Market Outlook

Mon, Feb 22 2010, 13:21 GMT
by Kenneth Broux


The risk of a double dip recession in the UK reared its head this week, with the biggest rise in unemployment in 6 months and steepest drop in retail sales in 11 months underlining the historical tendency of the economy to slow ahead of a General Election. Whilst weak data were repeatedly met by GBP selling, the bigger danger for a negative GBP spiral is associated with the gilt market. In contrast to sterling, negative news on the economy is no longer greeted by a safe haven bid and lower yields, as worries over public finances and a possible ratings downgrade dictate higher risk premia. This could jeopardise the fragile recovery and force the BoE’s hand to eventually resume asset purchases. With the Fed walking the exit strategy walk, worries of a deeper correction in GBP/USD are warranted. Fed chairman Bernanke’s semi-annual testimony, the reaction in China after a weeks’ holiday to the Fed’s discount rate hike, and the reception of Greece’s 10y syndicate (tbc) will impact G10 currencies in the week ahead.


USD

  • December TIC data got greater than usual attention after it emerged that China’s Treasury holdings fell to $755bn from $790bn, the lowest since February 09. Part of the drop can be blamed on the maturing of individual holdings. Though purchases can be concealed through UK and Caribbean based institutions, the data underlines that the peak of China’s Treasury holdings may be behind us. With Japan and the UK/Caribbean stepping into the breach and markets growing nervous about Fed commentary on the unwinding of agency MBS holdings, China’s buying or selling does not need to be bearish USD per se, especially vs the EUR and GBP.

    FX Technical Strategy

  • After three failed attempts, the dollar index finally broke resistance in the 80.60 area and subsequently took out 81.0, assisted by the Fed’s decision to hike the discount rate to 0.75%. Strengthening bullish momentum, supported by higher Treasury yields and a run of positive macro data puts the index on course for a test of the June-09 high of 81.47 followed by 81.90 resistance, the 50% Fibo retracement line.

  • Fed Chairman Bernanke’s semi-annual testimony to Congress on Wednesday/Thursday dominates the week ahead along with $126bn in Treasury issuance. With the FOMC minutes barely announcing changes to the latest 2010 growth and inflation projections, the Q&A over exit strategy and tools to shrink the Fed’s balance sheet will dictate currency flows. The second estimate of Q4-09 GDP is due on Friday (prelim 5.7%).


EUR

  • Fears over the exposure of European banks to Greece and wider concerns about public deficits and contagion from the periphery continue to stalk the single currency. The EU summit and Ecofin meetings got a mixed reception and have not quite helped to assuage worries of how the EU plans to intervene if investor confidence in Hellenic sovereign paper again evaporates.

  • The clearance of 1.35 option barriers in EUR/USD and a tightening in US/ EU 2y spread below 10bp favours a further increase in EUR short positioning. Support for EUR/USD runs at 1.3392-1.34. EUR/USD 1mth risk reversals are closing in on the February 8 low of -1.76. With US economic data for January showing a tendency to surprise to the upside, it is unclear what can stop the bearish EUR/USD trend in the short-term. Our medium-term target is 1.30.

    FX Technical Strategy

  • Talk of a 10y Greek syndicated debt auction next week has been circulating, helping 10y Greece/bunds to tighten a fraction from 335bp to 320bp. A successful auction could help negative EUR sentiment to stall but may not change preference to sell short-term rallies.


GBP

  • A combination of weak macro data and doubts over the path of public finances hit sterling crosses hard and caused fears of a double-dip to flare up. A widening in 10y gilt/bund spread to 88bp testifies to growing nervousness of the investor community on how the Treasury will square the public borrowing and funding circle in the March Budget.

  • GBP hardly got any traction of the 9-0 February MPC vote to pause QE. With the MPC minutes not ruling out a resumption of gilt purchases and the economy still subject to downside risk, sterling could pay a heavy price if speculation of additional gilt purchases intensifies. The simultaneous decision by the Fed to raise the discount rate is an unfortunate coincidence (part of coordinated G7 tactics?) but risks compounding GBP/USD selling if incoming UK data disappoints and the US recovery spreads to employment.

  • With technical trendline support in the 1.5535 area having disappeared for GBP/USD, we have now set our sights on 1.50. Key support is situated at 1.5352, the May-09 high. A growing base of GBP shorts is likely to transpire from the next IMM stats. 1mth risk reversals slipped to -1.6275 on Friday, the lowest since January 4.

  • For EUR/GBP, tight trading ranges remain in place with a bias for a rally over 0.88 to 0.8841, the February 11 high. The 200d MA of 0.8822 acts as key resistance. The cross failed to extend above the 200 d MA earlier this month, testifying to the small base of EUR/GBP bulls. Relative performance of EUR/ USD and GBP/USD have kept EUR/GBP in a range, with internal problems in the EU and the UK clouding performances vs the USD. Tentative optimism that a cyclical recovery in the US will lead the EU and the UK bodes for fairly static price ranges in EUR/GBP, unless investors mark up the risk of a UK rating downgrade or debt problems in the EU periphery escalate.

