Market Outlook

Mon, Feb 15 2010, 13:15 GMT
by Kenneth Broux

Risk aversion remains very much on the forefront of global currency markets, with sovereign debt jitters and actions/roadmaps to normalise monetary policy in China and G-3 currency regions helping the USD to cement gains. The euro’s woes have been widespread and have caused interesting changes in G10 dynamics, with the SEK notably standing out as one of the best performers against the single currency, along win the AUD. The EU Ecofin faces an uphill task in restoring confidence in the peripheral debt markets next week and it may require the intervention/assistance of the ECB/IMF to arrest the euro’s fall. However, with global sentiment in the single currency tarnished, the risk of broader currency reserve diversification has to be taken into consideration. For GBP, upside CPI risk is likely to be overshadowed by dovish February MPC minutes which could force a breakthrough for GBP/USD below 1.55 if some members on the Committee favoured extending asset purchases.

USD

• Outflows from EUR (57.6% share of the dollar index) and GBP (11.9%) propelled the DXY through our 80.0 target post US non-farm payrolls. Safe haven buying on the EU/Greece crisis has helped the index to establish a firmer footing above 80.50 this week, with a narrowing in most implied US/G10 rate differentials adding support following Bernanke’s comments. Our short-term view calls for a rally to the June 2009 high at 81.466. We look for a move up to 85.0 in the medium-term.

• Fed chairman Bernanke did not signal a shift in monetary policy in his testimony earlier this week, but the roadmap for exit strategy has put in place an additional base for the USD to build gains especially vs the EUR and GBP. The Fed’s base case scenario for rates is unchanged, though reverse repos and a higher deposit rate are set to be deployed to unwind excess USD liquidity when the economy moves into a higher gear. Though the comments were credited for a steepening of the FF curve, we don’t expect rate differentials to become a major driver of USD strength until evidence of a labour market turn is evident.

• The FOMC minutes (and January CPI data) are due next week and should get a fair amount of coverage, knowing that Mr Hoenig dissented at the last FOMC meeting. Is Mr Hoenig’s opposition representative of first cracks in the committee’s unanimity on the outlook for low rates or is Mr Hoenig a lone hawk? Signs of growing divergence may help the USD to stay bid.

EUR

• We see no light at the end of the tunnel for the EUR as the market waits for more details of how the EU plans to resolve the confidence crisis in peripheral debt members. The Ecofin meeting should bring greater clarity over the assistance framework if investor confidence in regional debt markets falters. Greater direct involvement of the ECB may be part of the solution, but may not be sufficient to turn the bearish tide which has engulfed the EUR, despite the resilience of forward-looking economic indicators. A lower outcome for the ZEW/PMI surveys next week would cast doubts over the economic outlook.

• A relief bounce in EUR/USD to 1.3839 has proved short-lived, with negative momentum resuming following the EU summit. We are sellers of EUR/USD rallies and eye a test of key support at 1.35 followed by 1.3487. One-month risk reversals remain bid for EUR puts (-1.60, the recent low is -1.76). Mar- 11 euribor/FF spreads narrowed below 50bp. We look for diversification of EUR holdings to accelerate below 1.35.

• EUR/SEK and EUR/AUD have been among the bigger movers lately with the handling of the EU/Greece crisis and divergent rate trajectories in Sweden and Australia dragging EUR/SEK below 10.0 and EUR/AUD below 1.55. Our near-term targets are 9.75 for EUR/SEK and 1.50 for EUR/AUD.

GBP

• A dovish BoE QIR sparked selective GBP selling this week vs G10 currencies, except vs the EUR, CHF and JPY. The releases of UK CPI and the MPC minutes next week will be key to short-term direction, with evidence of a split vote to a pause QE likely to trigger further GBP selling vs the USD. GBP/ USD has been flirting with a break of key trendline support in the 1.5590- 1.56 area since February 5th. The MPC minutes could provide e breakthrough for a pullback to 1.55.

• For EUR/GBP, a key reversal at 0.8829 (200dMA) on corporate supply and broad based EUR selling squeezed the cross below 0.87. This puts the cross on collision course with key support at 0.8602, the ascending trendline stretching back to June 09. The bearish set-up is supported by a jump in the UK/EU 2y spread to 17bp, but runs against the uptrend in one-month risk reversals (0.53, favouring EUR calls). The Ecofin meeting, UK CPI and MPC minutes will dictate price action into next week.

