

• The Bank of Canada moved away from a dovish inflation bias this week, providing the CAD with a platform to rally on speculation of a tightening in the overnight rate in late summer. Following the Bank statement, the February employment report will command close scrutiny on Friday. The consensus is for a net change in employment of 15,000, a third gain in four months. Stronger housing starts data for February are pencilled in for Monday. 

• For CAD/JPY, a rally through the 50d MA (86.52) opens perspectives for a move to the upper end of the 7-month trading range at 90.63. For next week, we target a test of 88.46, the February 22 high.

  
  

CHF

• The SNB quarterly policy meeting is scheduled for Thursday. We look for the 3-month Libor target range to stay at 0-0.75%, and the SNB aiming to keep Libor close to 0.25%. Considering the steady depreciation in EUR/CHF, we expect the SNB to reiterate that it will ‘act decisively to prevent an excessive appreciation of the Swiss franc vs the euro’. Having said this and considering the deterioration in EUR sentiment, targeted intervention in EUR/CHF by the SNB has only had limited success. Sell EUR/CHF rallies. 

• For EUR/CHF, a steady grind lower in early 2010 and extremely tight trading range has kept the cross close to 1.4630 and inside the 1.46-1.47 bands since four weeks. The SNB intervened around 1.46 a year ago so we expect participants to be on high. One-month risk reversals have flatlined at 0.08, marginally favouring EUR calls. This compares with -1.10 prior to the SNB intervention a year ago.

   

• EUR/CHF is down 3.2% since the December SNB policy report, making it unlikely that inflation and growth forecasts will be revised substantially higher for this and next year. The more crucial question for the statement and the CHF is whether the view remains that ‘a risk of deflation remains’. Hints of a more tolerant SNB vis-a-vis CHF strength could trigger selling in EUR/CHF below 1.46. Support rests at 1.4579 and 1.4544.

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Published on  Mon, Mar 8 2010, 11:37 GMT

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