  • The 2nd estimate of Q4-09 GDP is the highlight next week, along with GfK consumer confidence, Nationwide house prices and BBA mortgage lending. The consensus is for an upward revision to GDP to +0.2% q/q vs +0.1%. The data should have only a marginal impact on GBP crosses, unless GDP is revised down. The DMO will auction £3bn of 3.75%, 2019 gilts. The previous 2019 sale was covered 2.38 times, but that was with GBP/USD trading at 1.63 (January 21). MPC governor King and committee members will testify on the latest Inflation Report.


JPY

  • Net JPY outflows rose over the latest MoF reporting week, with net purchases of overseas securities by domestic residents complementing net Japanese securities sales by non-residents. This resulted in net JPY outflows for a 5th week in 6. The BoJ kept the overnight target rate at 0.10% on Thursday and left the economic assessment unchanged.

  • A rally in the S&P 500 over 1,100 and a widening in US/JGB spreads, led through the 10y part of the curve, provides good support for the rally in USD/JPY through 92.0. Key resistance runs at 92.27, the 200d MA. A seasonal bounce in late February/March has occurred more often than not in the last 10 years and will fuel optimism for a rally back up to the January highs around 94.0. A pullback in stocks favours a return to 90.25 support. Watch progress for the S&P 500 vs 1,108, the 50d MA.

  • For EUR/JPY, range trading around the 21d MA of 124.50 looks set to continue following the break of trendline resistance at 122.61. Fears of contagion in the EU periphery and subdued EU yields should keep EUR/JPY capped around 125.0

  • Japanese macro data next week includes January CPI and industrial output. For the Nikkei-225, failure and subsequent reversal below the 50d MA (10,381) favours a return to 10,000 where buyers should emerge.


CAD

  • Heavy GBP selling dragged GBP/CAD below 1.62 to the lowest level since 1985. A retracement towards the 1.50-1.60 zone is on the cards if bearish sentiment continues to engulf sterling. A straight decline of 11 big figures since January 27 (1.7288) puts the pair on collision course with 1.60.

    FX Technical Strategy

  • USD/CAD has held up surprisingly well around 1.05, with positive Canadian rate differentials and volatile crude oil prices helping the CAD to extend this month’s outperformance in the G10. A narrow trading range around 1.05 mid-point remains in place, keeping the cross rangebound between 1.0398 and 1.0781, descending trendline resistance.

  • There are no data releases from Canada next week. The S&P TSX is up 5.5% in February, outpacing the FTSE 100 (+2.6%) and the S&P 500 (+3.1%). Could Canada’s opposition to a global bank tax (G20) be a boon for the CAD? See http://www.financialpost.com/story.html?id=2583353 for more details.


AUD

  • The prospect of an RBA rate increase in March and resilience in equities are giving the AUD support in the 0.89 area, though conviction to push AUD/USD to the 100d MA at 0.9069 remains light.

  • Hawkish comments from the RBA in the past week along with heavy EUR selling helped EUR/AUD to extend below 1.51. Unless equities reverse, we look for the bearish EUR/AUD trend to remain intact, though a narrowing in speculative AUD longs vs EUR shorts (IMM positioning, see chart) urges caution against a relief bounce. Medium-term, diversification flows from EUR into higher yielding AUD favours further downside in EUR/AUD.

    EURAUD

  • RBA deputy governor Battellino speaks next week and is the highlight of a light economic and event calendar. How Chinese equity markets open after the Lunar New Year holiday and their impact for commodities may dictate near term performance of AUD crosses ahead of the March 2 RBA meeting. Gold has to break $1,123 trendline resistance to keep bulls on side.


SCANDIES

  • Weaker than forecast Q4 GDP data from Norway pushed forward expectations for the next rate hike by Norges Bank from March to May, triggering a sharp decline in NOK/SEK to key technical support in the 1.2150 area. This level has proved critical in the past and coincidentally, 1.2160 corresponds with the 200d MA. A narrowing in NO/SE bond spreads aside (see chart), Swedish Q4 GDP data on March 1 may prove critical to near term direction.

    FX Technical Strategy

  • For EUR/SEK, further selling dragged the cross to below 9.80 and two standard deviations (lower Bollinger band) from the 20d MA (10.0592). With conditions looking technically oversold and the Swedish data calendar thin, we look for the cross to track equities and relative performance vs the USD in the week ahead. The EU/SGB 5y spread bounced off -49bp to - 41bp, backing up a relief bounce in EUR/SEK. Resistance is situated at 9.90.

  • Norwegian unemployment is due next Wednesday but should not play a major role in the near-term direction of NOK crosses. June FRA’s dropped 7bp this week to 2.48% the lowest since December 11. Direction of USD/ NOK will be dictated by Bernanke’s testimony and expectations of the next step in the Fed’s exit strategy. USD/NOK rallied through 6.0 this week and could line up a run at 6.0447, the February 5 high. Charts look technically bullish for USD/NOK and support our medium-term target of 6.20.