• A CPI outcome for January topping 3% will prompt a letter from the BoE governor King to the Chancellor but we expect to see limited follow-though GBP buying. The BoE projects CPI to undershoot the 2% target on a two-year horizon. Rallies in GBP/USD should be sold, with momentum building for a move below 1.55.
  
  
  

JPY

• Net JPY outflows fell in the last week to the lowest level since Jan 2, supporting the bounce in USD/JPY from 88.56 back up to 90.13, the 100d MA. We look for positive momentum to carry the cross up to 90.76 where trendline resistance is situated. Negate upside on a reversal in stocks and reduce USD/JPY targets to 89.0. US/Jap 3-mth libor spread remains fairly stable at 0.5-1bp.
  
  
  

• For EUR/JPY, our target at 122.0 got hit, but subsequently ran into support in the 120.70-121.50 area. Moves in EUR/JPY are dictated by flows in EUR/ USD and sentiment vis-a-vis stocks. For GBP/JPY

• Japanese Q4-09 GDP data next week is forecast to show a 0.9% annualised gain (3.5% y/y). A big drop in the deflator, forecast at -2.3% vs -0.5% last, should keep the BoJ firmly sidelined on rates. The Nikkei225 is down 5.5% since Jan 1, underperforming the S&P500 (-5.2%) and the FTSE100 (-4.9%).

CAD

• Following on from the bullish Canadian employment stats released last week, positive Canadian rate differentials have so far managed to neutralise the adverse impact for the CAD of lower oil prices and helped the CAD to outperform in the G10 along with the SEK.

• For USD/CAD, a narrow trading band has been observed since mid- January, keeping the cross rangebound between the 100d MA of 1.0549- and 1.0781, descending trendline resistance. For CAD/JPY, a bounce from 82.39 ran into offers in the 86.0 area. For GBP/CAD, a retracement from the January 1.7288 high pushed the cross below 1.65 to 1.6402, matching the January 7 low. Key support rests at 1.6232. Resistance runs at 1.6912, the 100d MA.

• The newsflow next week from Canada is set to be dominated by January CPI and retail sales data. However, in the context of the latest Bank of Canada statement on monetary policy, we don’t think the data is a major market event per se that will alter the policy outlook. CAD strength remains pretty much on the BoC’s mind and may dissuade participants to push for a return below 1.04.

AUD

• Strong January employment data revived speculation of an RBA hike at the March meeting following the Bank’s surprise pause in February. Following on from the strong data, comments from committee member Debelle and the testimony by governor Stevens next week are high on our event calendar and could be pivotal for the next move, though the close of Chinese market for the lunar new year holiday could keep volumes below average.

• The AUD has demonstrated good resilience to the jitters in debt and equity markets this week, but failure to extend to 0.90 vs the USD suggests the cross may be subject to downside risk. How the Shanghai composite digests the latest rise in the PBoC lending ratio could hold the key for the next move in AUD crosses as we count down towards the next RBA meeting.

• The widening in AU/G10 2y spreads helped AUD/USD to bounce off trendline support at 0.8571, but gains have been capped at 0.8921, below the 50d MA (0.8994). The AUD chalked up good gains vs the EUR on jitters in euro zone debt markets, dragging EUR/AUD below 1.55.

SCANDIS

• The SEK ranked as the best performer in the G10 currency bloc last week as EUR aversion and hawkish Riksbank comments on the SEK and interest rates boosted demand for the SEK. The correlation between EUR/SEK and stocks has completely reversed (see chart), and means the SEK should continue to do well vs the EUR even as stocks falter. We have lowered our near-term target to 9.75 following the break through 10.0, with SE/EU 2y spread at 70bp adding support. Beyond the near-term and with 2y bunds trading below 1%, we look for EUR/SEK to retrace to 9.50.

• A big week for Swedish data releases next week may fuel speculation over the timing of a first rate hike from 0.25%. SGB 2y yields have shot up 16bp since early February to 1.67%, with September FRA’s firming to 0.75%. Headline CPI is forecast to have edged up to 1.0 in January from 0.9% in December. One-month risk EUR/SEK reversals dropped to 0.6875 (favouring SEK calls), the lowest since October-08.
  
  
  

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