Forex - Markets Talk of "Contagion" Weighs on EUR

Forex News and Events:

Risk appetite saw slight erosion in the Asian session, with the USD as the principal gainer. Equity markets across the region were weaker, with the Hang Seng down -1.66%. The heavy tone was not helped by New Zealand, which saw a jump in unemployment data from 6.5% to 7.3% (a 10yr high). Pre-data, markets had been aggressively pricing in RBNZ rate hikes as early as April, but these worrying numbers severely dent this argument. On the figures, the NZDUSD gapped down to 0.7005, paused briefly, and then took another leg down to 0.6960 (triggering stops below 0.7000). On a more positive note, Australian Retail Sales ex-inflation data for Q4 were slightly stronger, rising 1.1% q/q while building approvals data were also significantly higher, up 2.2% m/m. The retail sales figures suggest that even with the withdrawal of government fiscal stimulus GDP growth in Q4 remains resilient. As we have stated numerous times since the surprise RBA rate decision, we believe the central bank is underestimating the positive momentum in the Australian economy and will be forced to raise rates in March. Tomorrow, the usually dull MPS should provide greater insight into the RBAs thinking. And should the RBA raise its expectations for growth and inflation tomorrow, it will clearly create questions on which of the external factors cited (China, sovereign credit and domestic bank lending) worries the central bank the greatest concern. And also re-instates the market belief in a March hike. In this environment, we believe the AUD should outperform. Yesterday the European Commission approved Greece's fiscal consolidation strategy, however gauging from the reaction in EURUSD and CDS spread the markets (nor are we) were not overly convinced / fooled. In the report, the EC has given Greece until the end of 2012 to trim to budget deficit to below 3.0% of GDP which we see as very optimistic. Since the press conference, the EURUSD has fallen to 1.3835, while Greek CDS spreads continued to widen. But what is even more concerning was the reaction in Portugal and Spain’s CDS spreads which suffered significantly. The move was reminiscing of early Greek price action and quickly fueled “contagion“ speculation. Due to yesterday’s response, we believe the post ECB press conference could contain some serious fireworks. Journalist armed with plenty of details (supplied by the EC assessment) won’t let Trichet just get away with a simple "absurd hypothesis" and generic dismissal of any ECB role in a potential bailout. We see significant event risk around this press conference, with the EURUSD risk skewed to the downside. For a complete analysis of today’s central bank meeting please see the ACM Central Bank Preview

Today's Key Issues (time in GMT):

11:00 EUR Germany: Factory orders % m/m (y/y) Dec (9.8) 0.3 exp
12:00 GBP BoE MPC Bank Rate decision, % Feb
12:00 GBP BoE MPC asset purchase target, £ bn Feb
12:45 EUR ECB rate announcement, % Feb
13:30 EUR ECB press conference
13:30 USD Initial jobless claims, thous (4wk mvg avg) 30-Jan 470 (456) prior
13:30 USD Nonfarm productivity, % q/q saar (y/y) Q4 p 0.3 5.6 (5.2) exp, 8.1 (4.0) prior
13:30 USD Nonfarm unit labour costs, % q/q saar (y/y) Q4 p -5.0 -2.1 (-2.4) exp, -2.5 (-1.4)
15:00 USD Factory orders, % m/m (y/y) Dec 1.2 (3.6) exp, 0.8 (-2.3) prior
15:00 CAD Ivey Purchasing Managers Index 53.0 exp, 48.4 prior

The Risk Today:

EurUsd EURUSD plodded gradually higher at the start of the week, and yesterday managed to overcome 1.4000 resistance setting off a few weak stops;butthe pair only got as far as the 1.4030 supply level before selling interest kicked back in and the pair resumed its ungraceful slump back below the 1.3900 handle. Heavy trading in Asia means we’re almost back to last Friday’s 1.3850 lows, and prior rebound level, but if ever there was a trading mantra to live by it’s that the trend is your friend; and with this bear market vividly in play we would steer well clear of the temptation to take another long punt ahead of Trichet and co later today. Instead we remain poised to sell more EURUSD on any bounces back toward 1.4000, and on a confirmed break of this 1.3850 support would look for a quick visit to 1.3750-60 coincing with the next major support and lower bound of the downtrend channel.

GbpUsd Yesterday GBPUSD gave us the tantalizing rally we had been expecting all week, and those alert enough to take advantage of the bounce to 1.6069 were rapidly rewarded with a GBP collapse all the way back down below 1.5900. Easier than taking candy from a baby. With the outcome of the BoE meeting today by no means clear cut, we prefer to take at least half our profits off the table at this point; this morning’s continuation of the sell-off (to 1.5866 lows so far) is within 15 pips of the Monday lows, and there is likely to be considerable support further down at 1.5833 coinciding with the major 30 Dec low and lower bound of the 2 week downtrend channel. Any rallies are likely to be capped once more by 1.6080, with the 50-day moving average resistance now coming in at 1.6125 which should attract further selling interest. If the BoE surprises the market with an extension to QE and 1.5833 support breaks down, thereafter look for the pair to target 1.5707 (13 Oct 09 low).

UsdJpy After a false break lower through the 1-week uptrend yesterday, USDJPY quickly took out stops through 90.35 (38.2% fibonacci retracement of the rally from 84.83 to 93.77) to touch 90.09. However, despite the short term technical picture favouring a resumption of the downtrend (as highlighted in yesterday’s report), the pair met strong buying interesting ahead of 90.00, eliciting a nice bounce back within the uptrend channel, attracting investors wrong-footed by the break to scramble back into their USDJPY longs. The momentum into the afternoon finally punched through the 91.00 resistance that had represented a major cap over the past week, and currently the pair is sitting just below the upper bound of this 4-week downtrend coming in around 91.15. From here we really need to see a confirmed break (i.e. daily close) above this 4 week downtrend to open up a challenge on the more significant 2.5 year downtrend coming in around 92.00, a development that would firmly shift the bias in favour of a major trend reversal.

UsdChf As we discussed yesterday, the dip lower through the 3 week uptrend line left USDCHF vulnerable to correction lower, and after a quick retest of the back side of the trendline in early Europen trading, the pair dropped rapidly from 1.0570 levels down to 1.0500 support, but much like USDJPY, the pair found bids around the lows and by this morning has staged a strong recovery back above 1.0600. Obviously with the gravity of upcoming risk events (non-farm payrolls tomorrow), it’s a precarious job to be making a call on the long term direction on the pair from here, but in the short term the technicals strongly favour a correction lower. We are currently trading around the major 1.0610 resistance level, with the major 14-month downtrend resistance now coming in at 1.0630, just ahead of the 1.0643 post-intervention highs. That’s in addition to the 14-day RSI already toeing the line of overbought territory at 69 and our stochastic oscillator crossover around the 90 level suggesting a correction from overbought levels is imminent. As such, this one’s sell in our view, but keeping risk light and positions nimble will be key in case the US data makes for a USD surge into the end of the week.

Resistance and Support: